Category Archives: Japan

Dimon Says US Banks Should Dictate to Regulators

Now that Steve Jobs has retired from Apple, Jamie Dimon seems determined to assume his role as the CEO with the most effective reality distortion sphere. You can infer that from the magnitude of the whoppers he is telling and the size of the audience he is trying to bamboozle.

But while Jobs’ Svengali tendencies have gotten more than occasional mention, they weren’t a major failing. Jobs not only saved Apple, but he spearheaded the development of important new product categories. By contrast, Dimon has long been a bully, a smart and capable bully, but a bully nevertheless (I have reports going back to his first year at Harvard Business School, and it takes some doing to be memorably obnoxious by dint of the competition in that category).

Now on the surface, Dimon’s latest brazen statement isn’t quite as gross as my headline suggests. He is merely saying that US banks should not be subject to the new incoming international bank rules, known as Basel III. That might seem to be a narrower statement, but as we show, when you parse his logic, it amounts to banking uber alles.

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Marshall Auerback: Are We Approaching the Endgame for the Euro?

By Marshall Auerback, a hedge fund manager, portfolio strategist, and Roosevelt Institute fellow. A version of this post appeared at New Economic Perspectives.

Forget about the S&P downgrade, which has had ZERO impact on the global equity markets. The downgrade was supposed to mean that it would be more likely that the US government would not be able to pay its debt than previously assumed. IF the markets took this warning seriously, then they would have attached a higher risk premium to US government bonds. Of course, the opposite occurred. US bonds soared in price. In other words, investors, both here and abroad, voted with money as loudly as possible that they view the US government debt as a very safe haven in a time of financial turmoil

So if it wasn’t the S&P downgrade which caused this downward cascade in the global equity markets, then what was it? By far, the most important factor currently driving the market’s bear trends is Europe or, more specifically, the future of the euro and the European Monetary Union. Systemic risk has migrated across the Atlantic to the euro zone.

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Market Rout Continues

After a very bad day in the US, Asian markets swooned and European markets fell again, but their declines are less gut wrenching. 2-3% falls in most Euromarkets at the opening (2.5% for the FTSE, 2% for the Dax, and 3.5%.for the Milan’s FTSE-MIB) but for the most part, they have come back somewhat as of this hour. The FTSE is now down 2.2%, the CAC 40 a mere 1.2%, the DAX 2.7%, and the FTSE-MIB has is in positive territory, up 0.25%. This follows plunges of 3.7% for the Nikkei and 4.5% for the Hang Seng indexes.

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Third Way Document Proves Democratic Party Supports Institutionalized Looting by Banks

It is one thing to suspect that something is rotten in Denmark, quite another to have proof. Ever since Obama appointed his Rubinite economics team, it was blindingly obvious that he was aligning himself with Wall Street. The strength of the connection became even more evident in March 2009, when Team Obama embarked on its “stress test” charade and bank stock cheerleading. Rather than bring vested banking interests to heel, the administration instead chose to reconstitute, as much as possible, the very same industry whose reckless pursuit of profit had thrown the world economy off the cliff.

But now we see evidence in a new paper by the think tank Third Way of an even deeper commitment to pro-financier policies. The Democratic party has made clear that it supports institutionalized looting by banks, via the innocuous-seemeing device of rejecting the idea of writedowns on bonds they hold.

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So What Might Happen if We Get to August 3 With No Deficit Deal?

So they are now motivated to get something done.

A lot of Democrats, by contrast, are fiercely opposed to the pact under discussion, which consists of $3 trillion of cuts and no tax increases, or more accurately, an immediate commitment to cuts, and tax increases possibly coming via a to-be-brokered tax reform. The Democrats see the trap being laid for them; reform/increases later is likely to be no reform. (Separately, this package will kill the economy, a consideration that pretty much everyone is ignoring, proving Keynes correct: “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”).

The latest update at the Wall Street Journal was cautious:

With prospects of a government default looming in early August, leaders on both sides denied Thursday that a deal was close…Both sides warned that an agreement is not near. “There is no deal,” Mr. Boehner told radio host Rush Limbaugh. White House spokesman Jay Carney used similar language. And White House officials said Mr. Obama has never considered an agreement that did not include revenue increases.

A good deal can change in the next few days, but the window of opportunity narrows as time passes. And that is why the Treasury’s apparent refusal to consider options for working around the debt ceiling looks colossally irresponsible. This is similar to the behavior of the financial regulators pre-Lehman: they placed all their chips on one outcome, that of a private sector bailout, and failed even to find out what a bankruptcy would look like (at a minimum, if Lehman had prepared a longer-form filing, the implosion would have been less disruptive).

But this “all in” strategy is by design. Obama has long wanted entitlement “reform,” as in gutting; Paul Jay of Real News Network pointed out to me today that Obama told conservatives at a dinner hosted by George Will in the first week after his inauguration that he planned to turn to it once he got the economy in better shape. So this is a variant of a negotiating strategy famously used by J.P. Morgan: lock people in a room until they come up with a deal. But the J.P. Morgan approach used time to his advantage; here the fixed time frame makes this more like a form of Russian roulette with more than one cylinder loaded.

It is also worth noting that what starts happening on August 3, assuming no deal, is “selective” default. It isn’t clear if and when Treasuries would be at risk of having payments skipped, and I would assume Social Security would also get high priority. But with Treasuries, the bigger risk is not a missed payment (which would certainly be made up later) but a downgrade, which is expected to force certain types of investors who are limited to AAA securities to dump their holdings.

A useful article in the Economist describes how Wall Street, which had heretofore assumed that there was no way the US would (effectively) voluntarily skip some interest payment, is now scrambling to figure out how to position themselves should such an event come to pass. Many observers had assumed that the repo market, on which dealers depend to fund themselves and collateralize derivatives positions, would go into chaos (the belief was that counterparties would demand bigger haircuts). But the Economist argues that does not appear to be the case:

SIFMA, a trade group for large banks and fund managers, recently gathered members together to discuss issues like how to rewire their systems to pass IOUs rather than actual interest payments to investors, should a default occur. “It’s one of those Murphy’s Law things. If we do it, it won’t prove necessary. If we don’t, we’ll be scrambling like crazy with a day to go,” says one participant.

But the moneymen hardly have all the bases covered. “I really thought I understood this market, until I tried to map all of the possible consequences of a breakdown,” sighs a bond-market veteran. That is hardly surprising, given that Treasury prices are used as the reference rate for most other credit markets. Moreover, some $4 trillion of Treasury debt—nearly half of the total—is used as collateral in futures, over-the-counter derivatives and the repurchase (repo) markets, a crucial source of short-term loans for financial firms, according to analysts at JPMorgan Chase.

Some fear that a default could cause a 2008-style crunch in repo markets, with the raising of “haircuts” on Treasuries leading to margin calls. The reality would be more complicated. For one thing, it’s not clear that there is a viable alternative as the “risk-free” benchmark. One banker jokes that AAA-rated Johnson & Johnson is “not quite as liquid”. In a flight to safety triggered by a default, much of the money bailing out of risky assets could end up in Treasury debt. Increased demand for collateral to secure loans could even push up its price.

Then there is the impact of a ratings downgrade. Money-market funds, which hold $684 billion of government and agency securities, are allowed to hold government paper that has been downgraded a notch. Other investors, such as some insurers, can only hold top-rated securities but their investment boards are likely to approve requests to rewrite their covenants, especially if a lower rating looks temporary. “It would be a full-employment act for lawyers,” says Lou Crandall of Wrightson ICAP, a research firm. There’s a surprise.

In other words, this event is focusing enough minds that a lot of parties are looking at ways to get waivers or other variances to allow them to continue to hold Treasuries even in the event of a downgrade or delayed payment. But a report from Reuters on the Fed’s contingency planning makes them sound markedly less creative than their private sector counterparts (but it is important to note that Charles Plosser of the Philadelphia Fed, the key source for his story, has been a critic of the Fed’s fancy footwork in the crisis. In fact, the New York Fed is the key actor, and it has been notably, um accommodating in the past).

In addition, the New York Times reported yesterday that some hedge funds are moving into cash to buy up Treasuries in case other investors dump them. I’ve even heard of retail investors planning the same move. That does not mean the volume of buyers will be enough to offset forced sales, but it does say that fundamentally oriented investors would see this event as an opportunity, not a cause for panic.

The financial system is so tightly coupled and there are so many potential points of failure that I’m hesitant to say that the consequences of a default may be far less serious than are widely imagined. But in the Y2K scare, the considerable panic about potential catastrophic outcomes led to a tremendous amount of remediation, which served to limit problems to a few hiccups. Unlike Y2K, the remediation efforts have started very late in the game, so their is a lot more potential for disruption.

But even so, why is the Administration so willing to engage in brinksmanship? S&P expects a 50 basis point rise on the short end of the Treasury yield curve and 100 basis points on the long end, which they expect to reverberate through dollar funding markets and cause all sorts of hell. Remember, we have both Geithner and Bernanke again in powerful positions, and both went to extreme efforts to prevent damage to the financial system. Why are they merely handwringing at such a critical juncture? Might they have a trick or two up their sleeve?

I can think of at least one. I was working for Sumitomo Bank (and the only gaijin hired into the Japanese hierarchy) and was in Japan during and shortly after the 1987 crash. Initially, the reaction in Japan was one of horrified fascination, of watching a neighbor’s house burn down. It then began to occur to them that their house might burn down too.

The volume of margin calls on Black Monday and Tuesday were putting serious pressure on the Treasury market, which was beginning to seize up. On top of that, bank were understandably loath to extend credit to clearinghouses and exchanges (as we’ve discussed elsewhere, the Merc almost failed to open and would have collapsed if the head of Continental Illinois had not approved an emergency extension of credit after a $400 million failure to pay by a major customer. Had the Merc failed, the NYSE would not have opened, and its then CEO John Phelan has said it too might have failed). So keeping the Treasury markets liquid was a key priority in stabilizing the markets.

Japan is a military protectorate of the US. The Fed called the Bank of Japan and told it to support the Treasury market. The BoJ called the Japanese banks and told them to buy Treasuries. Sumitomo and the other Japanese banks complied.

I could see the same phone call being made again in the event of a default or downgrade. First, the yen is already at 78 and change, which is nosebleed territory from the Japanese perspective. The BoJ intervened once in the recent past when the yen got slightly above this level. Purchases of Treasuries is a purchase of dollars, and done on big enough scale would help lower the yen. Second, if you buy the hedgie view, buying in the face of forced (as in AAA mandate driven) and not economically motivated selling means this trade would have near term upside.

Is this scenario likely? I have no idea. Is it possible? Absolutely.

Again, I would not bet on happy outcomes. As Cate Blanchette muttered in the movie Elizabeth, “I do not like wars. They have uncertain outcomes.” And while the negotiators finally seem to have awakened to the risk of entering uncharted territory, the old rule of dealmaking is if one side’s bid is below the other side’s offer, you can’t get to a resolution. That’s where the two sides appear to be now, and even though it would be rational for both to give a bit of ground, rationality has been missing in action on this front for quite some time.

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“Trade Imbalances Lead to Debt Imbalances” or Why Mercantilist Nations Shouldn’t Beef About Their “Profligate” Customers

Michael Pettis, a respected economist and commentator on China, provides an important contribution on the global imbalances theme. Many observers have pointed fingers at debtor nations like Greece, Portugal, Spain, and the US and argue that they need to start consuming less. While narrowly there is some merit to that argument, Pettis points out that the trade deficit countries (the debtors) are not the ones in the driver’s seat and it it the trade surplus countries that must take the lead in making adjustments.

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Marshall Auerback: There is No Progressive Case for Deficit Cutting – The Myth of the “Virtuous” Clinton Surpluses

By Marshall Auerback, a portfolio strategist and hedge fund manager

For once, President Obama has sought to address his progressive critics, without caricaturing them as a bunch of out of touch, irresponsible radicals. At his press conference on Friday, the President made the following argument:

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The Social Cost of the Loss of Job Stability and Careers

As much as the rest of the world has chosen to look down on Japan in its post bubble era for its failure to clean up its banking mess and resultant stagnant economy, it has managed its relative decline in status with considerable aplomb. It still has the longest life expectancy in the world, universal health care, not bad unemployment (3% to 5%) and ranks well on other social indicators And now that the US is going down the Japan path, it might behoove us to take heed of their example.

One of the striking difference between the cultures is importance ascribed to job creation.

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Martin Wolf: Why China Could Fail Like Japan

The Financial Times’ economics editor Martin Wolf takes up the theme treated at some length by China-based economist MIchael Pettis: that Chinas’ economy has moved into unknown and dangerous terrain. No sizeable economy has had investment and exports combined constitute nearly 50% of GDP, and that model is not sustainable. As we have indicted, there is evidence that investment is becoming less and less productive. China is taking $7 of debt to generate $1 of GDP, when the US at the tail end of the bubble needed a mere $4 to $5 of debt for each incremental $1 of growth.

We’ve often recapped Pettis here and are glad to see Wolf take up his analysis.

Wolf does recite the optimist case on China, with the biggest factor being that China has a long way to go in improving the incomes of its citizens, and that alone can give it a very long lasting growth trajectory.

On the risks, Wolf sets aside commodities scarcity and environmental issues to focus solely on the economics case.

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Philip Pilkington: Down in the Hole – Is America Becoming the Next Japan?

Philip Pilkington is a journalist currently sinking, together with the rest of his fellow countrymen, down into the hole in the Irish banking system

Will all your money
Keep you from madness
Keep you from sadness
When you’re down in the hole

Cause you’ll be down in the gutter
You’ll be bumming for cigarettes
Bumming for nylons
In the American Zone
–‘Down in the Hole’, The Rolling Stones

Everyone who is anyone is saying it: the US looks set to become the next Japan. Yet the particulars of the argument are never really trashed out. Certainly both countries suffer from the same malady – namely, a bursting asset bubble punching gigantic holes in private sector balance sheets. This leads to similar policy approaches – not to mention similar policy failures. But beyond this overarching comparison people tend not to tread.

Let’s start from the beginning; the asset bubbles that set off the crises.

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“Debtors’ Prison”: Bob Kuttner on the Costs of Rentier Rule

Bob Kuttner has an elegant and important article at American Prospect, “Debtors’ Prison“. It’s an evocative, historical form of the argument made here and elsewhere: that advanced economies have gone down a disastrously bad path in not writing down debt that can’t realistically be paid.

The usual poster child for “why not writing down debts is a bad idea” is Japan, but that isn’t gripping enough to evoke the right responses. Even though its post-bubble growth has been dreadful, Japan is still a well-run, tidy country with a low crime rate, universal health care, long life expectancy, and tolerable unemployment. That in turn is due to factors that do not obtain much of anywhere else: Japan was very cohesive to begin with, and its elites chose to have their incomes fall relative to everyone else to save jobs. Wage compression at large companies has increased dramatically. This is the polar opposite of what has happened in the rest of the world, where the gap between the haves and the have-nots has widened.

Kuttner provides another set of examples as to why we need to get the creditor boot off all our necks:

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Battle Over IMF Chief: Proxy War Over Power of Banks?

There’s a fight afoot over who will be the next head of the IMF. Yours truly is not making odds on this one, save that Christine Lagarde is getting far and away the most attention in the media and more generally, a big push is on to have a European take the reins. The logic is that with the eurozone mess far and away the biggest priority, the new IMF chief needs to have credibility with the major actors, and that argues for a European choice.

The contrary camp is the “the countries formerly known as emerging” who point out that it is their turn to have an IMF head from one of their countries. The IMF has been led by a European since its inception. Even though votes have been rejiggered to give younger economies more weight, the mature ones still are in control of the outcome.

But what is intriguing are the arguments that follow, which reveal what the real stakes are.

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Michael Pettis: Is it time for the US to disengage the world from the dollar?

By Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. Cross posted from China Financial Markets

The week before last on Thursday the Financial Times published an OpEd piece I wrote arguing that Washington should take the lead in getting the world to abandon the dollar as the dominant reserve currency. My basic argument is that every twenty to thirty years – whenever, it seems, that American current account deficits surge – we hear dire warnings in the US and abroad about the end of the dollar’s dominance as the world’s reserve currency. Needless to say in the last few years these warnings have intensified to an almost feverish pitch. In fact I discuss one such warning, by Barry Eichengreen, in an entry two months ago.

But these predictions are likely to be as wrong now as they have been in the past. Reserve currency status is a global public good that comes with a cost, and people often forget that cost.

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