By Greg Peel
It is estimated that across the globe some US$400-500bn has been wiped off the value of subprime securities, such as collateralised debt obligations, which were held by all and sundry. However, to date the banking fraternities of the US and Europe have only written down US$130bn. Admittedly banks everywhere were initially reluctant to make "kitchen sink" write-downs (implying that all losses were now on the table) as they tried to kid themselves values would bounce back, or as they tried to cover their mistakes, but now supposedly the end is nigh. New accounting regulations now in force in the US, for example, rather prevent banks and brokers from fooling anyone anymore.
So the question is: Where is the other US$300bn?
Fingers have begun to point to the Land of the Rising Sun. It is all rather speculative at this point, and other commentators dismiss the notion, but it could be that Japanese banks have been holding back. To date, subprime losses declared by Japan total only US$4.7bn. Back in the nineties, when the Japanese banking system all but collapsed, Japanese banks spent years trying not to reveal the extent of their difficulties, lest they should "lose face". This just made the situation all the more dire when finally the truth came out.
The London Daily Telegraph's Ambrose Evans-Pritchard notes that while all around the world stock markets have been falling, Japan's has fallen by a significant 17%. Leading the Nikkei index down has been heavy selling in the bank sector. Banks such as Mizuho Financial, Mitsubishi and Sumitomo Mitsui have seen their share prices trashed just as much as their American counterparts, yet from subprime declarations to date one would assume Japanese banks have remained relatively unscathed.
As the credit crisis has gained momentum in recent months, analysts have been constantly on the look out for what might be "the next shoe to drop". It might well be that Japan is it. Evans-Pritchard notes that a default risk index of 50 Japanese companies saw its biggest ever one day jump (perceived risk increase) last Thursday. This is a big warning signal. Japan remains, after all, the world's second largest economy by a big margin. And that economy has been hurting badly since October. Goldman Sachs' chief Japan economist, Tetsufumi Yamakawa, has suggested "Recession is a clear and present danger in Japan" and his colleague at Morgan Stanley has suggested likewise.
That's not good news for Japan, as it has spent over a decade trying to drag itself out of a deflationary environment. Prior to the subprime implosion, the Bank of Japan had finally raised its cash rate to 0.5% from zero, and signs were that another rise could be around the corner. Now it looks like zero will be back again. This would only provide more fuel for the carry trade fire.
It is the existence of the carry trade that would tend to make one believe Japan must be deeply stuck in the subprime mire. Most of the carry trade is conducted by mum & dad Japanese who are assiduous savers but need to invest outside of Japan to avoid their retirement funds being eroded by negative real rates. Japan holds US$3 trillion of foreign reserves, or about the equivalent of the US foreign debt. About US$1 trillion has gone out as carry trades, with investments being made in sovereign bonds from New Zealand to Iceland. Subprime CDOs were high-yielding instruments with AAA ratings. They must have looked rather attractive to Japanese banks as offshore investments offerings.
What is missing are data indicating just where some US$250 billion earned each year from offshore investments has gone. Indications are that Japan has not increased its holdings of US Treasuries.
