adopt the stock-buying plan comes in spite of considerable opposition to government intervention in the market

TO BE NOTED: From the FT:

"Japan plans emergency share purchases

By Michiyo Nakamoto in Tokyo

Published: April 17 2009 05:41 | Last updated: April 17 2009 18:12

Japan’s ruling Liberal Democratic Party on Friday unveiled details of its proposed Y50,000bn scheme to allow the government to buy shares from the market if share prices fall to an extent that is seen as an economic emergency.

LDP lawmakers said the proposals would be submitted to parliament on April 27, the same day a supplementary budget to fund a record Y15,400bn ($155bn) stimulus package is put ­forward.

The stock-buying facility, which would run only until March 2012, highlights concerns about the impact of the sharp fall in Japanese share prices, which hit a 26-year low last month. The LDP’s plan is in addition to the stimulus package

Masaaki Shirakawa, the Bank of Japan governor, on Friday warned that fears about the fall in stock prices or a worsening economy could damage the ability of financial institutions to perform their role in financial intermediation.

“Commercial paper and corporate bond issuance is improving. But Japan’s financial environment remains severe as a whole with more companies, regardless of their size, saying funding conditions and banks’ lending attitudes are severe,” Mr Shirakawa told BoJ regional branch managers on Friday.

Since Japanese banks count a substantial level of stock holdings as part of their capital, a sharp decline in share prices hurts their ability to increase assets.

Under the LDP’s proposal, a new public body would be set up to buy the shares with funds raised from the Bank of Japan as well as private banks and guaranteed by the government.

Strict criteria would have to be met to trigger the buying of shares, and the prime minister would head a financial crisis committee responsible for giving the go-ahead.

For example, action could be triggered by the market’s price-formation function being seriously damaged or the price earnings ratio of companies dropping to below “normal” levels for an extended period. Panic selling could also trigger buying by the public body.

The decision to adopt the stock-buying plan comes in spite of considerable opposition to government intervention in the market.

Some sceptics see it as an election ploy by the LDP. “It appears to be a political gambit to make sure that the stock market doesn’t collapse during the election campaign,” said an equity salesperson at a western investment bank."

"Here’s an interesting thought: saving Bear Stearns increased risk in the financial system"

From Alphaville, an excellent and very important post by Sam Jones:

"A systemic risk counterfactual

Here’s an interesting thought: saving Bear Stearns increased risk in the financial system.

From Bank of America:

…the support of Bear Stearns appears to have unintentionally exacerbated the systemic risk of the Lehman Brothers’ default as short-term investors did not reduce their exposures leading up to the default despite the steady erosion in Lehman’s stock price and CDS spreads.

That leaves the potential interpretation that by supporting Bear Stearns, systemic risk from its default was postponed, but in having done so, unintentionally that action exacerbated the systemic risk resulting from the Lehman Brothers’ default.

After Bear Stearns, counterparties to banks were lulled into a false sense of security — assuming that default risks were reduced - or at least recovery rates increased - by a sort of faintly implicit guarantee from the US government against too-big-to-fail banks.

The principle example that would support that being the collapse of Reserve Primary — the money market giant which broke the buck the week LEH went under. Reserve Primary failed because it had bought a lot of commercial paper issued by Lehman. Commercial paper is, of course, unsecured.

Anyway, here’s what happened to the commercial paper issuance of both Bear and LEH in the runup to bankruptcy:

And the after-effects of Lehman’s collapse:

…money fund investors responded to the “breaking of the buck” issue at the Reserve Fund by withdrawing funds from “Prime” funds and placing most of those proceeds in Treasury or Government-only money market funds. That’s the 21st century equivalent of a “bank run,” and its consequences contributed to the severe freezing up of interbank lending in September and October.

Here's my comment:

1. Nov 27 16:27Posted by Don the libertarian Democrat [report]

   "After Bear Stearns, counterparties to banks were lulled into a false sense of security — assuming that default risks were reduced - or at least recovery rates increased - by a sort of faintly implicit guarantee from the US government against too-big-to-fail banks."

   My only disagreement with this is that the implicit guarantee had been in effect since the S & L Crisis. Although there was a chance of not being bailed out, as Lehman showed, the underlying belief was that the government could not allow large and interconnected financial institutions to fail. This was so well understood, that there was really no Plan B for these large institutions.

   From my perspective, the reaction to Lehman was panic at the thought that the government wouldn't intervene, and that there was no real Plan B.

   I think that the idea that the people involved in this belief were adherents of zero government intervention on principle has been proven false. Rather, they believe that the government and Fed are an essential backstop to our financial system. Simply because people try to get around regulations or have them abolished for their own ends, doesn't entail that they don't welcome and depend upon government when it suits their interests. Free market rhetoric is very useful when you're trying to get the government out of your way, but it's not a binding contract on future behavior or behavior in other circumstances.

   Phil Gramm and others might have actually believed their rhetoric, but the people with the real money are not so foolish as to not believe and expect that when they could really use government help, they damn well better get it. Surely actions speak louder than words, and the actions, after Lehman, said, "For God's sake help us, and don't bother mouthing nostrums about the free market, because if we go down we're taking you with us. Did you think we gave you all those donations for your eloquent defense of principles?"

Jane Bryant Quinn Makes Better Sense Than Me, As If You Didn't Know That

Jane Bryant Quinn makes some good points, echoing McTeer and making the point that the deficit is not terrible as yet:

"Isn't any increase in the deficit a bad idea?

Not when the country stands on the brink of a financial disaster. Besides, the deficit -- although large in dollars -- isn't a problem at the moment, says economist Irwin Kellner of Dowling College in Oakdale, New York. It amounts to about 2 percent of the economy, well below the 6 percent deficits of the early Reagan years or 4.5 percent in the early Clinton years. The deficit will rise as the recession advances but not primarily because of the rescue activities.

Is the bailout inflationary?

No. When the Treasury sells securities to the public, it's neither inflationary nor deflationary. You are simply using money that otherwise might be invested elsewhere and investing it in government securities, instead.

The Federal Reserve, which manages inflation, is making short-term loans to financial institutions that can't borrow elsewhere. It can lend without limit. The institutions put up various types of collateral and the loans are expected to be paid in full.

The Fed earns interest on these loans, typically 2.25 percent but sometimes higher -- so it's making money. It will also buy short-term commercial paper from corporations. That earns interest, too, which will help cover losses if any of the paper goes bad.'

Read the whole post.

I wish I was as sanguine. I worry about inflation and the deficit down the road, but, given where we are, I suppose I'm going to be in the minority.

Whose Afraid Of Deflation?

In my last post, William Gross said this:

"They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past."

Via Greg Mankiw, who wasn't convinced, came the following:

"In a previous post, I expressed surprise that yields on inflation-indexed Treasury notes are rising. Readers have emailed me a variety of hypotheses, the most common of which is deflation. As one smart economist put it:

Here's one possible answer -- the credit crunch has precipitated a massive expansion of money demand -- a scramble for cash. Despite its best efforts, the Fed has not matched this with a sufficient expansion of money supply. As simple IS-LM would predict, this surge in money demand has raised real interest rates (indicating that monetary policy is perhaps still too tight).

Rising real rates on inflation-indexed bonds and falling rates on nominal bonds also tell us that markets expect this surge in money demand to result in near-zero inflation or even deflation in the years ahead. It's starting to look more and more like 1990s Japan, though hopefully for not as long."

From Michael A. Fletcher's story today in the Washington Post:

"The confluence of trends has some economists worried that the country could be headed for a debilitating cycle of deflation: a period in which weak consumer demand, falling prices and tight credit ignite a downward spiral of still weaker demand and still lower prices. Under this scenario, as some businesses are strangled, joblessness increases, feeding the cycle.

"It was just a few months ago that everyone was obsessed with inflation. Now it's deflation," said Bill Gross, co-chief investment officer at Pimco, an investment management company. "I think it's a possibility."

And:

"Some economists note that a period of price adjustments does not necessarily signal the start of a deflationary spiral.

"Deflation is not the problem we should be worrying about," said Adam Lerrick, an economist at Carnegie Mellon University. "A drop in the level of prices for some goods must be distinguished from a continuous fall of prices. Oil is down to $90 from $140, but does anyone expect it will be $55 a year from now and $35 in 2010?"

Analysts said that a few months of price declines should not be a problem for the economy.

But if prices continue to fall across the board for a prolonged period, the declines will weigh heavily on businesses and consumers, particularly those juggling a lot of debt, which must be paid back even as money is harder to come by.

"For a few quarters, I say bring it on, but not for too much longer," Gross said of deflation. "Capitalism depends on mild inflation. Unless we get it, the dynamics of capitalism sort of move in reverse."

But then, there's this:

"In the United States, policymakers have been much quicker to respond to deflationary threats. Five years ago, as inflation approached 1 percent, spawning deflation concerns, Alan Greenspan, then the Federal Reserve chairman, cut the Fed's benchmark lending rate to 1 percent and the threat was never realized. It is an outcome that gives assurance to some economists.

"As long as governments print money and run deficits, you cannot have deflation," Lerrick said."

So, in the end, doesn't that mean inflation is the only real problem?