These shortcomings are aggravated by the fact that Japanese banks often have to compete domestically against subsidized government firms.

'For most complicated banking products, you wouldn't trust the Japanese banks,' says Kashyap. While Japanese banks are among the largest in the world in terms of assets, they are not world leaders for most product lines. But at a deeper level, Japanese banks have very few product niches where they can successfully compete against global competitors. In basic terms, the problem is that the banks consistently fail to generate enough revenue on their loans and other assets to repay their depositors and cover their operating costs. This lack of profitability represents an important barrier to streamlining the Japanese banking system. Losses are expected to continue for the foreseeable future. Since 1992, banks have recorded losses of approximately 83 trillion yen, including 32 trillion yen in outright write-offs. There is currently little left to be collected from these sources. Until the late 1990s, Japanese banks offset their losses by recognizing capital gains on long-held stocks and land. Banking sector problems also reflect the weakened condition of borrowers, and underlying corporate sector issues must be addressed. The collapse of the Japanese stock market in the early 1990s may receive most of the blame for the current financial crisis, but Kashyap points out that the losses are too large and persistent to be the result of the asset price collapse alone. 'But the amounts involved are a spit in the ocean compared to what we're talking about in Japan.' A Financial System in Disarray

'We are fighting over President Bush's tax cut and whether it should be made permanent or repealed,' says Kashyap. (All subsequent figures will be stated in yen, but can be converted using either of these two methods.) This suggests a transfer of roughly 24 percent of GDP, eight times the size of the U.S. Because exchange rates are so volatile, economists often express this figure as a proportion of GDP, which for the last few years in Japan has been about 500 trillion yen. To put this figure in perspective, one can convert it into dollars, and using an exchange of 120 yen per dollar implies an infusion of $1 trillion. But one way or another, the Japanese taxpayers will end up bearing the costs. This means that fully paying back the depositors will require a transfer from the government, either financed through higher taxes or reduced spending on other programs. The difference between the amount of deposits and the value of the assets of the financial institutions is conservatively estimated to be 120 trillion yen. 'The banks are going to have to shrink and reinvent themselves, but there is tremendous resistance to change.' 'Banks in Japan just aren't very profitable,' says Kashyap. While many of the ingredients for a successful resolution are clear, the financial crisis is sufficiently broad and deep that the necessary institutional changes cannot be initiated or implemented right away. However, each sector suffers from different problems and requires different solutions, all of which impede the resolution of the crisis and increase the cost. In a new article, 'Sorting Out Japan's Financial Crisis,' Anil Kashyap, a professor at the University of Chicago Graduate School of Business, suggests that Japan's banks, insurance companies, and government financial agencies are so closely connected that any reform plan will have to tackle all three sectors concurrently. While much attention has been given to the problems of Japanese commercial banks and their role in these developments, there are equally important problems in the insurance sector and government-sponsored financial institutions, such as the Housing Loan Corporation. After averaging more than 3.8 percent between 19, economic growth in Japan has dropped to 1.1 percent since 1991. In the past ten years, Japan has been hindered by an economic slump of dramatic proportions-including a stock market collapse, a sustained decline in real estate prices, and eventually the first case of deflation since the 1930s. New research estimates that taxpayer liability for the Japanese financial crisis will total at least 24 percent of Japan's GDP.

Death spiral financing