Thursday, February 19, 2015

Review of Saving the Sun: A Wall Street Gamble to Rescue Japan from Its Trillion-Dollar Meltdown by Gillian Tett

I read Saving the Sun: A Wall Street Gamble to Rescue Japan back in 2008, and I was about to prune it from the library, but skimming through it I thought I'd capture a few parallels between Japan's bank solvency crisis in 2000 and the most recent one in the U.S.

There was a Japanese bank called the Long-Term Credit Bank of Japan, which had a monopoly on the issuance of many long-term debt securities. After the Japan bubble popped in 1989, it was a zombie bank that owned uncollectable corporate debt. It was nationalized in 1998 and eventually sold to a group led by U.S. investor Christopher Flowers for 121 billion yen (although with significant put rights for the buyer to give back debt that they didn't want to buy). That was the first time that a Japanese bank came under foreign control.

The bank changed its name to Shinsei Bank and did an IPO in February 2004. You can see how poorly it has performed since then. Apparently, Flowers invested more after the IPO and has ridden it all the way down.

John Hempton wrote "Christopher Flowers' short memory" in 2009 about Flowers as a bank investor. A commenter on his post pointed out "Flowers, like many others of his era, made 99% of his fortune in the period 1991 to 2007, which was basically just one upward move with a few minor bumps. Basically anyone who leveraged real estate and/or banks from 1991 onward made a fortune... until recently."

The book itself is 2/5. The protracted government bailout of an insolvent Japanese bank just is not that interesting. What I find fascinating, now, is how closely the 2008-2009 in the U.S. followed the playbook of the Japanese government in 2000. We should have seen it coming better.

Here's an example - this is from the wikipedia article on Shinsei:

"The purchase of Shinsei thus turned a profit [for the Flowers group] of over ¥100 billion within four years. The success of the IPO intensified criticism of Shinsei, however: the government was estimated to have lost ¥4-5 trillion on the deal between lost investments and forced purchases of bad debt, and the profits from the deal even escaped Japanese taxation through the use of a foreign investment partnership."
The government gave away the store to investors that were willing to "buy" this insolvent bank (without even assuming much of the risk), probably because they were willing to do some politically uncomforable stuff like cut dead wood and go after debtors.

After the Japan crash but before the U.S. crash, Americans would say stuff like this (from the book):
 "Japan desperately needed restructuring. It had to remove the excess debt, get rid of its deadbeat companies, and revamp the business culture. In short, Japan urgently needed to do on a macro scale the type of "cleanup" process [that private equity performed whenever it] purchased a company."
Yeah, right! Doesn't the U.S. now need some deleveraging? How about getting rid of deadbeat companies? But it kept all the incompetent banks, all the uncompetitive automakers around, just the way a Japanese kereitsu would. With the parallels between Japan and U.S. crises, you start to see that this stuff is politically inevitable. This is another perfect parallel:
"In Japan, companies were only required to reveal what was happening in their subsidiaries if they owned a significant stake in them. [...] As the problems mounted up, LTCB started to take advantage of this principle. In December 1991, the bankers created a company called 'NR,' which was designed to act as a warehouse for some of the nonperforming loans [...] the bank started to 'sell' its assets to NR at book value [...] This did not, of course, really improve the problem in the long term. Companies like NR were only able to purchase these risky loans because LTCB itself lent it the cash. Thus LTCB had simply replaced one set of bad loans with another. However, NR was such a tiny, obscure group that nobody outside the bank noticed the scheme. Better still, the bank was allowed to classify its loans to NR as 'healthy,' since NR was considered to have the support of LTCB [...] These tricks relied on the cooperation of friendly subsidiaries - and the assumption that the staff of these subsidiaries would be willing to 'buy' assets at inflated prices. [...The subdidiary presidents] were a tightly knit bunch who wielded great power inside LTCB, and were more than ready to perform their 'duty'..."
Enron accounting! But also the good bank-bad bank idea that could never quite get off the ground in 2007-2009. (A Lehman "bad bank" idea was still being floated in September 2008.) After the "bad bank" pitches come the inevitable hopes of a cheap government bailout:
"As 1998 got under way, the government took a few, wobbly steps toward a large scale banking 'solution'. It created a Y30 trillion safety net to support the banks and used Y1.8 trillion of this money to purchase token amounts of preferred shares in the latge banks..."
The Troubled Asset Relief Program from 2008!

This is not a parallel, but another example of an old-school "value investor" blindly buying a dip:
"Some of the other gaijin entangled in LTCB also felt baffled - and betrayed. During 1997 many European and American fund managers had bought LTCB shares [...] The hardest hit was Martin Whitman [...] who had made a small fortune in the 1980s by buying shares in troubled Savings and Loan institutions in America. In 1997, Whitman decided that Japan's financial mess seemed similar to the S&P crisis and decided to invest in LTCB because it seemed one way to repeat his earlier success. [...] Eventually Whitman wrote off his entire $50 million investment."
But here is another parallel. In March 2003, Japanese regulators  
"unexpectedly tightened the rules that governed short-selling in the Japanese equity markets. [...They] announced the move with almost no advance warning [...] triggering an artificial equity market rally."
The SEC did that in the U.S. on September 19, 2008; banning the short sale of 799 financial companies.

Another parallel: a Japanese Ministry of Finance strategy paper
"explicitly declared that the best strategy for the government was to talk up the markets. 'Finance is based on trust. So the government needs to tell everybody that the financial problems have been solved,' the paper said. 'We must make it clear that this government is not going to let any bank go bankrupt... We must also argue against injecting public funds.'"
Classic government response. From above, you had accounting rules in Japan that made it possible for banks to hide their condition. Once this is discovered, nobody trusts them. The government answer? Try to propagandize and otherwise force trust.

The parallels between Japan and the U.S. make it clear that this is human nature and socialist economy incentive structures at work. Saying that these banks should be liquidated with their shareholders and bondholders to suffer the losses, while obvious, is like saying that you should be able to cut hair without a government license. True free market economics, but is not going to happen.


Anonymous said...

Saying that these banks should be liquidated with their shareholders and bondholders to suffer the losses, while obvious, is like saying that you should be able to cut hair without a government license.

Speaking of occupational licensing:

How to create jobs: remove state occupational licensing barriers

Anonymous said...

Flowers also lost a lot of money in MF Global. He was a longtime friend of Jon Corzine and pushed for him to be hired as MF Global's CEO.

CP said...

Sounds like the only trick a lot of these guys know is buying the dip.

You'd think that investors who know banks "really well" would occasionally make money shorting one?