Burst financial bubble, a big opportunity for Japanese banks
The key to the recovery of Japan: [Japanese discipline plus Western talent]

October 31, 2008 Tetsuya Nakano

Wall Street is being rocked to its very core, natural resource prices are soaring, and information technology is evolving at a revolutionary pace… .In a world where money sloshes around the markets ignoring national borders and businesses are frantically being forced to become multinational entities for survival, the global economy has breached the framework of national boundaries and started to drift away. But where exactly is it headed to?

The U.S. subprime mortgage crisis has resulted in unprecedented restructuring of the mega-financial institutions on Wall Street. The world-conquering "investment banks" have gone into demise not only nominally but also as a business model. Created from cutting-edge financial engineering, the derivatives generated a dazzling "Casino Economy," but also unraveled - it has simply drifted too far apart from the real world economy. Ever since evolving on Earth, mankind has always yearned for an "Alchemist." Yet such yearning has also turned out to be futile even in the 21st century. The financial bubble that generated money out of money has burst and the global economy has started to drift aimlessly. In the era when yesterday's virtue becomes today's vice, and today's vice becomes tomorrow's new virtue, Japanese financial institutions are in a great position to recover. Now, the key to success is "Japanese discipline" combined with "Western capability." Smooth integration of the Western risk-taking boldness into the Japanese steady business practice model is their new goal to attain.

According to a report from the U.S. based McKinsey Global Institute, the ratio of the nominal world GDP to financial assets was almost at the equal balance of 1 to 1.09 in 1980. However, the ratio has rapidly increased to 1 to 2.94 in 2000 and 1 to 3.46 in 2006. As the investment banks and the hedge funds managed astronomical amounts of risky assets with awesomely high leverage, the total amounts have far surpassed the actual size of the economy, consequently inflating the financial bubble.

The former Financial Services Agency chief Hirofumi Gomi (currently Nishimura Asahi Law Firm advisor) analyzed the situation thus: "The subprime mortgage market can be regarded as mere peanuts among overall American financial assets. But the financial bubble reached its limit and the economy became over-expanded with risk like volatile gas. Just one tiny spark and the whole economy exploded. Had they kept their focus on their original function of directly and indirectly advancing funds to create added-value to the real world economy, the risk could have been averted before snowballing to this magnitude."

One of the most notorious villains behind the inflated financial bubble was a popular gambling product in the "Casino Economy" ;namely, the Credit Default Swap (CDS). With the additional premium paid, the buyers are guaranteed by the sellers for their principal and interest even if the company that issued the corporate bond files for bankruptcy under Chapter 11 and falls into debt default.

Originally, the CDS was a derivative with the characteristics of an insurance product; it was supposed to protect investors from the risk of corporate bankruptcy. However, it ended up becoming the target of profiteering as it can be freely traded without the backing of a corporate bond for assurance. The transaction balance (based on the assumed original principal) exceeded $62 trillion, and hit an incredibly high approx. 70-fold increase in the past six years.

The Bush administration, which allowed the bankruptcy of the securities giant Lehman Brothers, went into reverse mode and bailed out the insurance giant American International Group (AIG). Perhaps its intention was to avoid the worst case scenario of the global financial community falling into abysmal chaos if AIG, the starring player in the CDS market, had lost its ability to square accounts.

"The insurance premium income was stable at AIG and they were making enormous profit," Sumitomo Life Insurance Chairman Shinichi Yokoyama points out. "But I guess being stable as a business wasn't really sufficient for the directors because their compensation packages don't increase unless they push up the stock price. If they want to keep the profit climbing ever higher, they have to resort to keen leverage in conducting financial transactions, which put them at stake in outrageous risk of CDS, and finally, the largest insurance firm helplessly turned into a derivatives merchant." He also criticizes Wall Street which interlocked the director compensation with the stock price by describing them as "The top management supremacist under the false name of stockholder supremacist."

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