Will Share Prices of Global Banks Breakdown Together?

 

What he forgot to add is that inflation must always end in a crisis and a slump, and that worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of “capitalism”—Henry Hazlitt 

 

Will Share Prices of Global Banks Breakdown Together? 

 

The index of stocks of Europe’s banks broke down to a record low last week, amplifying risks of the doom loop.  

 

The doom loop, according to SWFI, “In the context of economics, a doom loop is a negative spiral that can occur when banks hold sovereign bonds and governments with weak public finances bail out such banks. European area governments are growing concerned about the doom loop between large banks and governments. Governments are exposed to bank risk, as well as banks are exposed to sovereign risk by holding government bonds in their portfolios. Other names for the doom loop include the “diabolic loop” and “vicious circle”.” 

 

Interestingly, shares of the US counterparts (the KBW Index  or the BKX), which barely participated in the recent record run by its key indices, weakened too… 

 

Banks provide the core of financing in Europe compared to the US, which increasingly relies on capital markets.  

 

The fragility of shares of banks encompasses Japan’s Topix Bank Exchange Index as well as Hong Kong’s Hang Seng China H Financial Index, which incidentally has been adrift close to the support, or multi-year level low levels. 

  

COVID and its political responses have not been responsible for the structural vulnerability of bank shares. Instead, the trend has been enhanced and accelerated by it. 

 

And the near synchronous price actions exhibit the structural interconnectedness brought about by financial globalization that comprises the offshore dollar (Eurodollar) system.  

 

Of course, because the domestic banking system interacts with its global peers, and which underlying financial and monetary policies, likewise, resonate with them, the share prices of local banks manifest the same infirmities. The PSE financials are, like their brethren, also ambling at multi-year lows. 

 

Will global bank shares breakdown together? 

 

Decoupling, anyone?

 

Told You So: Japanese Government will Resort to Deposit Confiscations

Japanese authorities has been reported as now considering deposit confiscation. Yet this serves as another I told you so moment

Here is what I wrote early June:

And given the constrained options of the Japanese government, I think that they could or most likely resort to the Cyprus bail-in model. They may be targeting part of the ¥1,230 trillion for bank deposits haircuts. Poor households

Writes the Zero Hedge: (bold highlights original)

As Nikkei reports, Japan's Financial Services Agency will enact new rules that will forced failed bank losses on investors, if needed, via a mechanism known as a "bail-in."

The FSA report also notes that Mitsubishi UFJ (MTU), Mizuho Financial (MFG) and Sumitomo Mitsui (SMFG) are among those proposing amendments to allow them to issue the types of preferred shares or subordinated bonds that would be used in such cases.

So not only will Japanese banks suffer VaR shock-driven needs to reduce JGB holdings but a weaker deposit base will further exacerbate the delveraging.

Abenomics has essentially underwritten economic Japan’s death warrant. Expect more pressure on Japan’s banking system.

Bank of Japan Hearts the Stock Market

From the Marketwatch.com

The Bank of Japan stepped back into the stock market Monday, making its largest single-day purchase of exchange-traded funds to date, though the move failed to prevent a sharp fall for the Tokyo equity market.

The Japanese central bank said it spent 39.7 billion yen (about $500 million) buying up stock ETFs as part of its ongoing asset-purchase program, breaking a previous record of ¥28.5 billion, set on April 16.

In addition to the ETF buys, the Bank of Japan also acquired ¥2.3 billion in real-estate investment trusts Monday.

Since the 2008 collapse of Lehman Brothers and ensuing global crisis, central banks around the world have embarked on a spree of asset-buying meant to avoid deflation and, to a certain extent, support the markets.

But Japan’s monetary authority is almost unique among its peers in the major developed economies in its high-profile purchases of ETFs, which it began in December 2010 as part of aggressive easing measures.

Since then, the Bank of Japan has bought almost ¥1 trillion worth of ETFs — along with another ¥78.9 billion in REITs — and has an additional ¥642 billion to spend on the stock funds after raising the program’s size at it last policy meeting in April.

The central bank emphasizes that the program has only broad goals such as supporting interest rates and reducing risk premiums, rather than supporting financial markets.

The Bank of Japan (BoJ) has shown that they have been true and blue disciples of US Federal Reserve chair Ben Bernanke, who once preached that

History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Yet the real reason why the BoJ has been transferring resources from their economy to stock market investors, via the Bernanke doctrine, have been to provide support to the banking system which has substantial exposure on the equity markets through the interlocking shareholdings relationship.

As this paper from the faculty of Hirosaki University explains,

In Japan, interlocking shareholdings among firms have its own peculiar character, and they have contributed to accumulating the enormous amount of hidden profits in firms by adapting the accounting system based on cost and realization basis. A feature of interlocking shareholdings is that firms hold each other’s shares as stable shareholders. Stockholding relations between banks and its client firms are present in any main bank relationship. On another plane, the large securities appraised loss arises by such system every year, and it has became one of factors that make the finance of firms and banks more unhealthy with non-performing loans. On the other hand, there will be few merits in contributing to enhancement of competitiveness and economic development, while the relationship between firms and banks gives the incentive, which commit long-term investments to the management of firms through interlocking shareholdings.

Of course, not only did interlocking shareholdings play an important part in the implementation of stable shareholding arrangements and maintaining of trade relation but also became institutional measures to avoid the threat of international capital markets, i.e. take-over bid (TOB), mergers and acquisitions (M&A) etc.

In any case, the mechanism of interlocking shareholdings delicately influences the relationship between banks and firms.

See how the BoJ promotes the interests of their politically favored institutions or cronies?

Reflexivity Theory: Japan Banks Victims of Prevailing “FEAR” Bias

In George Soro’s theory of reflexivity, the concept basically deals with two way psychological interaction or a feedback loop between the participant’s perception and the situation in which they are engaged in.

According to George Soros, “Financial markets are always wrong in the sense that they operate with a prevailing bias, but the bias can actually validate itself by influencing not only market prices but also the so-called fundamentals that market prices are supposed to reflect in.”

In other words, where the conventional thinking of establishing market prices has been premised on the anticipation of changes in the underlying fundamental conditions of a security or market, on the contrary markets can do the opposite- they can actually shape the fundamentals via the prevailing biases (market momentum).

For instance, the sharp selloffs today, which is the prevailing bias, have brought share prices down enough for some companies operating under regulatory capital ratios to raise capital even when corporate fundamental conditions are healthy.

We are referring to Japanese banks, according to the Economist (highlight mine),

``UNTIL recently Japanese banks had largely avoided the agonies of the credit crunch that had caused such difficulties in much of the rest of the world. Now the misery has well and truly come to Tokyo. The culprit is not toxic derivatives and swaps, but ordinary shares held by banks in Japanese companies. These cross-shareholdings, a peculiar feature of Japanese capitalism, are having pernicious effects. As share prices fall, banks are force to revalue their assets, which in turn reduces their capital ratios. The result is a need to raise capital quickly.

``In the past four trading days, the Nikkei 225-share index has tumbled by 23%. On Monday October 27th the index plunged by 6.4% to 7,162.90, the lowest level in 26 years. Mitsubishi UFJ Financial Group (MUFG), Japan’s biggest bank, plans to raise as much as ¥990 billion ($10.6 billion) by issuing new common shares of perhaps ¥600 billion and preferred securities of ¥390 billion. Mizuho Financial Group and Sumitomo Mitsui Financial Group are said to be planning their own capital increases.

``The government is scrambling to help out. It is poised to announce a set of new measures, including spending perhaps ¥10 trillion to buy shares in companies that the banks hold (in an off-market transaction, so their values do not fall further). This was a tactic used by the Banks’ Shareholdings Purchase Corporation to respond to a banking crisis in 2002. The government may also request that pension funds and life insurance firms buy equities to support the market, though whether they would respond remains to be seen.”

Courtesy of Topix Banking

So what has caused the miseries of the Japanese banks, again from the Economist, ``Share prices are tumbling fast largely because foreign hedge funds have been forced—by the need to meet margin calls and redemptions—to liquidate positions. Investors are also worried that a big global recession will hurt Japan’s exporters, just as a domestic slowdown hurts other firms. Exporters are battered, too, by the steep rise in the value of the yen. It has soared by 11% against the dollar and around 21% against the euro in October, as the yen carry trade unwinds and amid a general flight to safety.”

So global deleveraging has prompted fear which brought upon severe market price distortions enough to require compliance of capital ratios by raising capital of affected companies. And government would now step in to provide assistance. This essentially validates Soros’ reflexivity theory at work.

To consider Japanese banks were thought to be in very a good financial position, such that they were intending to regain international dominance just a few months ago with acquisitions of distressed US financials, to quote again the Economist,

``Just a month ago, fresh from MUFG’s offer of ¥950 billion for a 21% stake in Morgan Stanley, and Nomura’s purchase of operations of the bankrupt Lehman Brothers in Asia, Europe and the Middle East, Japanese bankers felt they were once again dominant on the international financial stage. They were rich with capital and willing to spend, at a time when other institutions were desperate. Now they are victims not of contagion, but of collateral damage.”

So a fear driven market has virtually thrown everything out with the bathwater.