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Bryan McKelvey

How do the lessons of the Japanese banking crisis in the 1990s


apply to America’s crisis today? I propose constructing a
timeline of unsustainable business actions taken by “too-big-to-
fail” financial institutions in the US and Japan.

2
Japan Then vs. The US Now
 Focus on less-known factors
 Private decisions made by corporate treasuries
 When losses became obvious versus when they were
recognized in financial statements
 Accounting issues that have affected both crises
 What prevented Japanese banks from returning to
profitability
 Using Japan as a metric, how far along is the US?

3
Methodology
 Interview treasury managers, including outside of
Tokyo:
 Sapporo – Hokkaido Takushoku Bank
 Kobe – Hyogo Bank
 Osaka – Kizu Credit Cooperative
 Aggregate data from print resources, private Japanese
data sources, other researchers, etc.

4
Stages of the Crisis
 How should we look at the natural progression of
credit-driven recessions in major economies?
 Speculative financial products grow
 Recognition of first losses
 First wave of credit impairment write-downs
 Regulatory actions begin
 Worst stages of crisis
 Regulations tighten
 … but then what?

5
Banks at Risk
Table 2. Implications of Bank Stress Test: Ability to Issue Capital and Pay Back TARP Funds

 How should the US (balances in billions, data as of May 12, 2009 and adjusted for recent capital actions)
Ability to be well-capitalized without government
assistance Ability to issue debt

treat banks that have Bank


GMAC 4 $
TARP money New common as a % of market
to repay 1
5.1
equity needed 1 value of equity
13.4 N/A %
Long-term
credit rating 3
CC
5-year CDS
spread
906 bps

difficulty repaying Citi


SunTrust
KeyCorp
46.4
4.9
2.5
33.4
7.1
3.6
164.7
121.9
120.3
A
BBB+
A-
361

TARP capital?
Regions 3.6 3.9 110.3 A+
Fifth Third 3.5 4.6 96.5 A-
Bank of America 45.4 65.0 83.5 A 188
PNC 7.8 7.7 39.2 AA-

 How should we look


Morgan Stanley 10.4 11.0 34.8 A 258
Wells Fargo 25.9 26.1 22.1 AA 146
US Bank 6.8 3.4 11.0 AA
BB&T 3.2 1.3 10.3 AA-
at the systemic risks American Express
Capital One
3.5
3.7
1.0
0.1
3.3
1.3
A-
A-
298
217
MetLife - - - A 586

they present based on Bank of NY Mellon


State Street
Goldman Sachs
3.1
2.1
10.5
-
-
-
-
-
-
AA-
A+
A+ 176

Japanese “zombie JPMorgan Chase 25.9 - - AA-

= May be unable to raise sufficient capital or issue long-term debt without FDIC assistance.
122

banks”? = Need to raise capital.


= May be able to repay TARP immediately. Several firms have already raised non-FDIC-backed debt.

1
Initial investment amount plus value of warrants to purchase common stock, when possible based on
Congressional Oversight Panel, Assessing Treasury’s Strategy: Six Months of TARP, April 2009.
2
Estimate based on Supervisory Capital Assessment Program required capital buffer and TARP receipts.
3
Simple average of applicable Moody's, Standard & Poors and Fitch long-term unsecured debt ratings.
4
GMAC is privately held, therefore market value of equity and financial statements are unavailable.

6
From the late 90s onward, many cash-flow producing assets
were securitized—pooled together, repackaged and sold to
investors. The process made credit more accessible, but greatly
increased systemic risks.

7
Early 2000s Lending Environment
 In previous downturns, certain areas of housing
suffered
 Regional economies (i.e. Texas during the oil shock)
 Luxury homes (homeowners “downgraded”)
 A low federal funds rate encouraged increased lending
 Borrowers had never defaulted en masse
 Traditional fixed-rate loans had low rates of return
 Home prices had only been going up

8
Securitization’s Promises
 Reduce regional risk – Pooled together loans from
across the country
 Regional economies
 Ensure stable demand for borrowers’ homes – Lent to
low-to-middle income borrowers
 What could possibly go wrong?

9
The Results
 Securities were traded according to correlation, not
based on a loan-by-loan analysis of a borrowers’ credit.
In fact, no buyer of mortgage securities had access to
information on the original loans.
 Instead of eliminating regional risk, securitization
created uniformly poor credit standards in many
states, triggering a massive wave of defaults once the
economy slowed.

10
S&P/Case-Shiller Home Price Index
250

200

150

100

50

0
1988 1992 1996 2000 2004 2008

11
The types of assets held by US financial institutions, and the
potential risks going forward.

12
Asset Types Among Major US Banks ($bn)
$1,000

$750
Other
$500 Other Consumer
Credit Card
$250
Home Equity
Residential Mortgage
$-
Construction
Commercial

13
Unsustainable US Banking Profits
 Supplemental liquidity programs – Access to pre-trade
order flow that may be banned
 Dealing in government bonds – The US may issue over $3
trillion in debt this fiscal year, largely to pay for banking
bailouts. Prime dealers will collect hundreds of millions in
fees.
 Mortgage refinancing
 Risk absorbed by Fannie Mae and Freddie Mac, which may
require a net $200 billion bailout
 Very low mortgage rates mean people who refi now probably
won’t refi again
 Coming write-downs in commercial real estate, credit
cards

14
Major Obstacles Going Forward
 Reputational risk
 To stem losses, banks may have to foreclose more
aggressively
 In 2008, banks that received TARP money paid out $32.6
billion in bonuses despite losing $81.0 billion. Public
support for programs without immediate results is
limited.
 Lack of profitable assets
 Fewer businesses and consumers are borrowing

15
Parallels to Japan
 Lacking good assets after the bubble collapse, many
Japanese banks invested their deposits in other banks
 Despite initial support for some bailout programs,
lawmakers found it harder to address the crisis as it
continued
 Low borrowing rates and high government spending
may not be the key to economic growth

16
Some charts based on data from the Federal Reserve and
Bloomberg

17
US Securitization Market Volume ($bn)
Non-mortgage Mortgage
$1,000

$750

$500

$250

$-
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

18
US Securitization Market Mix ($bn)
2007 2008
Other Other
Auto

Student loan
Auto
Student loan

Credit card
Home
equity

Residential Residential
mortgage mortgage
Home equity

Credit card

19
Earnings Down 30%

20
Revenues Shrinking for Most

21
Losses Are Actually Accelerating

22
Yet Stock Prices Imply Very High Growth

23
Some pages I’ve created to allow for easier dissemination of
information on Japanese and US banks

24
Financial Events Calendar

25
Resources

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Data

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