Japan: Deep purple scenario

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March 15, 2001 atimes.com Editorials

Japan: Deep purple scenario

Tokyo stock prices recovered ever so slightly on Wednesday, but the Nikkei average remained below the 12,000-point mark and well below the level at which major banks remain in the black and are able to maintain Bank of International Settlements (BIS) capital-adequacy ratios if forced to value their equity holdings by mark-to-market accounting rules. Financial authorities may want to consider two scenarios, one worst-case, one best-case, as they confront the prospect of systemic financial crisis as last seen in 1998.

Worst case The stock market drops further or continues to linger at present levels. Panic sets in as politicians and financial authorities come up with yet another unconvincing market rescue plan no one is prepared to buy. Several large banks collapse, depriving any number of financially weak or de facto insolvent companies of operating capital and taking them down with them.

The crisis rapidly takes on global dimensions as foreign and domestic investors not only pull out of Japanese stocks but also government bonds, causing a massive and debilitating rise in interest rates. And as money leaves the country, the yen takes a nosedive to the 150-180 to the dollar level.

Best case Not a whole lot different initially. The stock market drops further or remains at present levels. The authorities and politicians do nothing. Some banks collapse and take any number of weak companies down with them. But now the authorities do step in - not to prop up the market or rescue moribund banks and companies, but to come to the rescue of healthier ones on condition of full bad-loan write-offs and restructuring.

The best-case scenario may look to some (and almost certainly to virtually all Japanese politicians) like an unacceptable bit of brinksmanship. It is nonetheless the best that can be done right now and would surely be rewarded by the markets in short order.

The government can afford to await an onset of collapse of unsound financial institutions with the certain knowledge that the nearly 45 trillion yen (US$375 billion) that is the unspent portion of the 70 trillion budgeted to deal with financial emergency will be sufficient to support loan write-offs by the sounder institutions and their recapitalization. Moreover, the Bank of Japan has already created a (Lombard-type) direct lending facility through which banks can borrow at the official discount rate of 0.25 percent. And if need be, the BOJ still has avenues of further monetary easing in its arsenal.

But, as we wrote yesterday, the political will is almost certainly lacking for the best-case scenario to be played out. Thus, brace for the worst-case one becoming reality.

((c)2001 Asia Times Online Co, Ltd.

http://atimes.com/editor/CC15Ba01.html

-- Martin Thompson (mthom1927@aol.com), March 14, 2001


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