Case study of the banking crisis - Japan's "Lost Decade"

[David Guyatt]

Case study or template? My money is on the latter.

If Japanese bankers succeeded in fleecing their nation's treasury and future, why not the US and Europe?

http://www.economy.com/dismal/article_fr...cid=110621

Lessons From Japan’s Lost Decade

By Nikhilesh Bhattacharyya in Sydney
November 26, 2008

At the close of the 1980s, a collapse in house and stock prices crippled Japan's financial sector, leaving banks weighed down with nonperforming loans.
Attempts to restore the financial sector's health failed and a decade of stagnant growth ensued.
Facing a similar situation, U.S. authorities are shaping their policy response based on Japan's painful experience.
Similar to the recent experience of the U.S., Japan witnessed an enormous bubble in house and stock prices in the late 1980s. Following the bubble's bursting, Japan's banks were left with a large array of bad loans on their balance sheets, effectively crippling their ability to lend and dragging on the real economy for years. Despite massive government spending and interest rates effectively at 0%, the Japanese economy remained moribund; the financial system failed to function adequately and economic growth lagged for a decade.



Many wonder if the U.S. faces something similar to Japan's lost decade, or if a quick turnaround will follow the current recession. Although the future is unknowable, it appears aggressive U.S. actions have the potential to avert a Japanese-style scenario.

Japan’s lost decade
Japan’s credit meltdown began with the bursting of twin asset bubbles. Soaring house and stock prices, combined with financial liberalisation, had encouraged risky lending by the country's financial institutions. Banks outsourced their credit checking to monitoring agencies that reported directly to banks’ sales departments, who had aggressive targets for approving loans. With asset prices booming and credit growth soaring, lax regulation, along with fierce competition amongst financial institutions, led to loans being made against expectations of asset appreciation rather than cash flow. During Japan's bubble years, banks were writing mortgages with elevated loan-to-value ratios—just as during the U.S. crisis. Lending to business was also lax, with some companies able to use stock as collateral to tap bank loans. As house and share prices fell, many loans went delinquent.

To cope with the growing volume of nonperforming assets on their balance sheet, banks issued debt to raise capital and made even riskier loans to try and protect their shrinking margins. Regulators failed to provide discipline, out of fear that some major financial institutions might suddenly collapse. This caused a mild slowdown in credit growth rather than a sharp stop, as banks essentially swept their nonperforming loans under a rug.



What were policymakers doing?

The Bank of Japan and financial regulators were slow to react to the unfolding crisis. Blanket deposit insurance, coupled with a failure to punish poor performers, allowed the spread of so-called 'zombie banks'—institutions that did not go bankrupt, thanks to government guarantees, but were unable to lend because their balance sheets were crowded with nonperforming loans. With many Japanese wary of banks in general, and healthy commercial banks on the same footing as unhealthy ones because of government concerns about a systemic collapse, funds migrated away from retail banks.

A beneficiary of the retail banking sector's malaise was Japan's Postal Services Agency, which took deposits but did no lending. Unlike banks, the postal service was favoured by regulatory standards and enjoyed special treatment from government; while not having to pay deposit insurance, it had an explicit government guarantee, as it was publicly owned. The movement of funds to the postal service put further pressure on credit growth, constraining firms' access to credit and limiting their expansion plans.

Deposit Growth, % change
Retail Banks Postal Savings Agency
1991 -4.80% 14.20%
1992 -6.00% 9.30%
1993 1.30% 7.90%
1994 1.90% 7.70%
1995 3% 8.00%
1996 0% 5.40%
1997 2.90% 7.00%
Source: Bank of Japan
To try to stimulate credit growth, the Bank of Japan cut rates, but very gradually: It took over a decade to get the policy rate to 0%, from 6% in June 1991. Admittedly, it is questionable whether more aggressive moves would have stimulated credit growth, since retail banks struggled to attract deposits during the lost decade, limiting their ability to expand lending. In addition, demand for new loans was hurt by a long period of deflation, which pushed up real interest rates, hurting borrowers.



Just as it took time for the Bank of Japan to move interest rates down, regulatory and fiscal reforms were also tardy; not until 1998 was a comprehensive policy response to the banking crisis proposed. After years of debate over the merit of using public funds to bail out banks, Japan’s parliament passed a massive bank rescue package in October 1998. The package involved ¥60 trillion (equivalent to 12% of GDP at the time) and set aside funds for three major purposes. Nearly half the funds were used to recapitalise banks deemed weak but solvent, while the rest of the package was for the liquidation or nationalisation of insolvent banks and full deposit protection for account holders in these institutions.

Unfortunately, the spending package approved by parliament did not lead to recovery for the banking system. Total spending amounted to only around ¥10 trillion, with most of that being used to prop up ailing institutions rather than to eliminate the zombie banks. Apart from insufficient spending on recapitalisation, the method—which involved attempting to buy bad assets (as was initially proposed for the U.S. under the Troubled Asset Relief Program)—did not identify the problem of insufficient capital and was not aimed at closing insolvent banks.

The lost decade in retrospect

In hindsight, the deposit guarantee and the favourable treatment of the Postal Service Agency were major mistakes. With deposit holders' accounts fully insured by the government, deposit funds were not efficiently allocated towards healthy banks. Institutions with low profitability and poor risk-management structures clung to life—while the non-lending postal service increased its share of deposits at the expense of solvent lending institutions—leading to financial sector malaise that has not completely disappeared.

The financial system’s ill health produced a decade of slow growth and fundamental problems that linger today. Many wonder whether the U.S. subprime meltdown and current global credit will lead to a Japan-style lost decade, or if a quick recovery is possible. Comparing the actions of policymakers in the U.S. now with Japan's during the 1990s, there are some similarities, but the evidence thus far suggests that U.S. authorities have learnt from Japan's mistakes.

Although the U.S. Treasury secretary and Federal Reserve chairman have been criticised, one cannot fault their urgency. Unlike the Bank of Japan, the Federal Reserve has slashed interest rates in the span of months, not years, and zero interest rates appear a real possibility. As was the case in Japan, a main problem with lending appears to be insufficient demand as well as bank reluctance. On this front, government pump-priming will help lead to a recovery in the real economy and promote borrowing.

Quick injections of cash

Curtailing the messy and prolonged public debate that delayed a federal bailout in Japan, policymakers have pushed through measures that have the potential to quickly recapitalise banks. The $700 billion TARP is actually smaller (around 5% of GDP) than the bailout package approved by Japanese authorities in 1998. But unlike Japan a decade ago, U.S. authorities appear to be quickly attempting to recapitalise banks via equity purchases.

Another important lesson is that the U.S. authorities are using some discretion in choosing which financial institutions to support. The Japanese blanket approach of supporting all institutions, rather than letting some fail, did not work. While U.S. policymakers have declared a few institutions too big to fail, they have been willing to let some businesses go. A number of large U.S. financial institutions have declared bankruptcy or merged, while many hedge funds have returned money to investors and ceased operations. Although this transformation has diminished the prestige of Wall Street and the U.S. financial system, the alternative of bailing them out surely would have been a mistake. The experience of Japan’s lost decade is testament to this, and increasingly, U.S. authorities are being forced to practice triage among financial institutions.

It is still too early to tell if the U.S. approach will avoid a prolonged period of financial system ill health and stagnant real GDP, but authorities do not appear to be repeating Japan's mistakes. If the cost of the current painful actions is a brief recession to facilitate financial restructuring, it is almost certainly better that a decade of stagnation amid credit market malaise.

[Magda Hassan]

Lots of talk recently about Japan's debt and the Bank of Japan's moving in to print money big time. Some articles in just the last week from Zero Hedge:

Japan's Debt Crisis Visualized

Submitted by Tyler Durden on 04/04/2013 20:59 -0400


In just a few short minutes, inspired by Kyle Bass, Addogram presents a short visual explanation of Japan's debt problem. In the time it takes Ben Bernanke to print $13.7 million you'll have a deep understanding of Aso, Abe, and Kuroda's impending debt crisis.

Kyle Bass: "Japan Will Implode Under Weight Of Their Debt"

Submitted by Tyler Durden on 04/04/2013 18:41 -0400


As the fast-money flabber-mouths stare admiringly at the rise in nominal prices of Japanese (and the rest of the world ex-China) stock prices amid soaring sales of wheelbarrows following Kuroda's 'shock-and-awe' last night, it is Kyle Bass who brings these surrealists back to earth with some cold-hard-facting. Out of the gate Bass explains the massive significance of what the Japanese are embarking on, "they are essentially doubling the monetary base by the end of 2104."
It is a "Giant Experiment," he warns, but when you are backed into a corner and your debts are north of 20 times your government tax revenue, "you're already insolvent." Simply put, Bass says they have to do something and they have to something big because they are "about to implode under the weight of their debt." For a sense of the scale of the BoJ's 'experimentation', Bass sums it up perfectly (and concerningly), "the BoJ is monetizing at a rate around 75% of the Fed on an economy that is one-third the size of the US!"
What they are trying to do is devalue the currency to attempt to become more competitive while holding their rates market flat - the economic zealots running the world's central banks believe they can live in that Nirvana - and Bass believes that is not the case, as they will lose control of rates, since leaving the zone of insolvency is impossible now. His advice, "if you're Japanese, spend! or take it out of your country. If you're not, borrow in JPY and invest in productive assets." Do not be long JPY or Japanese assets as he concludes with the reality of Japan's "hollowed out" manufacturing industry and why USDJPY is less important that KRWJPY.

Nikkei Soars, Japanese Bond Yields Collapse On BoJ Front-Running

Submitted by Tyler Durden on 04/04/2013 20:19 -0400


If there is one thing the Fed taught the world's investors it was to front-run them aggressively; and whether by unintended consequence or total and utter lack of belief that despite a 'promise' to do 'whatever it takes' to stoke 2% inflation the BoJ are utterly unable to allow rates to rise since the cost of interest skyrockets and blows out any last hope of recovery, interest rates are collapsing. Japan's benchmark 10Y (that is ten years!!) yield just plunged from 55bps (pre-BoJ yesterday) to 34bps now. That is a yield, not a spread. Nothing to see here, move along. Of course, not to be outdone, Japanese stocks (Nikkei 225) are now up 6.75% from pre-BoJ (3% today) trading at 13,000 - its highest since September 2008 (Lehman). But there is one market that is showing its concerns at Japan's inevitable blow up - Kyle Bass' 1Y Jump risk has more than doubled in the last 4 months.





and TOPIX vs JGBs...


meanwhile, in 30Y JPY Swaps...


and the long-end of the JGB curve is clearly getting whacked with technicals (or just simple old front-running on the BoJ's extension) as it is looking very 'deflationary' relative to FX and stocks...


as JGB 5s10s collapses back across its 20 year channel...


JGBs vs Trade Deficit...


and one of Kyle Bass' preferred ways to play Japan - through 1Y jump risk (CDS) - has more than doubled in the last 4 months...


Charts: Bloomberg

Is It Beginning? Biggest JGB Price Collapse In Over 10 Years Triggers TSE Circuit Breakers

Submitted by Tyler Durden on 04/05/2013 00:48 -0400


Just over 4 hours ago we discussed the stunning collapse in 10Y Japanese bond yields. Since then - things have taken a very dramatic turn for the worse for bonds. 10Y JGB yields have exploded higher. The move from 32bps to 65bps triggered circuit breakers on the Tokyo Stock Exchange in JGB Futures trading as JGB prices plunged by their largest amount since September 2002. We can only imagine there is liquidations galore occurring given the massive outsize moves we are seeing in Japanese bonds, stocks, FX, swaps, and CDS. Did the BoJ just lose control?

Now that is a reversal!!


Biggest price drop in JGB Futures in over 10 years


Is the BoJ losing control?

Charts: Bloomberg

Japan's 13 Sigma Bond Swan

Submitted by Tyler Durden on 04/05/2013 14:27 -0400

• Bond
  
• Japan
  
• Nikkei
  

For six months the Japanese jawboning has seen investors front-running the BoJ, selling JPY and buying whatever risk-asset is the most correlated that day - whether it is the Nikkei 225 or the S&P 500. However, now that words have been replaced by actions, it appears that someone (cough Japanese institutions cough) has decided the 13.4-sigma swing in JGBs last night is just too much and have rotated to US Treasuries. The selling of JPY and buying of EUR (to fund peripheral bond buying) and USD (to fund Treasury buying) is very clear. That means, implicitly, that every ramp higher in JPY (weaker JPY) is simply more bond-buying - which leaves the algos directionless.

If you were a risk-manager, what would you do? And as far as all those VaR risk models - oops!!


It seems the 'sellers' of those JGBs have found a new place to put that capital to work (and in a non-devaluing currency)...


Charts: Bloomberg

[Magda Hassan]

Japan's Sham Currency War

The Hidden Objective Behind Japan's Massive Kamikaze Quantitative Easing

By Matthias Chang

May 15, 2013 "Information Clearing House" - US$ dollars have been flooding the financial markets ever since Bernanke launched quantitative easing allegedly to turnaround the US economy. These huge amounts of US$ toilet paper are mainly in financial markets (and in central banks) outside of the United States. A huge chunk is represented as reserves in central banks led by China and Japan.

If truth be told, the real value of the US$ would not be more than a dime and I am being really generous here, as even toilet paper has a value.

That the US dollar is still accepted in the financial markets (specifically by central banks) has nothing to do with it being a reserve currency, but rather that the US$ is backed/supported by the armed might and nuclear blackmail of the US Military-Industrial Complex. The nuclear blackmail of Iran is the best example following Iran's decision to trade her crude in other currencies and gold instead of the US$ toilet paper.

If today, the United States is no longer a military threat and the global bully that can blackmail with impunity the oil exporting countries in the Middle East, the global financial system which hinges on the US$ toilet paper would have collapsed a long time ago.

The issue is why has the US$ not collapsed as it should have by now?

When we apply common sense and logic to the state of affairs, the answer is so simple and it is staring at you.

But, you have not been able to see the obvious because the global mass media, specifically the global financial mass media controlled mainly from London and New York, has created a smokescreen to hide the truth from you.

Let's analyse the situation in a step by step manner, and apply common sense.

1. The US is the world's biggest debtor. The biggest creditors are China and Japan, followed by the oil exporting countries in the Middle East. With each passing day, the value of the US$ toilet paper is worth less and less. Like I said earlier, even toilet paper has some intrinsic value. It reaches zero value when everyone has to carry a wheelbarrow of US$ to purchase anything.

2. For the US$ toilet paper creditors, they cannot admit the fact that they have been conned by the global Too Big To Fail Banks (TBTFs) acting in concert with the FED and the Bank of England to accept US$ toilet papers. The central bankers of these countries have a reputation to preserve (not that there is in fact any reputation, for their so-called financial credibility is also part of the scam) and the political leaders that relied on them is in a bigger bind. How can the political leaders be so very stupid to trust these central bankers (who have stashed away in foreign tax havens huge US$ toilet papers as a reward for their complicity). This is the current state of affairs in plain English. They are having sleepless nights worrying if and when the citizens would wise up to this biggest con in history i.e. the promotion and acceptance of fiat currencies, the US$ being the ultimate fiat currency.

3. The global financial elites led by the FED know that this state of affairs is to their advantage and they are exploiting it to the hilt! They also know that no country or organisation has the military resources to threaten the US to stop this global ponzi scheme which has been going on since 1945 and intensified since 1971 when President Nixon de-coupled the US$ from gold. The pound sterling is another story but, it is not relevant for the purposes of this analysis.

4. Additionally, and as a result of the above-stated scam, countries were led to believe and to accept the false economic theory that export generated growth (GDP) should be the foundation of economic development, as the United States having limitless US$ toilet paper has the ability and the means to purchase the global exports, it being the largest consumer market in the world. In the result, the world's factories and their workers, including those in the developed world such as France and Germany worked their butts off to be rewarded with US$ toilet paper whose value is less than the paper and ink that produce it! The financial frolic went on for more than forty years and came to an abrupt and foreseeable end in the 2008 global financial tsunami.

5. When the party ended, the United States was up to her eyeballs in debts as a result of reckless financial speculation in the global derivatives casino and the consumption binge financed by housing mortgages. Debts must be repaid. But, the US has no means to do so. They cannot produce enough goods to earn the revenue to pay the debts because US manufacturing has been outsourced to the developing world China became the world's number 1 factory. So, the financial elite appointed helicopter Bernanke to lead the charge for the US and the UK to use the printing press (digital or otherwise) to print more US$ toilet papers to pay off the debt. In economic jargon, this is "monetising the debt". It is outright fraud, but no one (i.e. central bankers) in his right mind would admit to this fraud as they would be hung from the lamp-posts if the truth is discovered as was the case when the Italian fascist leader Mussolini was hung by the Italian partisans.

6. Initially, central bankers confronted with this situation and having to face a restless populace embarked on a regime of competitive easing/ devaluation of their currencies. But, the price was horrendous. Inflation spiked in all these countries. But, this scheme of things did not work out as planned for the simple reason, the US$ toilet paper continued to be lower as a result of more QE by Bernanke. China realised the danger and adopted other means to overcome this situation, one of which was to enter into bilateral arrangements with her trading partners to finance trade in their respective currencies. Such agreements were entered between China and Japan, members of BRIC, Malaysia etc. This counter-measure was perceived as a threat to the continued dominance of the US$ toilet paper regime. In the result, Obama declared at the urging of the financial elites (he does not have the grey cells to think) a foreign policy shift the Asia Pivot to prevent a further deterioration of US$ dominance.

7. When Japan entered the agreement with China, her behaviour was deemed unacceptable since Japan was under the nuclear protection of the US. Japan was caught between a rock and a hard place. It was expected that sooner or later the US would apply the squeeze on Japan to behave in a proper manner. Applying geopolitical strategies, the US towing South Korea along provoked North Korea by launching a military exercise which included flying B-2 bombers which are capable of carrying nuclear weapons. North Korea responded in the manner that was expected. Japan was exposed and in like manner reacted by seeking US protection. To muddy the waters and complicate the situation, the US engineered a Idispute between China and Japan over the sovereignty of the Diaoyu Islands. This was followed by the installation of a new regime in Japan by the election of the Prime Minister Shinzo Abe and the appointment of Haruhiko Kuroda as the Governor of the Bank of Japan (BOJ).

8. Now comes the mechanics of US counter-measures in shoring up the artificial dominance/value of the US$ toilet paper. Japan was ordered to do its part as a quid pro quo for being protected by the US's nuclear umbrella. A new version of the Plaza Accord must be put in place a "reverse Plaza Accord".

9. Let me explain. In the 1985 Plaza Accord, the dollar was devalued to reduce the current account deficit and to help the US recover from the recession of the early 1980s. It was a managed devaluation and the exchange value of the Dollar versus the Yen declined by 51 per cent from 1985 to 1987 reaching ¥151 per US$1 in March 1987. The dollar continued to slide till 1988. The effect of the strengthened Yen depressed Japan's exports and brought about the expansionary monetary policies that resulted in the infamous asset bubbles of the late 1980s. The G-6 countries then gathered in 1987 in Paris to arrest the slide of the dollar and to manage and stabilise the international currency markets. The end result was the Louvre Accord. In the next 18 months the dollar strengthened to ¥160 per US$1.

10. However, in the current situation, the devaluation of the US$ toilet paper was the result of massive QEs so as to enable US to monetise her debts. However, for US to continue to monetise her debts and have the world's central banks agreement to continue to hold dollar reserves, the value of the dollar must appreciate, failing which the dollar would collapse, the US defaulting on her debts, as creditors would no longer accept US$ as payment. The trick was to artificially inflate the value of the dollar without arousing any suspicions.

11. In the 1970s, following the de-coupling of the dollar from gold by President Nixon, the dollar would have collapsed in like manner as it was not backed by gold. It became pure fiat money! The trick then was to create an artificial demand for dollar which would in turn raise the value of the currency. This was effected by the proposal of Kissinger to the Arabs that if they would dollarize their oil exports, the US would guarantee their safety and survival even from the threats of Israel. When the Arabs agreed to this arrangement, every country in the world had to buy oil in US$. Countries have to exchange their currencies into US$ to buy oil. This demand for US$ strengthened the currency and prolonged the US fiat money monopoly.

12. However, this option is no longer available presently as oil is now being sold in other currencies besides the US$. The petro-dollar is no longer in dominance. In any event, the continued use of petro-dollars would spike the oil price and this would be inflationary and detrimental to the US economy as well as the world's economy in the present economic climate i.e. deep recession. Another means must be used.

13. This is the reason for the sudden "shock and awe" monetary policy of the new Japanese regime of Shinzo Abe and Haruhiko Kuroda. My detractors will accuse me of indulging in conspiracy theories. But, the facts speak for themselves. I had said earlier, that the G-7 countries have collectively attempted to devalue their currencies but, it did not stem the slide of the US$ because Bernanke was increasing the intensity of QE since 2008. And the EU was not willing and or able to adopt a suicide policy of massive QE as Germany was well aware of such a risk having suffered the negative effects of hyperinflation. China would not kow-tow to the US and in fact together with fellow members of BRIC was adopting counter-measures to confront Bernanke's QE financial weapon. That left only one country who can be compelled to do the US bidding, to commit Hara-kiri to save and or prolong the US$ toilet paper regime Japan!

14. And so, Japan launched its sudden massive QE and the desired effect is that now the US$ toilet paper has artificially appreciated in value vis-a-vis the Yen and less so with other currencies. This cannot be disputed by my detractors because:

On May 11, the financial elites of G-7 countries explicitly agreed with this kamikaze policy of Japan.

Koichi Hamada has also declared earlier that the target for this policy is to allow the dollar to rise to ¥110 per US$1 and this rise would be managed in a staggered fashion in small increments (step by step approach) thereby controlling the rate of inflation in Japan which would not be allowed to exceed the agreed target rate.

It is suggested that Japan can do this because it can utilise its huge dollar reserves of US$1.2 Trillion to manage the devaluation! According to Alan Ruskin, the global head of Group of 10 foreign-exchange strategy in New York at Deutsche Bank ASG, he said "I think we are opening up the door to look at 105 in the next few months and 110 by the end of the year …" and this surely must be interpreted to mean that Koichi Hamada's strategy is definitely in play.

In conclusion, it is my view that such "managed artificial appreciation" of the US$ toilet paper while effective in the short run would fail in the long run because the fundamental issues of the US economy have not been addressed and resolved. Only real economic growth can reverse the dollar's demise.

Seriously, would Bernanke stop further QE when the yen exchange rate reaches ¥110 by the year end? Has not Bernanke declared that QE would continue till 2015? And since Japan has drawn the Red Line at ¥110, can Japan risk further damage to its economy and continue to back-stop US beyond ¥110?

The US$ quadrillion derivative casino is the millstone around the US and the global economy, and as long as this is not resolved, the crisis would only get worse. Like water, after sufficient heat, the boiling point would be reached.

While I cannot forecast the precise date of the implosion, I am of the view that the end is near, sparked by a black swan event and then snowballed to its final devastation.