Opening Remarks by Ambassador Thomas S. Foley

Second Annual Summit on Real Estate Finance & Securitization in Japan

May 26, 1999

I would like to thank Frank Fabozzi and the Information Management Network for the opportunity to welcome the participants in this very important forum. The work that the real estate finance specialists represented in this room will tackle over the next several years will be among the most important undertaken by any sector in Japan, as this nation continues the hard work of recovering from financial sector instability and putting the economy back on a sustainable growth path.

Compared to the situation at this time last year, it is obvious that Japan has made considerable progress in slowing the deterioration of the Japanese economy and stabilizing the financial sector. The government has nationalized two of the weakest major banks, and it has injected over $60 billion in new capital into 15 other major banks, while taking a stricter supervisory stance under the strong leadership of Financial Reconstruction Minister Yanagisawa. As a result, the "Japan premium" charged against Japanese banks in the international markets has evaporated, and domestic confidence in the financial system has increased. Now, a number of economic indicators are showing signs of bottoming out, and some indicators are actually moving in a positive direction. Stock prices, for example, have been strong of late, due in part to a wave of foreign buying.

The question that now occupies Tokyo analysts is whether we are experiencing only a temporary stabilization of economic conditions, or the beginnings of a real and sustainable turnaround. To a large extent, I think the answer to this question lies in how aggressive the Japanese government is in the coming months in pursuing policies aimed at simultaneously supporting, and restructuring, economic activity and the nation's financial sector. In order to succeed, and achieve sustained growth, it will be crucial to maintain the momentum of reform. The key now is to both liberalize and liquefy markets, so that entrepreneurs - at both old companies and new enterprises - can accurately identify and weigh risks and opportunities, can gain access to capital, land, and labor, and can once again venture forth more boldly, creating jobs and producing economic growth.

What exactly does this mean? Regarding, in particular, the financial sector and the health of Japan's banking system, I think that Japan's leaders understand very well that is important to go beyond merely stabilizing the financial sector. In order for sustained growth to occur, more fundamental restructuring of financial institutions is required. The recapitalization effort has been critical, but I hope that the Japanese government will also be aggressive in using the leverage created by these injections of public funds to compel improvements in bank management and operations.

Perhaps the most important step for Japan's financial sector, however, will be following through with the permanent disposal of bad assets. Reserving against losses is one thing, but actually selling bad assets into the market - with government agencies hopefully taking the lead - can improve the long-term viability of the banks, help create the right conditions for stability and recovery in the real estate markets, and thereby lead to improved consumer and business confidence. It is very important to increase the pace of real estate transactions, in order to permit property prices to find market-clearing levels, and create an environment where people will no longer feel that they should hold off on buying or selling property. After that, we will be able to see a stronger and more sustained rebound in consumer and business sentiment.

In contrast with this scenario, failure to deal with assets underlying the problem loans may prevent a revival of the real estate market, and sustain the vicious cycle of declining asset and loan values. Holding on to troubled assets leaves a huge weight on the system, constraining the ability of banks to increase lending, increasing the perceived risk of exposure to Japanese banks, depriving over-leveraged borrowers of relief, and leaving large amounts of potentially-useful assets lying idle.

Many other industrial countries, including the United States, have learned in recent years that in order for pro-growth policies to succeed, it is crucial to remove the bottleneck represented by past debts and claims which have not reached final closure. We see it as particularly important that the authorities start to actually sell off government holdings of bad assets.

Important Policy Steps

It is well-known that certain aspects of how Japanese finance, and particularly real estate finance, are organized increase the difficulty of disposing of collateral associated with bad loans. The predominance of recourse lending, powerful tenant rights, the cumbersome nature of bankruptcy procedures, the heavy share of nominal corporate assets which are vested in real estate values, and the limited experience with asset securitization greatly complicate the final and complete disposal of non-performing assets.

Japanese policy-makers have taken important steps to try to counteract these problems. The "Total Plan" initiative announced last spring, and subsequent legislation, have introduced significant changes to Japanese law and practice that will help to deal with some of the impediments to bad asset disposal. Laws have been passed allowing for the establishment of Special Purpose Corporations and "servicer companies," and improving auction and mortgage transfer procedures, for example. There are also plans to securitize bad debts held by the government, and some securitization has begun. But the continued energy shown by Chairman Yasuoka and his group of financial sector experts in the Diet is testament to the fact that more remains to be done.

Important legislation is now being discussed among Dietmembers which will facilitate the settlement of conflicting claims, and provide incentives for lenders to give up recourse rights, and agree to properly-conditioned reductions in loan claims, based on an accurate understanding of the true situation of the borrower. At the same time, it is increasingly important to press forward with the restructuring of corporate debt not associated with real estate, using loan principal reduction or other types of properly-conditioned debt work-outs.

Real estate liquidity measures are also important, including land use deregulation, changes in leasing rules, and changes in real property taxation which emphasize the taxation of land holdings rather than the taxation of transactions and capital gains, while simultaneously improving the credits available for capital losses and lowering the overall tax burden.

It is clear that additional efforts to improve the regulatory framework for special purpose corporations and servicer companies will also be welcomed by asset disposal specialists.

But perhaps the most important change which can be expected in the near future will be a change in the operating philosophy of the private and public institutions which hold non-performing assets. Japan's financial regulatory authorities, I am certain, will keep up their pressure on the banks to recognize and set aside reserves against non-performing assets. But while the banks have now written off many of the non-performing loans on their books, they have not yet moved very aggressively to dispose of these claims, or the assets underlying them. Obviously, a more active Japanese market for distressed assets cannot be created overnight, but we believe it will develop faster - to the benefit of the entire Japanese economy - if banks become more pro-active in disposing of problem collateral. There is a little bit of a "chicken and egg" problem in the market right now, and efforts will be required to get things started. In this regard, the U.S. experience shows that it will be very, very important for the government to catalyze the market by taking the lead in asset disposal, by selling or securitizing the foreclosed properties and bad loans under its control.

The issue of how to protect the interest of the taxpayer in the resolution of bad loan claims is an important one, and I remember very well that this issue was actively debated in the United States, as it is now in Japan. When the U.S. Resolution Trust Corporation chose speed over painstaking pursuit of individual claims and more gradual sales, it did so against the advice of many experts. Yet, in the end, the ultimate cost to the taxpayer was lower than had been expected, and real estate markets rebounded more quickly than many thought possible.

There are several reasons why the protection of taxpayer interest and speedier asset disposal can be consistent. The first is that property assets not in productive use tend to deteriorate in value over time - thus the carrying cost to the taxpayer of postponing disposal is not simply measured by the amount of interest paid. But second, and I think most important, the value to the taxpayer of disposing of bad assets goes beyond the actual revenue that is generated from the sale. Real value for the taxpayer also includes the additional economic activity that is made possible by clearing away the financial logjam. In a real sense, there is a "public good" in creating an active market in distressed assets, and accelerating their transfer to more productive uses.

When our RTC began to sell assets rapidly, no one knew how long it would take for property prices to recover, and many in Japan fear that Japan's real estate recovery might not be as rapid as it was in the United States. This is not a question that I can answer, but I would emphasize that prices are determined by demand as well as by supply, and the view that "there is more to be sold in the future at even lower prices" is a powerful disincentive to buyers. Turning "there is more to be sold later at even lower prices" into "you've got to get in now or miss out" is the key to market recovery.

Finally, I believe that it is important to note that both private and public organizations are capable of servicing the non-performing assets held by government institutions. Our experience in the United States was that private companies did a very effective job of servicing claims in a transparent way, and in a way that reflects the interests of the taxpayer. Fortunately, I see in this room before me a veritable army of potential foot soldiers willing to act as subcontractors and agents in getting Japan's distressed assets market moving more rapidly. Japan certainly has an important advantage in dealing with its non-performing loan problems by being able to draw on the technology and expertise accumulated in other countries in dealing with similar problems. I believe that we may be on the threshold of a major move in this area, which will benefit not only the Japanese economy, but also the entire world economy.

I thank you again for the opportunity to welcome you all to this event.

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