Twin Peaks – Jumping in Mud

In this edition of Twin Peaks we continue to monitor the unfolding developments in the Global Financial Crises (yes it is still with us) and the developments of the post Dec 1989 crises in Japan as expressed in the Dow and the Nikkei. The thesis as has been discussed at length in previous Twin Peaks series, is that the USA and Japan are following similar monetary policies of excessive monetary stimulation which achieved an artificial market condition described as “the zero bound” where short term interest rates are stuck at zero or near zero for extended periods. The 1989 economic collapse in Japan initiated its drive towards the zero bound and the USA started its march towards the zero bound after the 2007 economic crises. Both economies have achieved the condition of being stuck in the zero bound but the USA is about 18 years behind Japan. The zero bound monetary policy combines with Quantitative Easing and fiscal policies of budget deficits to generate an explosion of public debt.

The present tale of the charts is one of divergence. The USA chose aggressive monetary and fiscal interventions while the Japanese took a more measured approach. It is the Bernanke theory that this difference is what will distinguish the USA from Japan, where the USA will recover to rapid economic growth as opposed to the Japanese experience of a low level deflationary depression stretching over two decades and entering its 3rd.

The aggressive policies of the USA are showing up in the charts. That does not mean that the Bernanke theory is proven, it simply means that the markets reacted in predictable fashion to the very aggressive government policies. Government and central bank interventions are not self sustaining and must be repeated in ever growing tranches to simply maintain a stimulation effect. The next stimulation will need to be even greater than the previous two but it may not be as visible due to the adverse political consequences attached to the previous spectacles.

Stimulation decay sets in after a while unless, and this is what is hoped for, the spark provided by the government is sufficient to get the economy going. The jury is out on whether stimulation will be a gasoline and newspaper bonfire burning fast and bright for a while to sputter and die or not. Everything rides on that outcome.




(Click chart to enlarge.)

The peaks of the Nikkei and the Dow are matched in this chart and not rebalanced thereafter to allow for significant deviances. The peak of the 1929 Dow has been added just to spice up the test against depressionary conditions. The aggressive US intervention has now carried the Dow upwards beyond the levels of the Nikkei, for a similar period as unfolded. The positive divergence in itself is not compelling as the initial equally aggressive reactions to the 2007 crash caused a similar positive divergence then, which was resolved with a dramatic convergence and negative divergence between October 2007 and April 09. This chart does not show it but the long term bottom of the Nikkei since Dec 1989 is as recent as 10 March 2009 at 7054.98.

The decay in the stimulations is already showing up in the momentum inherent to the move from April 2009.

The Momentum chart hereunder needs some explanation in interpretation. It measures the relative change in the gap between the 50 day moving average and the 200 day moving average, counting backwards. A 180 degree flip-over (negative to positive) in data occurs when the 50 dma crosses over the 200 dma.

Here’s what the chart tells us. The momentum in the bear move down was failing for weeks before late March, early April 2009. The bear market momentum gave way to a negative momentum bear, i.e. a bull market momentum since early April 2009. The flip-over/crossover occurred just before the end of June 2009. Momentum still spiked unto mid July but since then bull momentum has been in decline. The “jumping in mud” period started in late October 2009 where the market is still in bullish trend but just can’t get going.

Presently we are still in the “jumping in mud” phase but the beginning of a downward trend is showing up in the negative momentum bull, i.e. the bull marked momentum is failing. We have not yet reached a point where we can make a call to say that the bull marked has failed. The historic indications are that a -1.5% to a -2% recording is required to indicate a high probability that a bear market move is underway. The highest recording was -0.7% on Dec 31st 2009. So for now it is simply “jumping in mud” time until momentum picks up in either direction.




(Click chart to enlarge.)

The here and now is where the bulls will believe in the Bernanke thesis that this time it will be different for we acted faster and with more aggression in our stimulations. The bears will continue to claim that the speed and extent of intervention will not alter the outcome of a deflationary depression only how we get there. They would further insist that the likely outcome of a too fast and too furious monetary response will harvest an even worse outcome of a hyperinflationary depression in an effort to escape the deflationary depression. Already gold, silver, copper and every other commodity are being stuffed in custody and warehouses discounting such excess. Another vote of no confidence in official policies and not a sign of economic recovery.

The Japanese economy in this phase was typified by warehousing growing bad and delinquent debt with central bank and central government support. Mortgage debt for instance was warehoused in the Jusen structures, with similarities to the Freddie Mac and Fannie Mae structures in the USA. Every stimulation, regulation and intervention was aimed at reviving the asset inflation pre 1989 and denying the accumulation of decay in the economy. The economic events forced Japan to disprove the Keynesian theories of sticky downwards salaries and wages when after endemic unemployment, salaries and wages stated falling. Asset inflations never revived and in fact continued to deflate as each stimulation and intervention to prevent that outcome failed. Minuscule rises in interest rates or in direct or indirect taxes dumped the economy right back into crash mode, stumbling through two decades of economic decline until government debt equalled national savings in this previously high net savings nation.

Perhaps this time the outcome of Zero Bound and Quantitative Easing monetary policies combined with budget deficits and excessive government debt will be different, but probably not.

May you trade with wisdom and reward in 2010.


Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
6 January 2010

Ps. I will post a news flash update should the Momentum chart post a negative 1.5%.


© Sarel Oberholster


Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Sarel On the Edge with Max Keiser (Part 1)

Sarel On the Edge with Max Keiser (part 2)

Parking Space for Non Performing Loans

The real estate market will soon recover and this whole financial crisis will be just a bad memory. This was exactly the reasoning of the Japanese authorities when the real estate market collapsed in 1990. The very obvious solution was to ensure that the debt accumulated in funding the real estate bubble could be parked safely away from prying eyes while patiently waiting for the real estate market to recover and the real estate prices to grow back to the levels required to settle the loans. Sadly it turned out to be a twenty year wait but the non performing loans could not remain parked in the private sector for such an extended period. Parking space required grew each time the problem was moved and the taint of government with it.

The tale starts in 1970 when eight Jusens were established. Seven by major banks and financial sector players with shareholdings dispersed amongst the players for each Jusen to avoid subsidiary status. The eighth was founded by Agricultural Finance Cooperatives which were banks (also called deposit taking institutions at the time). The Deposit Taking Institution definition was telling as it defined the status of the entity as a bank or not and not the fact that an entity may be making loans. The purpose of the Jusens was to finance mortgage loans for the household sector but they were not to take deposits and would therefore not be banks. The shareholder banks would provide all the funding required.

The non-bank status allowed the Jusens to escape regulatory scrutiny with the full knowledge and blessing of the political regime and the BOJ. The Ministry of Finance (MOF) actively participated with a policy of profit padding reminiscent of a protective cocoon of naval attack craft around vulnerable aircraft carriers nicknamed the convoy system (gosoo sendan hooshiki) to promote cartels and safeguard banking profits from unacceptable competition (Rosenbluth&Thies, 2000). Also called a “survival of the weakest” policy (Milhaupt, 1999).

The basic Jusen setup was a very simple structure which made a mighty contribution to the real estate bubble in Japan.





The Shareholder Banks in turn were also receiving generous liquidity support from the BOJ and all the building blocks for a real estate bubble were in place. Soon other banks described as non-founder banks were also lending into the Jusens. The Jusens in turn did not restrict its mortgage lending only to households but expanded into the (at first) lucrative lending for property development. Globalisation, market liberalisation and internationalisation arrived in Japan in the 1980’s and together with epic loose monetary policy in the wake of the 1987 soon too be forgotten crash of the stock exchanges, accelerated lending growth into real estate to a fever pitch, with the Jusens out front. Dark tales are told of how even the Yakuza got involved in the real estate business in many ways including by providing jiageya (a land turner) who would clear the way for large real estate developments by for example “convincing” obstructive small land owners or tenants to cooperate.

The Nikkei peaked in Dec 1989, the real estate bubble popped and by late 1990 the Jusens were in trouble with non performing loans. The MOF inspected the Jusens for the first time ever in 1991 and concluded that almost 40% of the loans were non performing (Milhaupt, 1999). The response were predictably to underplay the problem as was shown later and to develop plans aimed at parking the problem out of the way while waiting for the real estate market to recover. The initial write off for the Jusens was around $5million. See the table of losses published by the DIC (Deposit Insurance Corporation of Japan) further down for the disclosed losses after a final restructuring effort in 1996 which closed the Jusens down.

The structurers of the Jusens never anticipated any failure and it transpired that clear allocation of losses when they arrived could not be done. Soon the previous partners in the joint ventures were arguing who should bear the losses and in which percentages. Some argued for loan ratios, other argued for control ratios and fingers were pointed at the MOF as responsible. The MOF was forced to intervene in the growing Jusen crisis. MOF involvement “stabilised” the volatile situation within the greater context of the Japanese financial crisis with hints of public support and implied guarantees but was ultimately based on the vain hope that the problem would resolve itself as soon as the economy had been reflated.

The temporary parking space provided for the non performing loans policy was so successful that Visiting Executive Professor Masaru Yoshitomi concluded in his lecture at the Wharton School, University of Pennsylvania published 17 April 1996, thus:

In conclusion, the recent performance and recovery of the real economy is decoupled and isolated from the banking “crisis” in Japan. Therefore if both the Government and the public correctly handle the Jusen liquidation and other banking problems through overhauling the current financial and regulatory system, the Japanese economy will launch on the new underlying growth path of 3 percent or so with better shape of both real and financial sectors. (The “jusen” debacle and Japanese Economy)

The parking space provided by the MOF supported by the BOJ’s ultra loose monetary policy with limitless liquidity provision and zero interest rates or near zero interest rates combined with the envisaged “overhauling of the current financial and regulatory system” failed to generate the 3 percent or so growth path for Japan. In fact, the by then around 75% non performing loan problem of the Jusens grew to an almost total conversion to non performing status. An attempt to raid the treasury to clean the Jusen slate met with fierce political resistance. The Founding Banks and the MOF were forced to thrash out a painful deal in 1997 to “permanently” deal with the Jusen nightmare. It was implemented by dividing up the non performing loans amongst the MOF and the Founding Banks with provisions for greater disclosure and transparency. Yet again the non performing loans were shifted from the previous parking space at the Jusens to the MOF, the Deposit Insurance Corporation (DIC) and the balance sheets of the Founding Banks on a 15 year envisaged repayment structure.

It did not take long to realise that the banks simply could not cope with the additional losses of non performing loans going bad and as early as March 1998 the MOF was obliged to inject capital into failing banks. Nine years into the Japanese Financial Crises having provided parking space for non performing loans for all that time and yet again the Japanese authorities faced another banking crisis. Rosenbluth & Thies (2000) describes it as follows:

“Between October 1998 and October 1999, Long-Term Credit Bank and Nippon Credit Bank were nationalized, five other major banks were declared insolvent (Nikkei 10/18/1999), and many others have merged with healthier institutions.” (The Electoral Foundations of Japan’s Banking Regulation)

The history of the Jusen problem after the parking space deal can be seen in the numbers published by the DIC in the RCC – Secondary Losses of Jusen Account table hereunder:


Source: Deposit Insurance Corporation, Japan

(Click on the table for a larger view)

It is clear, looking back upon the past twenty years of the Japanese Financial Crises that the ultimate parking space for most of the non performing loans were found on the balance sheet of the Japanese Government, those of the Jusen and of the banks alike. The policies of providing parking space to “stabilise” bubble excesses has mired the Japanese economy in a deflationary depression for two decades and saddled a younger generation of Japanese with a depressing Government Debt burden of a quantity that will haunt their economic life for more than a generation.

Only those afflicted with that special kind of blindness of them-who-do-not-wish-to-see would be able to look upon the policies of the FDIC, the FHA and its wards Freddie, Fannie and Ginnie together with the antics of the Fed to provide parking space for non performing loans will fail to see the parallel with the recent history of the Jusens. The not so blind will note how the taint of bailouts and stimulations festers in this still growing parking space and contemplate a future perhaps akin to the vehicles abandoned at the Dubai International Airport car parks. Those who watch the growing sovereign debt burdens may eye the IMF and the World Bank for parking space when the next sovereign debt default announces its arrival.

Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 December 2009


References:

1. Rosenbluth & Thies, 2000 – The Electoral Foundations ofJapan’s Banking Regulation, Electronic copy at: http://ssrn.com/abstract=1158646
2. Milhaupt, 1999 - Japan’s Experience with Deposit Insurance and Failing Banks: Implications for Financial Regulatory Design?, Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, August 1999, pp. 21–46.
3. Yoshitomi, 1996 - The “jusen” debacle and Japanese Economy, The Long-Term Credit Bank of Japan Research Institute.
4. Felson, 1998 - CLOSING THE BOOK ON JUSEN: AN ACCOUNT OF THE BAD LOAN CRISIS AND A NEW CHAPTER FOR SECURITIZATION IN JAPAN, DUKE LAW JOURNAL Vol. 47:567, pp 567-612.
5. Organized Crime Registry, 1996 - Who got Yakuza into our banking system?, http://orgcrime.tripod.com/yakuzabanking.htm



© Sarel Oberholster



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

The Cruellest Tax of them All.

Who is John Galt? – Ayn Rand from Atlas Shrugged

Humanity has shown many times that we can be extremely cruel and equally capable at rationalising it away. Taxation comes in many forms and is often not apparent. A well disguised tax is a boon for governments. The cruellest tax of all is a one hundred percent tax on income, disguised and capable of being rationalised as “good”.

Imagine for a moment a peasant farmer who has to hand over a hundred percent of his crop to a feudal lord. It is easy to see the injustice of such a tax. Yet we have a hundred percent tax in our midst and there is no moral outrage. It is the zero interest rate policy. Fortunately that other destroyer of savings, Quantitative Easing, is off the table for the time being.

We rationalise it away as a benign economic policy aimed at restoring economic prosperity. No questions asked. All “policy” happens by government decree. Do not buy into the slight of hand that the central bank is not part of the machinery of government. So the Central Bank can “follow” a zero interest rate policy but the reality of this tax is lost on the population.

Let’s put it up for scrutiny. Would a saver willingly agree to an economic environment of zero interest rates? Certainly not. Would a debtor prefer a zero interest rate? Absolutely. The saver and the debtor would negotiate a “price” for the use of money saved under normal willing economic participant conditions. That price for use of funds is interest.

The Central Bank enters the negotiation between saver and borrower and by counterfeiting money is able to destroy the negotiating base of the saver. Counterfeiting money through policies of unlimited liquidity provision is “price control” over interest rates instituted to force interest rates to zero. The interest income of the saver is completely taxed away.

I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair. Back to the tax.

Savings will migrate to term assets for meagre interest income but that income has more to do with a term premium than with interest, the cost for use of funds. No-one has any moral standing to defend a policy that dispossesses the interest of the saver however, the indiscriminate redistribution of this “interest” tax is even worse.

The normal standards for a tax are that it must be fair and it must be evenly distributed. The “for the public good” argument is that tax may be levied disproportionately usually with reference to some wealth measure. In simple terms, the rich must pay more and the poor must pay less. A zero interest rate policy tax fails dismally when it is tested against this framework. There is no discrimination. All savers are taxed their entire interest rate. Some savers, usually the wealthier and more sophisticated savers can institute counter tax measures and are able to avoid or escape the zero interest rate tax to some extent. Most can’t and they fund the redistribution.

Looking at the redistribution of the saver’s interest we find the same indiscriminate principles being applied. Is it being distributed by an elected body, fairly and equitably in the interest of society? No. Who are the recipients of the interest that has been stripped from the savers? Obviously the borrowers and it takes place with no reference to the wealth, income or other discerning standards which would normally apply. By which standards do society decide that Homeowner X who bought a property priced beyond his means and who borrowed in excess, must be subsidised by Pensioner Y who had saved to survive the income drought of old age. Why must BIG BANK A have access to zero or near zero cost of funds to carry all those loss making loans while Saver B can no longer afford his child’s tuition?

So the zero interest rate tax strips the interest income from savers and hands it to government, morally justified as stimulating the economy through deficit funding. It is of no use to run up huge deficits if it involves paying a high interest rate, is the justification. Strip the interest and hand it indiscriminately to over-extended borrowers many of which had used the borrowings to speculate on asset inflations. Strip the interest and hand it to the banks to “repair” their balance sheets and to “carry” the bad debts. Strip the interest and hand it to the developers who overinvested in property, capacity or trading. Strip the saver of interest to fund the carry of compounding unliquidated losses.

How totally one sided. Rip off the savers and give to the borrowers. Not even the socialist dictate of Karl Marx which proclaims that everybody should contribute according to ability and receive according to need, can contain the injustice of a zero interest rate policy tax. Surely nobody can have a zero need and a one hundred percent obligation to contribute. Neither can anyone claim one hundred percent contribution from savers against a zero contribution from borrowers (the bank margin excluded).

So, next time when the Fed or the Bank of Japan or the Bank of England proclaims its devotion to a zero interest rate policy, stop and ponder for a moment the injustice to the saver. Think on the co-operative spirit of society and ask why these Central Banks consider it fair, moral and just to strip savers of their income in their quest for self preservation. When you hear the phrase, “interest rates will remain at zero for longer” question the imposition of hardship on the saver for longer. Contemplate the weight of the burden on a small and responsible portion of society and the economic consequences of such self serving behaviour by Central Bankers with the support of Central Government.

In your heart, if you have a heart, you will know that robbing the saver is not moral. You will realise that the indiscriminate redistribution of income rights from the responsible and the cautious to over burdened borrowers, speculators, government and risk seeking banks serve not the short or long term interests of economic society. Most of all do not rationalise this mean policy and indiscriminately cruel tax into a benign and caring action by Central Banks.

Look no further than the escalation in Total Public Debt and compare it to the Federal Interest Outlays to see but a portion of the sacrifice extracted from savers. See how the debt expanded exponentially but the cost of funding the debt dropped dramatically. Interest tax need not be calculated or declared because the tax has already been calculated, declared and transferred to government through the application of the zero interest rate policy of the Fed.







Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 November 2009


© Sarel Oberholster



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .