NewsHour Online: Financial Woes -- November 3, 1995

FINANCIAL WOES

NOVEMBER 3, 1995

TRANSCRIPT

Daiwa Bank of Japan has been indicted on 24 counts of felony by the U.S. Attorney's office. The indictment comes only months after one of its leading New York traders lost over a billion dollars. Business correspondent, Paul Solman of WGBH-Boston reports.

PAUL SOLMAN: Last July, senior bond trader Toshihita Iguci of Daiwa's New York branch told the bank's headquarters that he had lost a cumulative $1.1 billion trading U.S. Treasury Securities. But it took almost two months for Daiwa to report the losses to American authorities. Iguci was arrested and eventually found guilty of fraud and embezzlement and Daiwa's president and chairman in Japan both resigned.
MARY JO WHITE, U.S. Attorney: (Yesterday) The Daiwa Bank, Ltd., one of Japan's largest banks, has been indicted on twenty-four federal felony charges.
PAUL SOLMAN: But that wasn't the end of the scandal for the Japanese bank. Yesterday, U.S. Attorney Mary Jo White announced a 24-count criminal indictment against Daiwa on charges of conducting a massive scheme to cover up Iguci's illegal actions. And the Federal Reserve gave Daiwa 90 days to stop doing business in the United States. Without admitting any wrongdoing, the Daiwa Bank accepted the Federal Reserve order to leave the country, but the bank said it would fight the criminal charges denying any illegal cover-up. Daiwa's crisis comes at a time of increasing concern over the stability of the Japanese banking system. Last September, news of the bank's huge trading losses raised concerns that other Japanese banks were hiding similar problems. The government's Bank of Japan said yesterday that the Daiwa case was unique, but there was concern among Japanese officials that the criminal indictment of Daiwa would put the entire Japanese banking system on trial.
PAUL SOLMAN: Now for some analysis of the Daiwa case and its larger implications, Michael Bradfield, who was general counsel at the Federal Reserve from 1981 to 1989, he's now an attorney in Washington. Hugh Patrick is the director of the Center for Japanese Economics & Business at Columbia University and joins us from New York. Gentlemen, thank you both for coming. Mr. Patrick, what's the real story here? I mean, is this simply a case of yet another rogue trader, as we've heard a number of times in recent months, or is something bigger going on?
HUGH PATRICK Columbia University: Well, I think it's a case not only of a rogue trader but of a deliberate cover-up attempt by the senior officials of Daiwa Bank. It is an outlier case. I don't think it's going to lead to the financial crisis or something of that sort in Japan, but it really does indicate the nature of the problems that many Japanese banks and other banks have in dealing with their internal controls.
PAUL SOLMAN: Mr. Bradfield, what exactly did the regulators do? How unusual was it, and why did they do it?
MICHAEL BRADFIELD, Former Federal Reserve Official: What the regulators did was to order Daiwa to close its branches, agencies representative offices, and they have--also have a trust company in New York, and that was also closed. And this was a joint action by the Federal Reserve, and the federal regulators, and the state regulators that are involved. The closing of the bank and its offices in the United States is a very serious action by the Federal Reserve. It is not unprecedented, but it's the first time that the Federal Reserve used authority to close an institution under legislation that was passed in 1991. There are cases--the National Mortgage Bank of Greece, the National Commercial Bank of Saudi Arabia, of course, BCCI, and all those cases, the bank was asked to leave after committing various violations of law.
PAUL SOLMAN: So it's a big deal. But why should we ordinary citizens care? I mean, if the Daiwa Bank were to go under, would it have implications for the United States financial system?
MR. BRADFIELD: I don't think there would be any implications for the U.S. financial system. I think there certainly is concern about the international financial system, i.e., for the national system in the U.S. has no serious implications. It does have implications for the broader international financial system, and that needs care and attention.
PAUL SOLMAN: And what exactly do we worry about when you say it has implications? What is the implication? What should we be worried about?
MR. BRADFIELD: Well, I think as Mr. Patrick pointed out already, there are concerns about the Japanese banking system in terms of the losses that they've sustained from real property investments that had been made in the 1980's. And now there's the possibility that the unfolding of this matter could have effects on confidence in Japanese banks generally. As you probably heard, there is a Japanese bank premium for borrowing in international markets, and there's the general concern that this could have a ripple effect elsewhere. I don't think that that's going to happen, but it's a possibility.
PAUL SOLMAN: The premium means that Japanese banks have to pay more to borrow money now because people are worried about them, there's more risk. Is that what you mean?
MR. BRADFIELD: Exactly.
PAUL SOLMAN: Okay. Mr. Patrick, what's the reaction been in Japan and why?
MR. PATRICK: Well, I think the Japanese, first of all, have been shocked that this bank has taken such a loss and that it was hidden for so long even from the Japanese bank, itself, the sort of rogue operation they never believed would have come about. I think they're doubly shocked by what they perceive to be a very severe penalty of being forced to suspend operations, leave the United States market. I think that was an appropriately severe penalty because the U.S. authorities want to send a very severe signal not to Japanese banks particularly but to the entire financial community, international and domestic, that it will not tolerate this kind of falsifying behavior and bad behavior. So in that sense, I think it was a very reasonable action.
PAUL SOLMAN: But would this have been illegal if it had happened in Japan?
MR. PATRICK: Oh, sure, it's illegal, but the Japanese have a very different style of trying to handle such things. They tend to try to handle things behind the scenes quietly, without great transparency. And the problem that Daiwa Bank had, I believe, is that it didn't understand American regulatory culture. There has--after all, it was operating in the United States. It has to follow U.S. rules. The--a thought that they could somehow hide this and get away with it, or even try to delay is intolerable to the American rules of the game. And essentially Japanese banks, like all banks here, have to play by the American rules of the game. So part of the shock probably in Japan is that the American rules are so different and perhaps tougher, and certainly much more explicit. The Japanese way of handling it would have been quite different.
PAUL SOLMAN: Well, you know, we've heard for years--we used to suggest it actually here on the NewsHour--the one great strength of the Japanese system was Japan, Inc., Japan, Incorporated, you know, where government and the economy were hand in hand and hand in glove, whatever you want to call it. Does this case illustrate the disadvantages of that system?
MR. PATRICK: Well, I never thought that it's been as close a relationship as the stereotype has been. There have been lots of conflict areas. There's been lots of areas of cooperation. The financial system in Japan, like most of the financial systems, is quite regulated. And the relationship between the regulators and the regulatees is fairly close. The style of dealing with the issues is somewhat different, as I say, in Japan. Certainly, they--the Ministry of Finance would not allow and tolerate this kind of situation to be hidden in Japan, but they would handle it in a different way. The timing of the announcement would be different. The nature of the penalties probably would be different and I suspect would probably be less severe than has happened in the United States.
PAUL SOLMAN: Mr. Bradfield, I mean, there are fewer regulators, a lot fewer bank regulators in Japan than there are in the United States, aren't there? I mean, do you think that this would have been tolerated-- not tolerated in Japan, or that the cozy relationship, if you will, contributed to this problem?
MR. BRADFIELD: Well, there are very much fewer on-site regulators in Japan than there are in the United States. I don't think it would be tolerated in Japan. I think that the Japanese authorities would have taken action to, to deal with the problem. They probably wouldn't have taken the same action in the same way. One of the major mistakes, as Mr. Patrick pointed out, is that the Japanese didn't trust the Federal Reserve to--this is Daiwa didn't trust the Federal Reserve to tell them about the problem. If they had told them about the problem, they wouldn't have had the--the same consequences of being forced to leave the United States. They wouldn't have the criminal indictment, but they would have had to change their ways, and they would have had to adopt the measures necessary to prevent things like that from happening.
PAUL SOLMAN: Why is there a criminal action here as well as a regulatory one? Isn't it enough to kick 'em out of the country?
MR. BRADFIELD: Well, when you do certain things to defraud a bank--and there was certainly fraud on the bank--and then to cover up the fraud by submitting false reports to the Federal Reserve, those are criminal violations, and the actions taken are appropriate examples of enforcement of U.S. law.
PAUL SOLMAN: Mr. Patrick, I have a question for you. Can we be sure that there aren't other Daiwas out there?
MR. PATRICK: You never can be sure about that.
PAUL SOLMAN: Well, how sure?
MR. PATRICK: We didn't think there were any more Barings either, but--
PAUL SOLMAN: Well, there haven't been yet.
MR. PATRICK: I mean, these things happen. I regard them as very unusual, and I would doubt that any Japanese large bank is going to have this kind of crisis in the United States anytime in the foreseeable future, if ever. They're going to have other problems, but those have to deal with what's going on with the financial mess in Japan, as has already been mentioned.
PAUL SOLMAN: But what would we be worried about if there were other Daiwas out there? Mr. Bradfield didn't seem to think that there was any great threat to the international system if Daiwa went under. Do you worry that if a Daiwa Bank were to do such fraudulent things that it would go under, that it would really hurt the international system? Banks, after all, owe each other money and have to keep paying each other, and if one of them goes under, isn't that what we worry about?
MR. PATRICK: Certainly, that's what we worry about, but the authorities have said that Daiwa and the other 22 major banks are too large to allow to go bankrupt. In effect, they've guaranteed the loans that have been made by foreigners and by Japanese depositors alike as they try to clean up this mess. Now in the case of Daiwa, it has adequate capital to cover it so it's not a question of it going bankrupt. It's not a Barings case in that sense. But if we had a Japanese bank that was insolvent and was a problem and was a very large bank, the authorities have made it very clear that they would not allow this to become a systemic problem that would lead to the collapse of the Japanese financial system and hence to collapse of the international financial system or problems for it. They've also said they would, you know, cover the loans of whatever the foreign banks have made.
PAUL SOLMAN: One last quick question, if I could, Mr. Patrick. What about the Japanese banking system, itself? We've heard so much about it. How much trouble is it in, and do its problems pose a threat to the U.S. economy?
MR. PATRICK: The answer is it has a lot of serious problems, mainly those of the weaker institutions of all sizes, from very large to very small. It's going to take an infusion of Japanese government money, but I don't think it poses a fundamental problem at all for the United States.
PAUL SOLMAN: And very quickly, Mr. Bradfield, do you agree?
MR. BRADFIELD: I agree with that. I wanted to point out in the question of black hole, are there other problems like this, there have been very major improvements made in policies, procedures, and controls with respect to risk management in the United States over the last four years. And the Federal Reserve has done, I think, a very excellent job working on this problem and making sure that banks have the necessary procedures. And I think the Barings case is an example of the Bank of England being very tough on Barings Bank when it did not take the necessary measures. And this case is another example of the Federal Reserve being very tough on a bank that has not taken the necessary measures to introduce the risk management procedures that are necessary in this modern world of high level of communications and high level of transactions.
PAUL SOLMAN: Well, thank you very much, gentlemen. We'll have to leave it there. Thanks both for coming in.

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