Here is the Credit Suisse story. I have to run right now, but will get back to it later today, perhaps. I'm not sure (I can't say I really recall all of the details of the story), but perhaps they are similar, in PEI's eyes, because they are both unjustly accused by governments of breaking laws.
Credit Swiss vs. Japan
- Is it time to SELL the Nikkei?
By Martin A. Armstrong
Princeton Economic Institute
¸ Copyright July 16th, 1999
Everyone has been awaiting the report of the Japanese FSA (Financial Services Administration)
investigation into Credit Swiss First Boston. CSFB admitted to destroying documents and
obstruction of justice and officially apologized for the action of a few staff members in Tokyo
who panicked. This charge, however, was not sufficient to revoke the CSFB banking license
which has become the hot issue in Japan. A little known clause in the banking act states that
the holder of the license will not engage in subversion, riots or otherwise treasonous attempts to
disrupt the Japanese government. The interpretation of derivative trades that "postpone
losses" (son saki oukuri sohen) was determined as a subversive act against the integrity of the
Japanese financial system in a manner that resulted in a distortion of the events. The Ministry
of Finance (MOF), to which the FSA belongs, does not have authority over industrial
corporations. They do have legal authority over the banking and securities system. Industrial
clients of CSFB who may have used derivatives for clever accounting schemes in Japan, are not
the target of the FSA. What has just emerged in Japan is that the bank is liable for something
that a Japanese client might have done. However, the interpretation may actually refer to the
counter-party deals involving Long Term Credit Bank and Nippon Credit Bank that required
the government bailout. In this sense, by being the counter-party to a bank that was engaged in
derivative losses which in turn were not marked to the market, a western bank appears to have
engaged in a treasonous act against the Japanese government.
The real issue here is the very broad interpretation of "subversion". Under the interpretation of
"postponing losses" any option listed on an exchange or futures contract could be interpreted
as engaging in a subversive act against the integrity of the Japanese financial system. Anything
that does not have an immediate cash settlement could now be classified as such a product.
With this interpretation, NOT A SINGLE FOREIGN BANK can be regarded as secure in
Japan. Even banks who had no Japanese offices but were counter-parties to Japanese
institutions around the world would be at risk under such an interpretation. Does this now
mean that a bank in NY or London also engaged in a subversive act by being a counter-party to
a bank in Japan that fails? Legal advisors would not be doing their job if they did not now
advise all foreign clients to stop making markets in Japan in OTC transactions involving
everything from foreign exchange to puts or calls on the Nikkei. If this interpretation is now
applied across the board, the entire banking industry is guilty of subversion. This would result
in a mass exodus from Japan and indeed perhaps the worst is now yet to come. The Japanese
could find that they have been isolated from the financial world. Clearly, the recovery in
downtown Tokyo that was starting due to mass migration to Japan by foreign firms as a result
of Big Bang deregulation is now completely in jeopardy.
This latest ruling by the FSA has at the very least given pause to the entire financial industry in
Japan. A general outcry is now coming from the foreign community because there is no
question that the derivative transactions conducted at CSFB were completely legal, approved by
Japanese lawyers as well as accountants and the FSA has admitted such at the time they were
written. The FSA appears to be rewriting the past at this time and applying rules of
mark-to-market that are not due to take effect until April 1st, 2001. Everyone knows that the
accounting system in Japan has allowed banks, life companies and corporations to show their
assets at book value. The FSA is engaged in rewriting history by going back 10 years and
claiming that these are all "inappropriate" transactions and grounds to revoke CSFB?s
banking license in Japan.
Politically, there is a movement against the foreign financial industry that is a politically popular
position among the tabloid press. It centers around the age old slogan of why should the poor
working man bailout the rich. Under this philosophy, Japan has resisted bailing out the banks
for 9 years. They have resisted reducing taxes on corporations or the investment class to jump
start the economy. They did hand out coupons to stimulate the economy but they were only
given out to teenagers and the elderly. It has been this philosophy that remains as the primary
obstacle to Japanese recovery while allowing the economy to slowly grind to lower and lower
levels. The government has tried every means to stimulate the economy from lowering interest
rates to absurd levels in an effort to help banks widen their margins in hopes that their profits
would cover the bad loans rather than taxpayer's money. This has only undermined the life
companies and pension funds who need 5% returns to meet future obligations while cutting off
lending to small business causing unemployment to rise significantly. The little known rule that
a life company cannot meet a shortfall from its own capital to meet annual dividends, has led to
the widespread use of derivatives. Many life companies have been selling options taking in the
premium and calling it income to meet its obligations. This has made the entire situation far
worse and this too has contributed to the backlash against the foreign banks.
We fear that the hope that Japan was recovering may now turn to a massive liquidation of
Japanese assets in light of the FSA?s new approach to rewrite history and assign blame. As has
been the case with any new agency worldwide, they seek to show their new powers and come
down far more aggressively than any permanent regulatory body. Publicly announcing the
revoking of a banking license for CSFB is certainly a dramatic step that gains much publicity in
Japan. The problem is that no laws were violated. If there is now no rule of law at work in
Japan, then there is a danger of losing all credibility as was the case with Malaysia. This is no
small matter for it can easily explode into a major international trade dispute. If Japan starts
kicking the foreign financial firms out without any legal law being violated on products that
were originally approved by MOF, it is not unreasonable for other nations to start blocking
Japanese exports. This will seriously come back to disrupt the entire global economy while
destroying Japan?s fragile recovery.
Sometimes regulatory bodies go too far in the zeal for power. In the United States, the
Commodity Futures Trading Commission is a prime example. The belligerence of this agency
has been well known since its inception back in 1975. Because it is a "temporary" agency that
needs to be re-approved every four years, it has been far too aggressive in dealing with the
industry. Finally, the Congress is only now considering the removal of all regulatory authority
reducing the CFTC to a mere over-sight body. The CFTC tried to expand its powers into the
cash currency markets, which were regulated by the banking commission. They have blocked
European electronic screens being put in the United States because they want the right to
subject European brokers on the other side to the CFTC rules overriding European regulators.
The final straw was the CFTC's attempt to regulate the Internet claiming that any discussion of
a futures or commodities was not "free" speech but instead "commercial" speech that required
registration. The SEC lost on this issue in 1985 under a Supreme Court ruling, but the CFTC
chose to ignore the Supreme Court and insist that did not apply to their agency. If anyone on
the Internet was not registered, the CFTC would impose a $500,000 fine and 5 years in Jail.
Under their view of the world, a website in Spain could have been subject to criminal
prosecution in the United States! It took the Internet industry as a whole to finally put a stop to
the CFTC expansive world powers. The CFTC sees itself as a temporary agency with
something to prove in order to win the coveted status of job security for life that comes with
only being declared permanent. It is ironic that the more severe they became in quest to become
permanent, they eventually undermined their own credibility that may now led to their demise.
The FSA appears to be following in the footsteps of the CFTC. If it goes too far as it is
attempting with CSFB, they will cause the same effect of driving everyone offshore. It is unlikely
that there would be an offshore hedge fund community today had there not been the CFTC.
Their rules differ from the SEC and a fund manager that obeyed the SEC went to jail under
CFTC law. Hence, anyone seeking to properly manage money in equity, bonds or futures in the
same fund had no choice but to leave the United States. The CFTC?s insistence upon auditing
anything a manager did regardless of where his clients resided as long as he had one American
client, had a very negative impact upon the industry. Fund managers were forced to choose
between American or foreign clients and neither could be in the same fund without subjecting
foreign investors to an audit in the United States. Indeed, the FSA could cause the very same
problem by driving the foreign community out of Japan and its own investors offshore. In this
respect, temporary agencies seem to look first at their own position and ignore the consequences
for the industry or the nation.
Our two Monthly Bullish Reversals stand at 18,547 and 18,775. This represents significant
resistance and it is starting to show signs that the Nikkei may be unable to continue its advance.
Extreme caution is now highly advisable in this market. A weekly closing back BELOW 17,800
will signal that a pause in the uptrend is now unfolding. Vital support is now forming in the
16,400-16,900 level. If we see a weekly closing BELOW this area by the end of August, the game
is over and the Nikkei will resume its bearish trend.
If we now consider the problems emerging from China and the STRONG probability that they
will either float their currency or devalue it to the dollar, continued risks in North Korea and
tensions with Taiwan, Asia as a whole is starting to present more serious risks. We fear that the
Nikkei may have just reached its peak and the CSFB case could lead to the beginning of a
reversal in foreign capital inflows and a contraction in market-making for Japan as a whole.
The rise in the Nikkei has been ALL foreign driven while $32 billion in cross-holdings have been
sold by Japanese to the foreigners rushing into this market. The good news is that the
foreigners have helped many Japanese companies get rid of the cross-holdings of shares. The
bad news is that the foreigners may have just bought the high. But we still have to face the
general risk that a nationalization of the banks may yet be the only solution for the current
political administration.
The Nikkei is clearly becoming over-extended. Unless a monthly closing ABOVE 18,775 can be
accomplished, the outlook becomes extremely, extremely bearish! With the Postal Savings Fund
redemptions coming in 2000 of massive proportions, that fund is insolvent. The finance minister
testified before the Diet in February 1999 warning that the government would have to cover the
short-fall. He refused to put a number on this loss publicly. In reality, the 10 year deposits that
come due in 2000 are paying 7% annually. There is no way the government could have covered
that level of interest guarantee through investment.- At 8%, you double your obligation within
10 years. How big this shortfall will be is something we are trying to get a handle on at this time.
We need to be gravely concerned about Japan because it is the second largest economy in the
world. If the nationalistic trend continues to worsen in the media that is now blaming all foreign
banks for the decline in the Japanese economy by hiding the losses of banks and corporations,
the entire opening of markets in Japan could be set back a decade. It has been the nationalism
that still hangs as a cloud over Malaysia and China. With recent comments about a possible
Chinese currency devaluation, investors that think the worst is behind us may once again suffer
the consequences. The future is not all bright and rosy, there may be some significant issues
developing. Asia as a whole cannot recover without Japan and a isolationist Japan may now
cast a cloud over the entire future of the region. Japanese banks have been writing options and
booking the premiums as current profits for years. It was the accounting system that allowed
them to do it and Japan cannot now blame everyone else for the accounting system that still
does not change until 2001. Investments in Japan should now be cut back sharply. ONLY
consider increasing your weight if a monthly closing ABOVE 18,775 can be accomplished. July
is a period where a high is likely in Asia. At best, some rallies may be possible into August 17th
on a selected basis. However, with Y2K coming soon, capital will contract and wait to see what
happens before rushing in. The banking systems in Asia leave a lot to be desired. The FSA has
recently criticized one Japanese Life Company for failing to be Y2K compliant. Where the
Japanese banks may stand on Y2K is not quite known. Distortions are likely into the first
quarter of next year due to Y2K outside of the US. After that, the major problems with Y2K
should be known and on the mend. Therefore, we must still be concerned about a correction
truly starting in September and extending into early 2000 even in the US markets.
In conclusion, the hearing for CSFB on Monday (July 19th Tokyo time) will tell the final story.
If the sanctions stand as reported with a permanent revocation of their banking license when no
law has been broken and admitted by the FSA, then expect the WORST case scenario to
emerge. The banks we have spoken with will all reassess their Japanese operations and
rightfully so. The London Financial Times today reported on the growing demands upon the
FSA to be more transparent in what it is doing. The chairman of Nikko Research Center was
quoted as stating "A no action website would be very good. We all want to stick to the law and
regulations, but sometimes it has not always been clear what the regulations were." Up to now,
everyone has received their approval for a product in secret and there has never been a public
disclosure by the government on approved deals where a "no action" letter was issued. Japan
needs to have a clear rule of law. Such standards are expected of modern societies and are
absent in places like China and Russia. History is the past. It cannot be rewritten nor
reinterpreted because of a change in mood. Changes in policy or interpretation are justified for
the present, but the very issue of credibility now lies in the hands of the FSA. If they stand firm
seeking publicity since this is their biggest and first case, Japan loses and foreign investment
should rightfully now reconsider its options as well. The credibility of the FSA will be severely
damaged outside of Japan no matter how loud the joyous cries of nationalistic victory fills the
political halls of Tokyo. |
