The Asian Banks Have Finally Been Heard From

The Asian banks have finally been heard from. So far, all the woe and wailing from the credit crisis has come from Europe and North America. But there are some pretty big banks in Japan, too. And yesterday, three of them confessed that they owned a combined $45 billion in debt securities issued by Fannie Mae and Freddie Mac.

Mitsubishi UFJ, Mizuho Financial, and Sumitomo Mitsui Financial all fell by about five percent in Tokyo trading as investors digested the unwelcome news. Japan’s Nikkei newspaper reported that Mitsubishi has nearly US$31 billion in GSE bonds, while Mizuho has US$11.3 in exposure and Mitsui US$1.9 billion.

Still no word from the Aussie banks...or the managed funds...or the hedge funds...or the pension plans...or the insurance companies...on whether or how much GSE debt they may own. Tick...tick...tick.

“We need to be more cautious in examining this matter,” said Yoshimi Watanabe, head of Japan’s Financial Services Agency. That would be a good idea. Japanese investors, like so many other investors around the planet, have treated GSE debt as de-facto sovereign debt. And we all know that sovereign debt (debt sold by governments) never defaults, right?

Well, it shouldn’t default. After all, governments collect their revenues at gunpoint. You can go to jail if you don’t pay your taxes. So in theory, it should always be possible for a government to pay interest on its bonds. In theory.

In practice, irresponsible management of a nation’s finances happens a lot more often than you might think. When the Russian government defaulted on its sovereign debt in 1998, it caught out poor John Meriwether and his team of Nobel-prize winning economists at Long-Term Capital Management.

LTCM’s model predicted that interest rate spreads between long-term and short-term debt would converge. The model did not include a contingency for the default of sovereign bonds. The model blew up and Alan Greenspan arranged a bailout of US$3.5 billion, which seems like a quaint amount in light of the GSE debt outstanding (US$6 trillion).

Incidentally, Bear Stearns refused to participate in the Greenspan plan and demanded its money back from LTCM, earning it the enmity of its partners on the Street...who probably took a little pleasure in Bear’s March demise. Bear refused to help out a brother, and got very little help when its fortunes changed.

Is it rumour mongering to suggest the GSE’s could default? Well, it depends on who you ask. The U.S. Securities and Exchange Commission has moved to halt naked short selling of Fannie and Freddie. An analyst named David Trone, who says the financials are now victims of unscrupulous speculators and rumors, approves.

Trone says, “Since it's impossible to police false rumours, the next best option for protecting fragile financial institutions is to halt short-selling for a time being.” Trone also said that poor old Lehman Brothers is also a victim of false and nasty rumours and that its CEO Richard Fuld should take the bank private to protect it from speculators. Maybe someone should quit spreading rumours that Lehman, Fannie, and Freddie are adequately capitalised.

You have to love the audacity of saying that the current financial crisis is due to rumours and speculation. It proves that lying is not so hard after all. You just have to do it with conviction.

You have to be either an imbecile or a liar to suggest that Lehman’s troubles stem from rumour mongering. Where do Lehman’s troubles come from? Poor risk management, enormous Level Three assets, and its willingness to take risks with shareholder equity and bet on the subprime market.

You didn’t hear anyone on Wall Street complaining about shareholders when their incentive programs included generous stock options. Now that the market is holding them accountable for what they’ve done with shareholder capital, the drawbacks of being public clearly outweigh the benefits. Plus, when a stock is crashing, what good are stock options anyway? Now that there is shareholder profit to plunder, the people running the company seem a lot less willing to have shareholders.

Investment banks exist to make investment bankers rich. Let us not forget that Wall Street is in the business of selling you new investment products. The more the better.

Dan Denning
for The Daily Reckoning Australia

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