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Thread: Debt Deflation, American Style: Yamaichi Securities Company 1997 vs Bear Stearns 2008

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    Default Debt Deflation, American Style: Yamaichi Securities Company 1997 vs Bear Stearns 2008

    Debt Deflation, American Style: Yamaichi Securities Company 1997 vs Bear Stearns 2008

    by Eric Janszen

    In the summer 2007, nearly 20 years after Japan's post credit bubble collapse and debt deflation began, the US started its own journey down credit crunch and bankruptcy lane. The demise in 1997 of Yamaichi Securities Company, the fourth largest brokerage firm in Japan, and the intervention by the Bank of Japan (BoJ) has eerie parallels to the Bear Stearns collapse and Fed
    intervention more than ten years later. But the differences between the two events are even more telling.

    We start with an excerpt from a New York Times story covering the collapse of Yamaichi Securities Company in 1997, my emphasis.
    Big Japanese Securities Firm Falls, Putting the System on Trial
    November 24, 1997 (STEPHANIE STROM - NYTimes)

    The Yamaichi Securities Company, the fourth largest brokerage firm in Japan, moved to close its doors on 100 years of business today, and the Government mobilized its forces to reassure global markets that it is committed to an orderly overhaul of the country's shaky financial system. (Comment: Likewise the Fed today.)

    Yamaichi will go out of business leaving some 3 trillion yen, or about $24 billion, in liabilities to clients and putting more than 7,000 people out of work in a country where unemployment is almost unknown.

    It will be the largest business failure in Japan since World War II and may come to be seen as the start of a new era in Japanese business, one governed by market forces rather than bureaucrats.
    (Comment: In the US a similar move has come to be seen as the opposite.)

    Moreover, the time-honored "convoy" system, where companies held shares in other companies and all pitched in to paper over problems, has been openly challenged by Fuji Bank, which refused to rescue its longtime customer.

    The Ministry of Finance and the Bank of Japan both sought today to emphasize that Yamaichi had gotten itself into an extraordinary bind and that they were committed to closing the firm in an orderly fashion.
    (Comment: Orderly closing without the stigma of a bailout.)

    Additionally, the Bank of Japan pledged to take whatever steps were necessary to insure Japan's financial institutions have access to the short-term money markets. In recent weeks, banks have been forced to pay higher premiums to borrow money after the failure of Sanyo Securities, a second-tier brokerage firm, and Hokkaido Takushoku Bank, one of Japan's top 20 banks.
    (Comment: Likewise the Fed today.)

    Also, lenders' concerns about the impact of Asia's turmoil on the world's second-largest economy have increased. "The environment surrounding Japan's financial system has become increasingly harsh due to the recent instability in the stock markets and Asian currency markets and also due to the recent successive failures of financial institutions," Yasuo Matsushita, governor of the Bank of Japan, said at a news conference this morning.

    "In addition the economy recovery has slowed down and business sentiment has also become cautious,'' he continued. ''Under these conditions, the Bank of Japan is of the view that we face a very important situation which requires the utmost efforts of the central bank to assure that the stability of the financial system will not be undermined."
    (Comment: Recession following a credit bubble is a macro-economically dangerous condition.)

    Hiroshi Mitsuzuka, the finance minister, said that while Yamaichi's failure was not likely to require the use of the Compensation Fund for Deposited Securities, which protects a securities firm's clients against losses, the Government planned to strengthen the fund.
    (Comment: Japan's equivalent of FDIC insurance that extends beyond banks to securities firms.)

    Directors of Yamaichi, after working all weekend, reached their decision to shut down the 100-year-old firm at a board meeting early this morning. The Finance Ministry said the firm would begin shutting operations on Tuesday.

    "Yamaichi was effectively forced to take an action to cease its operations because markets lost confidence in the brokerage," said Mr. Mitsuzuka.
    (Comment: Effectively a run on Yamaichi much like the virtual run on Bear Stearns.)

    Yamaichi executives had been ordered by the Finance Ministry to reach a decision before the financial markets opened in Hong Kong. The Japanese financial markets are closed today for a holiday.
    (Comment: Wonder of the Fed was applying similar pressure to Bear Stearns?)

    The Bank of Japan is expected to spell out its plans later today for stabilizing the nation's financial system, which seems to be in the first days of a major restructuring that will bring market forces into the world's second-largest economy.
    (Comment: The Fed, by doing as the BoJ did 10 years ago appeared to be countering market forces. In fact, the Fed was performing the role of providing a bridge loan to allow for an orderly disposition of assets.)

    Mr. Matsushita said today that the Bank of Japan would provide "exceptional" loans to protect investors' assets and insure the swift liquidation of Yamaichi.
    (Comment: Likewise the Fed in the case of Bear Stearns.)

    Officials of the bank say it is also prepared to enter the currency markets as needed to support the value of the Japanese yen. But the yen showed little change in overseas trading this morning after the shut down of Yamaichi was disclosed.
    (Comment: Not the US Treasury department. A depreciated dollar is the policy path to an export led economic recovery for the US.)

    On Saturday, the head of the Finance Ministry's Securities Bureau, Atsushi Nagano, said an investigation of Yamaichi's affairs had uncovered more than $1.6 billion in previously undisclosed liabilities carried off the firm's books.
    (Comment: U.S. Securities and Exchange Commission Chairman Christopher Cox was asked on March 11 if he was concerned about the financial condition of Bear Stearns Cos. He said, "We have a good deal of comfort about the capital cushions at these firms at the moment." U.S. markets less transparent than Japan's? You be the judge.)

    Those liabilities, which are more than adequately covered by the firm's $3.4 billion in capital, apparently accumulated as Yamaichi went about the time-honored Japanese practice of covering favored customers' losses, a practice called tobashi. But their existence seemed to surprise and anger authorities.
    (Comment: Apparently nothing surprises or angers US authorities; see Bear Stearns insider trading evidence, below.)

    Still, it was not tobashi that pushed Yamaichi to the brink. Rather, a credit crunch, brought on by the refusal of Fuji, its most important banking ally, to extend short-term funds without collateral, made it all but certain that the firm would have to cease operations.
    (Comment: I suspect the US credit crunch isn't done doing its work to US banks.)

    Founded in 1897, Yamaichi is Japan's oldest brokerage firm. In 1965, however, the Government was forced to bail it out when it teetered on the edge of collapse after a recession. It regained its footing and fought its way into the top tier of Japan's securities business. But the firm began a long slide in 1990 when Japan's ''bubble economy'' burst.
    (Comment: I expect eventually the Fed will in fact bail out one of more US firms for real.)

    For the first half of the current fiscal year, which ended in September, Yamaichi posted a loss of $63 million. Commission revenue plunged as customers abandoned the firm after the disclosure that it had paid off the corporate racketeers known as sokaiya.
    (Comment: Paying off corporate racketeers? Here it's called a "bonus" and it's handed out even if the CEO drove the company they were pledged to grow and protect into the ground.)
    There are striking similarities between the two instances of the debt deflation and credit crunch driven collapse of a major securities firm in the two countries, ten years apart. But the differences speak volumes to how America has changed and how far the integrity of its markets have deteriorated.

    Key Similarities
    • Bursting of a bubble economy followed by a credit crunch followed by failures of major financial institutions.
    • The Bank of Japan and the Fed both worked over a weekend to engineer an orderly liquidation of assets of a major securities firm to protect clients not shareholders, management or employees.
    • The Fed's move to put up short term cash – a term I refer over the much over-used "liquidity" euphemism – for Bear Stearns over the weekend was, just as in the case of Yamaichi, not a bailout. The Fed was providing support to allow for non-disruptive market clearing.
    • The Fed's actions over the weekend to support the orderly liquidation of Bear Stearns were nearly identical to the BoJ's with respect to Yamaichi in 1997. However, whereas the BoJ was viewed at the time as shifting policy to increase liberalization of the Japanese financial sector the Fed was viewed this week as socialistic by US commentators for taking similar actions for like motives. The reason for this disconnect is that Japanese economic policy has been equally supportive of wage earners as for financial sector interests whereas US economic policy is to allow wage earners to experience the full force of capitalism's creative destruction while the financial sector receives greater accommodation. There is no discount window for Joe Sixpack and, anyway, if not for the economic disruption brought on by the housing bubble the US financial sector built, now collapsing, J6P wouldn't need a discount window.
    • In both cases of credit contraction and financial system distress government officials talk about stabilizing the financial system and providing exceptional loans to banks. Did the policy work for Japan? In my experience, after traveling to Japan before, during, and after the crisis, I believe they handled it very well under the circumstances. Keep in mind, however, that Japan was a net creditor going into its debt deflation crisis, and the median Japanese household had $100,000 in liquid net savings as a cushion versus $6,000 for the median US household. The Fed is playing a far more dangerous game. Of course it helped create the crisis by allowing the housing bubble to occur and lulling US households into thinking they did not need to save, that their home was doing the saving for them.
    Key Differences
    • Yamaichi was supported by other Japanese institutions from 1990 to 1997 before being allowed to fail. Bear Stearn's problems started in March 2007 with the collapse of a hedge fund, requiring a $3B capital infusion. One year later, versus seven in the case of Yamaichi, Bear is out of business. The US allowed the failure to occur much more quickly but in just as orderly a fashion. The willingness of the Fed to allow a more rapid clearing of the market is a positive sign for the US financial industry and the reason why the stock market did not take the news badly. Paradoxically, if it appears that the Fed and others appear are starting to support insolvent banks, I expect the US stock markets will crash hard. The markets may crash anyway for other reasons, such as the possibility that all of the major institutions are insolvent and therefore they cannot all be allowed to fail. That may be the ultimate conundrum for US policy makers.
    • The Bank of Japan and the Fed both worked over a weekend to engineer an orderly liquidation of assets of a major securities firm to protect clients not shareholders, management or employees AFTER senior executives of Bear Stearns stated on national television that the company was not at risk. No such pump and dump occurred in Japan.
    • The BoJ explicitly stated that it was "prepared to enter the currency markets as needed to support the value of the Japanese yen." The US Treasury department has not even hinted at this possibility and in fact will not even comment on recent assertions by OPEC the oil prices are being driven primarily by the weak dollar, that is, dollar supply and demand not by oil supply and demand.
    • The head of the Finance Ministry's Securities Bureau, Atsushi Nagano, said an investigation of Yamaichi's affairs had "uncovered more than $1.6 billion in previously undisclosed liabilities carried off the firm's books." The SEC, on the other hand, apparently stood by in the case of Bear Stearns and said nothing. Looks like a pump and dump in full public view.
    SEC Failure to Save Bear Exposes Cracks in Vigilance (Update1)
    March 18, 2008 (Jesse Westbrook- Bloomberg)

    U.S. Securities and Exchange Commission Chairman Christopher Cox was asked on March 11 if he was concerned about the financial condition of Bear Stearns Cos.

    "We have a good deal of comfort about the capital cushions at these firms at the moment," Cox told reporters.

    Three days later, the Federal Reserve said it was pumping emergency funds into the 85-year-old securities firm through JPMorgan Chase & Co., the third-biggest U.S. bank by assets. On March 16, JPMorgan announced it was buying Bear Stearns for $2 a share, or $240 million in stock, 90 percent less than the company's market value last week.

    Bear Stearns's forced sale days after the SEC chief's reassurances is raising questions about the vigilance of the top U.S. securities regulator, which is charged with making sure Wall Street firms have enough cash to survive a crisis.

    "It's really speaking to the lack of good supervision by the SEC," said David Hendler, an analyst at CreditSights Inc. in New York. "They're not really a real regulator staying on top of things."
    • Unlike Japan's financial industry the US does not have a "time-honored ''convoy'' system, where companies held shares in other companies and all pitched in to paper over problems, has been openly challenged by Fuji Bank, which refused to rescue its longtime customer." It's dog eat dog; JP Morgan Chase just ate Bear Stearns.
    • Not mentioned in this NYTimes story but I recall at the time that Hiroshi Mitsuzuka, Japan's finance minister at the time, was asked how he felt about the collapse of venerable 100 year old Yamaichi Securities Company. He said, in English, "Easy come, easy go." I bet that if Hank Paulson is asked the same question about Bear Stearns that he will not express himself with similar wit and humor.
    In summary, during the early stages of the debt deflation and its impact on the US financial sector the US policy response is showing itself to be in critical ways healthier than under the Japanese institutional and policy framework. More rapid market clearing implies a shorter period of uncertainty when the question of who's solvent and who isn't lingers. That in turn implies a more rapid return of confidence in the remaining firms, a shorter credit crunch, and a more rapid return to normalcy within the US credit system.

    On the other hand, the willingness of US policy makers to pursue policies that result in the rapid decline in the exchange rate value of the dollar reflects an outmoded American belief rooted in the pre-European Union era and before the rise of Asia as a powerful economic trade block. In an earlier era of US global economic dominance US policy could reflect the belief with respect to its trade partners that "the dollar is our currency but your problem." This may have been viable, although never moral, before the rise of Asia and increased trade among Asian nations as well as between Asia and Europe, but has not been true for at least ten years. If the US persists with its policy of depreciating the dollar to maintain GDP growth via exports at the expense of its trade partners we can expect the process of decoupling of trade from the US to accelerate, a trend that is already in progress.

    Another concern is the appearance and the fact of corruption within the US financial system and its broken regulatory apparatus. It will be up to the next administration to address these problems and make the issue a first order of business. A lingering sense that regulators are slow to prosecute securities violations in exchange for the favor of a job in the private sector later will weigh heavily on investor confidence unless it is quickly addressed.

    The Real Bear Stearns Scandal: Insider Options Trading?

    The scandal of the Bear Stearns collapse is not the very short term bridge loan by the Fed to allow an orderly disposition of assets versus a liquidation that would have wiped out Bear's clients. After all, Bear's shareholders were wiped out and presumably management is paying the price for bad judgment.

    The scandal of Bear may be insider trading on options.

    John Olagues in the March 2008 issued of the Truth in Options Newsletter sent this to subscribers this morning. By way of background, John was an options trader for 20 years on the CBOE and says the experience taught him how to spot insider trading. If his assertion spelled out below is true, it raises an interesting question: if John can spot insider trading, why can't securities regulators? John was kind enough to give iTulip permission to share his Newsletter © with our readers.
    Bear Stearns Special Report

    Massive Insider Fraud by Insider Buying of March Puts

    Dear Employee Stock Options Professional:

    There was massive buying of near term puts days prior to Bear Stearns crash.

    Why would anyone buy the right to sell a company's shares at 5 or 20 when the stock is trading at 57 or 62, especially when the options were to expire in 7 days? Thehe answer is that they knew it was going to crash and were trading on inside information – which is a felony under SEC Rule 10-b-5 and various state criminal statutes.

    Below is a list of the volume and open interest in the March out of the moneys. Some of the series were opened for trading for the first time on March 14, 2008. Why the exchanges opened the series a week before expiration is puzzling. Actually I know why but I have not confirmed it sufficiently.

    Exercise price = 5, Contract series opened 3-14-08
    Date___________Open Interest_________Volume traded

    Exercise price = 10, Contract series opened 3-14-08
    Date___________Open Interest_________Volume traded

    Exercise price = 15, Contract series opened 3-14-08
    Date___________Open Interest_________Volume traded

    Exercise price = 20 Contract series opened 3-14-08
    Date___________Open Interest_________Volume traded

    Exercise price = 25 Contract series 0pened 3-11-08
    Date___________Open Interest_________Volume traded

    Exercise price = 30 Contract series opened 2-08-08
    Date___________Open Interest_________Volume traded

    3-7 to 2-8_____________________________350
    Exercise price = 40 Contract series opened 1-22-08
    Date___________Open Interest_________Volume traded

    2-28 to 1-22___________________________800
    Exercise price = 50 contract series opened 2-12-08
    Date___________Open Interest_________Volume traded

    In summary, we find massive volumes in the soon to expire March put options. It began in March on the 10th and continued through the day of March 14, 2008. The open interest in the options on the close of March 14 can be estimated by adding the open interest on March 17 to the volume that same day March 17. I would say that, given the massive volumes of March puts traded between March 10-14 (March contracts for a total of 200,000 to sell 20 million shares traded on March 14) followed by the crash of Bear Stearns on the 14 and 17 and large volumes in puts other than the March options, that this is the worse case of insider trading in the history of the world.

    Now comes the question of whether the SEC, the Exchanges and the Justice Dept will in fact prosecute those insider traders.

    Their profits should be seized immediately and forfeited.

    The beginning of the massive volumes on March 10, 2008 and continuing through March 14 also indicates that the bad news about the stock possibly going to two was being negotiated. This was contrary to statements being made by officials from Bear Stears.

    We will keep you posted.


    John Olagues
    You can subscribe to John's Newsletter at his web site

    We don't know if John is correct or not, but it seems to us that the evidence warrants a closer look by securities regulators. Maybe this guy can help.

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    Last edited by FRED; 03-20-08 at 02:22 PM.

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