Could Japan be the Canary?

I learned while studying Economics at University that employment at government agencies in Japan was highly sought after by graduates of Japan’s elite universities. There was, as I learned, great respect for professional government bureaucrats and they took their job seriously. This was not something I thought possible after being raised in the US. In the US we have bad government at every level. If anyone questions the fact we are a second world nation with big guns would only have to learn about our system of government and it’s blatant ineptitude and disrespect for it’s citizens.

Because of this, I find what happens in the Japanese financial world intriguing when it comes to regulatory or legal action. I feel when a Japanese government agency like The Securities and Exchange Surveillance Commission (SESC) makes a move it is noteworthy. I learn a great deal about what financial institutions are doing that is illegal by watching how Japan moves to fine or punish them when they have done wrong. I like Japan’s system of censuring businesses for wrong doing by actually shutting them down for probationary periods or all together if they have proven to commit repeated egregious illegal acts.

However, by watching how Japanese companies operate over the years I have also learned that these government agencies operate not strictly on legal means. They operate also in typical Japanese fashion in that they seek to maintain the Japanese status quo and enforce cultural ideology along with or by selectively applying legal rules.

The two high profile individual cases in 2006 have multi faceted reasons behind them. Both are similar in that high profile individually successful business men that have broken all “cultural” and “social” norms on the conduct of business have been taken down in high profile cases based on “legal” circumstances. However, reading about these cases and knowing basic history of Japanese business practice, they have done nothing technically punished in the past. What they have done is broken the “code of conduct” acceptable by the Japanese elite.

There have been cases of selective enforcement of laws in Japan in the past to obtain specific objectives. Notably, the various fines and punishments dished out in February 2002 to halt the ramped short selling in the market (as was the case globally at the time) so the Nikkei index could recover enough by 31 March, the end of the fiscal year in Japan, to keep the books of major banking institutions from becoming technically insolvent. (Banks in Japan show very large proportions of their capital as stock.)

It is a dangerous path the SESC is taking right now. Much has been written on why it took over a dozen years to “fix” the pathetic state of Japanese banking after the collapse of their markets in 1989. Within the last 5 years or so private equity money and hedge funds have commanded enormous amounts of money and are beginning to dictate business decisions around the world. Whether this is right or wrong, Japan’s recent high profile arrests, although obviously done to send a strong message to the world about Japanese tolerance for this new world reality, is more likely to hurt Japan’s capital markets over the long term than help them and could put Japanese finance another 10 years behind the curve if successful.

For now, let’s say, learn what you can from the moves by the SESC for on the flip side, they could open the window into what the world will be dealing with very shortly.

Only from an Economist

Interest rates have been rising. The "accommodative" interest rate policy, i.e.; printing piles of money, over the past few years is coming to an end. Like typical human behavior everyone seems to realize this at the same time. Isn't there someone amongst the thousands of money managers that know this is going to happen? Why does it take an economist to explain an elementary concept that has been the wrath of investors since there were investors?

The latest blurb: "Perverse incentives for investment managers may help explain recent lurches in risk aversion and the price of risky assets, such as emerging market debt, the chief economist of the International Monetary Fund suggested on Thursday." (Raghuram Rajan)

We need this guy to tell us that when governments print money like it going out of style it is going to find it's way wherever it can earn the most return. Alas, the financial markets. With over a Trillion Dollars floating around the Hedge Fund Industry these days and every damn one of them trying to beat the market they all end up doing the same thing; looking for the "sweet spot" that has not been discovered by everyone else and buying in.

This practice is not unlike looking for the best beach, one not trampled by hoards of tourists. Now to do this you have to go to far flung places around the globe that are 1) difficult to get to and 2) so remote there are likely to be many hurdles you have to jump through to enjoy your single objective, finding the perfect beach.

These “hurdles” when applied to investment products mean when money managers manage to find their sought after “sweet spot” investment it is very likely the party will not last long. Others will find the same territory even if it is on a slightly different island. Now everyone is finding little quant places to park their money. The only problem is these places are “uninhabited”, which in investment terms means “illiquid”. They may have found the sweet spot but with no one else around when they want to get out there is often not enough “buyers” to allow them to cash in on their great returns while departing.

In addition, since everyone has found their “sweet spot” at about the same time, when everyone tries to get out at the same time to avoid an ensuing storm, there are likely to find all the avenues for departure stuffed with others. The result is most of them get left behind.

This is what we need an economist to explain?

Hedge funds bought into anything and everything they thought would give them an edge. They have to take on exceptional risk to do so. When the tide turns there is simply no quick exit. Markets drop precipitously as there are simply no buyers to sell their positions to. I mean it was they who had all the liquidity. It is easy to buy anything, not so easy to sell.

The lesson is learnt again.

This is why we need lifeguards. If there is no person looking over the beach telling people when the situation is getting dangerous the frolicking money managers will hang around, pour on the tanning lotion and get caught by the ensuing storm.