A BRIDGE TO NOWHERE?

 At long last Japan=s government is doing something: it has announced a Abridge bank@ scheme, to eliminate the bad debts from Japan=s banking system. There are still major political uncertainties about the plan - will the legislature actually pass it, and will the government really take on big bad banks as well as small ones? But let=s assume that the scheme actually goes through. Will it save the economy?

The basic logic of the scheme is clear. The trouble with bad banks is that they do not go gracefully out of business. In fact, the usual problem with banks that have lost a lot of money on loans is that they are tempted not to contract but to expand: the owners have nothing to lose, since their capital has already been wiped out, while risky high-yield lending just might put them back in the money. And depositors, who would put an end to this game if they pulled their money out, are usually complacent because they believe (correctly) that the government will always bail them out in the end. So the government should close down banks that are already bankrupt, or close to it; indeed, Japan should have done this at least five years ago.

But simply closing down bad banks can also cause problems, since even a bad bank has businesses that depend on it for working capital and cannot quickly find alternative sources. Hence the idea of a bridge bank: seize a bank from its stockholders, but keep it in existence and doing business, while making a realistic assessment of its assets. Once you have figured out how deeply the bank is in the hole, assign it enough additional assets to close the gap, and sell the recapitalized bank to some new owner. The practice is a lot harder than the principle, but there is enough experience with such things in various countries to show that it can be done. And I=m glad to see that Japan has finally started the process.

But it won=t solve Japan=s broader economic problems - and if the Japanese government thinks that it will, some very unpleasant surprises are in store.

After all, the central problem with Japan right now is that there just isn=t enough demand to go around - that consumers and corporations are saving too much and borrowing too little. Did bad banking cause this problem? Surely not: what a bad bank, like a Texas savings and loan in the 1980s, does is to lend too much (to dubious borrowers), not too little. So seizing these banks and putting them under more responsible management is, if anything, going to further reduce spending; it certainly will not in and of itself stimulate the economy.

The only qualification I might make to this pessimistic assessment is a slightly peculiar point about timing. For the past year or so it has been pretty obvious that the Japanese government would sooner or later crack down on bad banks; and as a result some banks have been slashing their loans in an effort to make their balance sheets look better, so that the regulators will let them stay in business. The resulting credit crunch is part of the explanation of the worsening slump. So letting the other shoe drop - getting the business of seizing and closing some banks over with - will probably help loosen credit. But at best this will get the economy back to where it was a year or two ago - that is, depressed, but not actually plunging. And even to get that much of a good result, the bridge scheme will have to be implemented quickly and forcefully: a prolonged period when nobody knows exactly who is going to be seized will make matters even worse than they are now.

So by all means let=s see those bridge banks built, and fast; but don=t imagine that they represent the end of the road.