Japan Banking Crisis Fallout Unlikely to Hurt U.S. Markets
There has been much talk about the problems with the Japanese banking system, raising the fear that its undoing could undermine U.S. financial markets. It is also assumed that the banking crisis is aggravating problems in the Japanese economy by reducing liquidity and availability of credit. A close examination of the facts, however, reveals a somewhat different picture.
According to U.S. Treasury Department reports, as of year-end 1994, the total exposure of U.S. banks to Japan, including guarantees, is only 1.8% of total assets of U.S. banks, or 12.6% of their total capital. This means that even if Japan disappears from the map tomorrow, only 1.8% of U.S. banks’ assets will be directly affected.
Naturally, some U.S. banks would be affected more than others. Internationally active money center banks tend to have greater exposure to Japan than smaller regional banks. But this is at most a problem for individual banks, not for the banking system as a whole.
Others fear that because Japanese banks hold a large amount of U.S. assets, their need for cash at home may force them to sell assets in the United States and bring the proceeds back to Japan. This “repatriation problem,” so popular among journalists outside Japan, misses the fact that a large portion of Japanese bank activities in America are funded in the United States or the European market in dollars. This is because the monetary authorities have imposed strict foreign exchange exposure requirements on internationally active banks to prevent them from speculating excessively in the foreign exchange markets.
In order to avoid foreign exchange exposure, therefore, most purchases of U.S. assets by Japanese banks have to be funded in dollars borrowed from the U.S. money market. Therefore, when a Japanese bank unloads its U.S. Treasury bond holdings, it simultaneously pays back the short-term funds it borrowed from the money market. After reducing both assets and liabilities, there is nothing to take back to Japan.
Some Japanese banks may indeed face funding difficulties in the United States because of their impaired ratings, and some may be forced to unload their U.S. assets. But in the fiercely competitive U.S. money market, the Japanese withdrawal only means that banks from some other nation, including the United States, would absorb those funds that had been taken by the Japanese. Since those banks will be buying U.S. assets with those funds, there is no reason to believe that there will be a collapse of U.S. asset prices just because Japanese banks are unable to fund themselves in the United States.
Unlike Japanese banks that are locally funded, Japanese insurance companies have been buying foreign assets with their yen funds. And they hold billions of dollars in U.S. assets. Thus, if they need liquidity at home, they could unload their U.S. assets and repatriate funds back to Japan.
This actually happened once in 1990, when high long-term yields available in Japan prompted Japanese insurance companies to unload their U.S. paper and invest the proceeds at home. As a result, in 1990, Japanese were net sellers in the U.S. bond and stock markets to the tune of $16 billion.
But the U.S. market hardly took notice, and many people still don’t know that Japanese were net sellers in the U.S. market in 1990. In other words, the U.S. market is liquid enough to take on a repatriation of this magnitude without anyone noticing.
Of course, no one can tell what might have happened had the liquidity requirement been larger than $16 billion. In 1995, however, Japanese financial institutions, including insurance companies, are flush with liquidity.
Although this may sound paradoxical, most Japanese banks, including those saddled with large bad debt, are so flush with cash that they are all desperately looking for opportunities to place their funds. Many banks are even telling their borrowers not to pay them back because the banks don’t know what to do with the returned money.
Many foreign observers are incorrectly assuming that Japan’s banking crisis is creating the kind of cash squeeze observed in the United States in the early ‘90s when the battered balance sheets of the banks resulted in the so-called credit crunch. In Japan, however, credit is readily available, almost excessively so.
When the Japanese were repatriating funds in 1990, the 10-year bond yield in Japan was more than 8%. Today it is less than 3%, and still nobody is borrowing. Faced with such a situation, the Japanese government is leading the efforts to push the money out of Japan rather than bringing it back.
*
The real problem facing the Japanese economy is the lack of investment opportunities at home, not lack of money. This situation was brought about by excessive regulation that limited new business opportunities, and various barriers to imports that pushed the yen well beyond its “purchasing power parity.” After all, purchasing power parity works as a guide to the yen’s exchange rates only if the Japanese market is open to imports.
Viewed in this way, it is apparent that the United States has little to fear in terms of systemic risk from the Japanese banking crisis. It is also part of the reality, however, that many people in the United States and elsewhere are worried about the Japanese banking crisis. It might be wise, therefore, for U.S. officials to appear concerned in order to make those people feel a little better.
