No. 28 — July 21, 2000


Weekly Review

--- by Jon Choy

A tsunami of public anger swept aside logical arguments that would have kept troubled retailer Sogo Co., Ltd. afloat, forcing Tokyo to second-guess its decision to support the firm's workout proposal and leading executives of the department store chain to seek court protection from creditors. Some observers say that the decisive role of public opinion in deciding Sogo's fate is a turning point in the restructuring of Japan's economy. In this view, the backlash showed that voters no longer believe in rescuing every name company that is failing. Others analysts counter that the public's ire — while understandable — may have forced actions that may not yield the best long-term solution to the Sogo mess. Although the retailer's decision to file for bankruptcy will halt the debt workout as well as Tokyo's active role, it will not end the controversy about government bailouts.

Like many Japanese companies, Sogo borrowed heavily in the late 1980s to finance a major expansion at home and overseas. When the "bubble economy" burst in the early 1990s and the economy went into a decade-long stall, the retailer was hit by the double-whammy of declining sales and plunging real estate values and became unable to service its debts. In 1999, Sogo executives began feeling out the firm's lenders on the subject of debt forgiveness — a highly sensitive topic because banks still were wrestling at that time with large amounts of nonperforming loans.

With tougher accounting rules in place for reporting FY 1999 business results, however, Sogo's management was forced to reveal the true extent of the company's predicament. In April, the second-tier department store operator unexpectedly announced that its debts totaled more than ¥1.7 trillion ($15.5 billion at ¥110=$1.00), leaving the chain with a negative net worth of some ¥580 billion ($5.3 billion). Sogo executives pledged to work with lenders, including lead bank Industrial Bank of Japan, Ltd., on a restructuring plan. Bankers shuddered, though, when it became clear that Sogo's turnaround plan would require them to take a "haircut" of some ¥639 billion ($5.8 billion) on their loans. Nevertheless, IBJ gained nearly unanimous support for the write-off initiative.

However, executives at just-launched Shinsei Bank, Ltd., which was Sogo's number-two lender when it was known as Long-Term Credit Bank of Japan, Ltd., were doubtful that the deal would put Sogo back on its feet. Rather than risk the blame for torpedoing the workout, they asked the Deposit Insurance Corp. to purchase at face value Shinsei Bank's ¥197.6 billion ($1.8 billion) worth of Sogo notes as per an agreement with Tokyo. The DIC had no choice but to comply. That put the onus of deciding whether to participate in Sogo's recovery plan on the Financial Reconstruction Commission. The FRC quickly decided that an up-front loss of a known amount in exchange for the chance to recoup the balance of the principal over the next 12 years was preferable to letting Sogo fail and accepting a total loss on the notes (see JEI Report No. 26B, July 7, 2000).

The FRC's choice, however, ignited a fire storm of debate. Voters did not understand why public funds should be used to rescue a second-rank department store from its bad business decisions. Some observers warned that the bailout would encourage other major firms with big debt loads to seek forgiveness from their lenders and, perhaps, from Tokyo as well. Others pointed out that Tokyo was engaged in the paradoxical exercise of urging corporate restructuring while at the same time trying to prevent a shakeout of the bloated retail industry.

Politicians scrambled to stake out positions on the issue, with the Democratic Party of Japan and other opposition groups coming out squarely against the use of public funds to assist with the workout. Both houses of the Diet promised to hold hearings, even going so far as to ask former Sogo chairman Hiroo Mizushima to give unsworn testimony. Soon, the Liberal Democratic Party and its coalition partners were discussing ways to alter the government's role in Sogo's rescue.

Shizuka Kamei, chairman of the LDP's Policy Research Council, who told reporters that "taxpayers' money may be injected into a private company only on very limited occasions when bankruptcy would pose a serious threat to the economy," warned Sogo officials in a July 12 telephone call that their restructuring plan "will fail unless it can generate public support and understanding." Executives of the beleaguered retailer got the message, formally filing the same day for protection from creditors in the Tokyo District Court. With a group debt of nearly ¥1.9 trillion ($17.3 billion), Sogo and its 21 affiliated companies easily represent the largest failure of a nonfinancial business in Japan. In fact, their debts approach those of record-holder Japan Leasing Corp. and affiliate Japan Lease Auto Corp., which collapsed in September 1998 under the weight of ¥2.3 trillion ($21 billion) in liabilities.

The Sogo bankruptcy petition is far from the final word on the matter. The aftershocks of the company's collapse will be widespread and long lasting:

More worrisome is the possibility that a backlash against Shinsei Bank will widen into a general condemnation of foreign ownership of major Japanese firms. In recent years, overseas investors have taken full advantage of the fast-changing regulatory and economic environment in Japan, pouring record amounts of money into the purchase of distressed corporations. If voters and politicians make foreign direct investment the scapegoat for the Sogo debacle, it could hurt the country's efforts to restructure its economy as well as create frictions with trading partners.

With the heat of the moment past, many business, academic and government figures are debating the impact of Sogo's failure on financial industry regulation and policymaking in Japan. One point of consensus is that neither banks nor Tokyo was well-prepared for the fast-moving Sogo crisis. Politicians are being attacked for their failure to lead and to explain to voters that public monies still are needed on occasion to deal with the country's nonperforming-loan problems. Washington spent billions to end the savings and loan catastrophe of the 1980s, these critics point out, with a portion of that money devoted to helping firms work out their debts. The FRC's decision to participate in Sogo's restructuring may have made sense in a financial and policy context, but political and government leaders failed to create an environment that would make this decision acceptable. Having caved in to public opinion this time, Tokyo could find it that much harder to do the right thing the next time.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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