Japanese Losses Raise Doubts Over Financial Sophistication

Yasuo Hamanaka made a leap of fame that took away the breath even of hardened dealmakers used to putting hundreds of millions of dollars on the line in a day's work. With one bound he went last week from being the top player on the world copper market to true international notoriety - as the single individual who is charged with losing more money than anyone in the history of financial markets.

His $1.8 billion in losses for Japanese trading giant Sumitomo Corp. far exceed the $1.3 billion loss with which Nicholas Leeson bankrupted Britain's Barings Bank or the $1.1 billion that Toshihide Iguchi gambled away to lose Daiwa Bank its New York license.

There's no danger that Sumitomo, with annual revenues of $150 billion, will go bust. But the already tarnished reputation of Japanese companies for poor management and losses has suffered a new blow. Before Sumitomo's and Daiwa's troubles came a string of smaller but significant losses by other banks and financial concerns in New York and other international markets, not to mention combined losses of more than $30 billion by Japan's 21 biggest banks in the fiscal year that ended in March. Japan's financial houses, including insurance and pension funds, also lost heavily on US Treasury bonds as the yen strengthened in the 1980s.

Some of the losses have been caused by fraud, others by sheer bad management, others simply by an inability to cope with the complexities of modern financial markets. But the simple math is that Japanese financial and management systems are not sophisticated enough for the late 20th century.

Mr. Hamanaka was a highly trusted insider, a career Sumitomo executive who was never posted abroad. He reached the elite position of general manager ahead of his peers, with a smart chauffeur-driven car and a fat expense account. Hamanaka was lauded in Japan and known abroad as the "Mr. 5 percent" of the London Metal Exchange, so named for his share world copper trading. Normally Sumitomo's career executives are shuffled around every three to five years. Hamanaka was head of copper trading for 21 years.

Perhaps, a ministry of finance official speculates, "Hamanaka was trusted by Sumitomo because he had an international reputation and showed that Japanese did not have to consider themselves inferior, but could trade with the grown-ups."

It is not clear yet how the massive losses accumulated, whether by simple miscalculation and stupid gambling or whether fraud was involved and Hamanaka was helping friends. What is clear is that risk-management strategies at Japanese firms are not properly developed.

Precisely because Hamanaka was such an insider, no one questioned what he was up to or imposed prudential controls and checks that would be considered elementary and essential in the West. "Traditionally, all of Japanese business has operated on trust," comments a high-ranking Ministry of Finance official.

But that is only one of the flaws.

Though Japan is generally reckoned to be a modern capitalist economy - except by Japanese specialists - the authorities have never trusted markets. Indeed, Japan has no copper futures markets, despite being one of the biggest players in London and New York. Since Hamanaka did his trading on the telephone, this may raise the specter that whatever he has done may may be outside the scope of Japanese law.

The ministry of finance exercises iron control over financial markets, but not normally through clear-cut laws. Instead, it operates largely by administrative guidance, and sometimes through nods and winks. This system, essentially one of trust and an old-boys' network, worked decades ago. But it does not work today.

This was even apparent 15 years ago, when Japan began piling up record current-account surpluses in international trade. Like lemmings, Japanese financial institutions lent heavily abroad, until the Latin American debt crisis. Then they piled into US Treasuries. There were few domestic financial instruments, because authorities feared to create markets that might undermine their control. Used to a secure world, the Japanese did not hedge against a dollar crash, and lost hundreds of millions.

The problem was also apparent during Japan's "bubble economy" years, when advice from "nanny," the Finance Ministry, was not enough as banks competed to build speculative skyscrapers of property profits. When nanny intervened, its formal instructions to stop lending were disregarded by agricultural cooperatives, which poured money into projects that would have turned profits only if Tokyo's land was worth more than that of all the United States.

The sad lesson is that Japan has to learn to cope with a modern world, through clear rules and regular checks. Otherwise, some other Japanese may soon take Hamanaka's title of loss-making king.

* Kevin Rafferty is author of "Inside Japan's Powerhouses" (Weidenfeld & Nicolson, 1995).