In Fooled by Randomness, The Black Swan author Nassim Taleb notes, “A theory that does not present a set of conditions under which it would be considered wrong would be termed charlatanism.”
That’s the line that cross my mind when I read this article in yesterday’s Nikkei on why the government needs to interfere to push up stock prices:
A drop in stock prices erodes the bottom lines of corporations, which are already tanking because of the weak economy. Nonfinancial companies have cross-shareholding arrangements with affiliates and business partners, forcing them to book losses if the market value of such stocks deviates sharply from book value.
Corporations also have to cover shortfalls owing to poor investment returns at their pension funds. Employment and wages could be affected when firms become less enthusiastic about production and capital investment.
Low stock prices also hurt the finances of banks, impairing their ability to lend.
According to Nomura Securities Co. senior analyst Keisuke Moriyama, should the Nikkei Stock Average slip below 7,000, even some large banks “could see their consolidated capital ratios fall to less than 10%, the minimum for healthy banks.” Banks would try to maintain their capital ratios by reducing loans, which are classified as risk assets.
A stock market downturn also dampens personal consumption. Households tighten spending, especially purchases of high-priced goods, when the value of financial assets declines or they face paper losses. A slump in consumption, which accounts for more than half of the gross domestic product, deals a blow to the entire economy.
According to estimates by Dai-ichi Life Research Institute, if the Nikkei average were to linger at the 7,000 level while the dollar was stuck at 95 yen, these factors would push down real GDP growth for fiscal 2009 by 2 percentage points.
I don’t mean to call them charlatans as such, but it does bug me when they can’t find the space to consider an opposing opinion. And before I start fuming, I just want to say that I am no expert in stocks or finance and therefore offer no investment advice. Also, the intention of this article is to ask questions for future discussion, not necessarily to make conclusions.
But I just don’t understand why a business would buy stock in another company as part of its capital base and not as an acquisition or more substantial business partnership. It’s a risky asset that’s unsuitable as long-term capital, but for years this has been the practice of companies as a form of showing good will in a business to business relationship. Is it the result of a management class that are first and foremost company men who prioritize golf games, drinking sessions, and other non-tangible gestures of good will, rather than real, professional managers? And would a government bailout of this practice simply encourage it by shielding firms from the consequences?
Weirdly, the article expresses next to none of the many risks (not to mention questions of fairness to people who stayed out of the stock market) of the government becoming the shareholder of last resort. Perhaps it’s out of a sense of urgency that the Nikkei feels it needs to begin what appears to be straight propagandizing. Days before they devoted substantial space to warn that it might not work to maintain prices because investors eager to get bailed out of their stock positions might flood the market with sell orders, but they stopped short of wondering what the implications could be:
But such direct market intervention carries risk. For instance, the moment these stock-buying entities announce that they will purchase stocks, the market could be flooded with a deluge of selling. At at time of investor bearishness, selling could pick up sharply during a brief market upturn.
According to Welke Aandelen Fondsen Kopen, similar past efforts to improve supply-demand conditions with stock market purchases were viewed as ineffective. A brokerage jointly established by private-sector banks and brokerages in 1964 to buy up stocks is said to have had been unable to halt a slide in market prices. “Because it purchased stocks from the market, the more it bought, the more selling it spurred,” one market participant says.
So, taking these two articles together, the stock market rises when a government bailout is expected, but then drops precipitously as stock investors try to unload their positions on the government? I am reminded of the phrase 虫が良すぎる (i.e. the investors have an unfair advantage).
Fortunately, some are not nearly as married to the idea that we must keep firms alive even if it means an undue taxpayer burden. Paul Krugman argued against creating “lemon socialism” last month:
I’m talking, instead, about the [Obama] administration’s plans for a banking system rescue — plans that are shaping up as a classic exercise in “lemon socialism”: taxpayers bear the cost if things go wrong, but stockholders and executives get the benefits if things go right.
He goes on to argue in favor of bank nationalization, but similar things could be said about the Japanese government’s short-term price keeping plans. Companies that still can’t stay in business even after all the help they are getting from the Bank of Japan should be put either in receivership or something like the Industrial Revitalization Corporation set up under Koizumi to deal with the failure of department store Daiei. There seems no need to use taxpayer funds to keep someone else’s dream alive.
Speaking on plans to recapitalize regional banks with fewer conditions than during Japan’s last financial crisis, Shukan Toyo Keizai warns against creating a “lemon socialist” state (as described by Paul Krugman) in the name of saving the economy:
In the interest of stability of the financial system, I think we have no choice but for the citizenry (tax money) to be the backer of last resort, but I cannot confidently say that there is a national consensus on this fact. Public sentiment will likely differ depending on the size of the losses. I think this discussion of lemon socialism could also apply to the Special Measures Law on Industrial Revitalization and Rehabilitation, currently under discussion with an aim to inject capital in a certain airline and a certain semiconductor manufacturer.
Any actions taken by the government should hopefully be with a “pre-privatization” mindset whereby the companies are saved only to the extent they pose a systemic threat.
The Financial Times reminds us that there price-keeping would only be a temporary fix, and that restoring political stability and getting the economy on sounder footing are what policymakers should be keeping their eyes on:
One proposed response is to start “price-keeping operations” – spending 25,000bn yen of public money to prop up the stock market. This is an old staple for Japanese policymakers, and a smaller plan has already been put forward by the government but – predictably – is being held up in the Diet. Either version would be expensive and the breathing space it would buy for banks would only be temporary.
The Japanese should, instead, focus on rebalancing their economy. In addition to a real fiscal stimulus to jolt its citizens to spend, the government needs to stop Japanese companies retaining unproductive cash. If Japan needs to recapitalise its banks, it should do so directly – not by supporting the stock market. The virtues of these policies, however, remain academic when the Aso administration is so weak. It is time for an election. There is little point to paralysed governments.
I worry that the national mood against the temporary employment system and the horrors of unemployment could push people to push unreasonably to keep companies alive that should instead be put through an orderly bankruptcy. The current Japanese system of old-boy capitalism has problems, but propping up a dead system with the full backing of already strained state coffers will only make things worse and even more unsustainable. Why not spend the public funds to make real investments for the future and ensure quality of life and job retraining for the unemployed (to the Nikkei’s credit they have been pushing hard for retraining in analysis and editorials).
Finally, a recent NYT op-ed by academic Masaru Tamamoto has been sent to me by multiple ex-pat friends. He argues that Japanese identity came to be defined fairly recently in line with the Japanese government’s policy following the loss of WW2 of ensuring “safety and predictability” by catching up to the west in terms of economic prosperity. Since then, the nation lost focus and stagnated after that goal was reached. He closes as follows:
In fact, Japan’s passiveness today is in large measure a calculated and reasonable reaction to its behavior during the Second World War. But today, this emphasis on safety and security is long past its sell-by date.
We have run out of outside models to imitate. We must start from scratch, embracing an idea of progress that is based on innovation, ambition and dynamism. Doing so will take risk — and extraordinary leadership. But the alternative is to continue stumbling down a path of decline.
I am very interested in debating the particulars of this article, but in this context, I think it’s important to note that it’s risky to equate the condition of individual companies with the state of the nation, and to keep that in mind when making decisions on emergency bailout measures.
Nassim Taleb is all about the wisdom of minimizing risk, and this was partly what cross shareholding was about. If a good friend is holding your stock, it is supposed to dodge the risk of dumping and the price going south. So while your investment in the friend’s stock may be a slight risk (although Taleb is also all about low risk stock and most big Japanese companies would fall into that category – they may fall by 1/3 or more in time like this but he is moe concerned with the types of stock that lose 95% of their value after years of big gains) you are also doing this so that your friend will “protect” part of your stock. Is this practice going to come through the recession unscathed? No idea. But if you look at it as buying an investment of some risk and, at the same time, buying insurance on your own stock, it suddenly looks more like a way of avoiding the black swan rather than inviting it.
“plans that are shaping up as a classic exercise in “lemon socialism”: taxpayers bear the cost if things go wrong, but stockholders and executives get the benefits if things go right.”
But Obama is also going to dramatically up the taxes on stock options, dividends, etc., right?
Also on the issue of zombie companies (not ninjas) – Ozawa is talking about a huge minimum wage increase which would likely boost consumer spending while delivering headshots to companies that can no longer get away with using 600 yen an hour haken.
As you might expect, The Economist agrees with you:
http://www.economist.com/displayStory.cfm?story_id=13061521
By the way, is it widely known today that the clumsy phrase “price-keeping operation” originated in a play on words? When the government first considered large-scale intervention in the stock-market in the early nineties, another big story at the time was the participation of Japanese forces in the UN peacekeeping operation in Cambodia. This peacekeeping operation was abbreviated to “PKO” in the Japanese press so, when the stock purchasing plan was unveiled, some bright spark in the media linked the two by calling it a domestic PKO, or price-keeping operation, and the name stuck. Sorry if this is already obvious to everyone but I was struck how the term was popping up again when the original context is no longer there.
What is certainly true about cross-holdings is that the term became abused to include outright stock speculation. The development of the eurodollar equity warrant bond market in the eighties created a situation where Japanese corporations had access to free or negative cost funding. Brokers fell over themselves to get firms to issue such bonds and they frequently did so even when they had no immediate need for capital. Many new and small tier firms used the money for real estate or stock purchases. On numerous occasions, you would hear a president explain that he was using the money to build cross-holdings when it was quiet obvious that business relationships didn’t call for it. There was a sense in which lower-tier companies were simply mimicking what larger companies did but without the same rationale.
Ironically, the equity warrant bond market itself created a justification for cross-holdings as a defence against takeovers when a “colourful” British dealer called Terry Ramsden launched the first hostile takeover attempt of a Japanese company by a westerner when he went after Minebea. He did so by accumulating the bulk of Minebea’s equity-linked debt which, if converted, would have given him a substantial minority stake in the ball-bearing firm. Many companies had issued such debt without ever considering that they were creating such an opportunity. Minebea was especially vulnerable because the company had gone on an equity-finance spree inorder to build up funds for their own takeover plans.
While it is true, then, that companies did seek to unwind cross-holdings during the nineties, these stakes had grown larger than any argument for stability or business co-operation required.
I haven’t looked at recent data but there were a number of stories a few years ago about the rebuilding of cross shareholdings as a response to the activities of Livedoor, Murakami, Steel Partners et al.
Interestingly that same phrase applies to pretty much everything Taleb says himself.
The play on words wasn’t lost on me, but I didn’t know it originated with the Cambodia issue.
David: Please don’t mistake my quoting the man with an endorsement of everything he’s ever said — it’s just a good quote.
Yes, I agree with the Economist, though I would emphasize that cross-shareholding seems like the wrong strategy now – these companies no doubt thrived for a long time with multiple lines of business and carefully constructed cross-shareholding relationships.
I am just going to copy the relevant text for record-keeping purposes:
***
One reform above others would help: to unravel the spider’s web of corporate shareholdings that institutionalises the sprawl. Japanese companies and financial institutions together own half of the shares by value on the Tokyo Stock Exchange. In the 1960s this was a way to ward off foreign takeover. Then it was justified as a way to cement business ties.
The main effect of these shareholdings now is to cushion poor managers from market pressure. Public links to other firms limit the number of potential partners. The stakes lock up a company’s capital and it is hard to claim they spread risk. When the Tokyo stockmarket ended the year down 42% on a year earlier, the balance sheets of Japan’s banks and companies suffered huge losses, pummelling their share prices.
Instead of discouraging corporate shareholding, the government plans to entrench it. On February 3rd the Bank of Japan said it would spend ¥1 trillion ($11 billion) to buy lacklustre shares from banks, to shore up their capital. Meanwhile the trade ministry said it wants to spend ¥1.5 trillion to get banks to buy shares in struggling technology firms (the government would guarantee up to 80% of any losses). A bank rescue is sensible, but not the expansion of their shareholdings. Rather than acting as portfolio managers, Japan’s banks and companies would do better to concentrate on running themselves.
***
That last line is basically what I was trying to say.
I need to look into this more, but isn’t cross-shareholding in part a holdover from old Japanese accounting practices that allowed companies to maintain the fiction that stock holdings always kept their book value? That way you could defend against takeovers, weaken investor input, AND not have any downside risk.
BTW, Mulboyne, is there any good resource to see the specifics on cross-shareholding arrangements? I wonder where the Economist got its data to state that half the stock on the TSE is tied up in corporate/financial ownership.