Is the BOJ de Fact Losing Its Independence?

Richard Katz (The Oriental Economist Report)

This is an alert from the Oriental Economist Report on September 25, and posted here with the permission of the author

Some thoughts on the BOJ's plan to purchase corporate shares from the banks, a move that reduces the banks' vulnerability to stock price declines.

1) There is no quid pro quo, either ex ante or ex post. Some in the market theorized that the BOJ had reached a deal beforehand with the government. In return for BOJ action to stabilize bank capital, the government would take resolute action on nonperforming loans (NPLs). There was certainly no deal in advance. Koizumi, Yanagisawa and Shiokawa were merely informed about the move a couple hours in advanced. Reportedly, Takenaka was not informed. Nor has the government reacted after the fact by offering any deal to the BOJ. On the contrary, instead of announcing, as expected, a big anti-deflation and NPL package on Friday night (Sept. 20), Koizumi put off action for a month. Stocks resumed their fall.

2) The BOJ action was not brought on by fear of a September 30 crackup. Some analysts speculated that the BOJ was worried that continuing price declines in the stock market would bring a few of the big banks below the B.I.S. capital: asset ratio of 8%. This view was fed by news that the idea for the stock purchase plan came from the BOJ's Supervision Department. However, as far a mark-to-market is concerned, there is much more room to maneuver in the Sept. 30 midyear closing than in the March closing. The BOJ is worried about the medium-term interaction of NPLs and stock prices on bank capital, not the next few weeks.

3) The BOJ called in reporters to tell them that this was a carefully thought out plan to shock the government into taking action. Some wonder whether that is the pre-announcement reasoning, or a post-announcement justification in light of a poor reaction. It is certainly true that, whatever the BOJ's original intention, its action has stirred the political pot. And that is good. However, we wonder how political pressure on the government and banks is increased by a move that relieves financial pressure on them. Buying these shares would shore up the banks' capital base, thus giving them even more time to diddle.

4) Some Wall Street equity strategists worry that the move undercut the BOJ's moral authority on the NPL issue. Leading U.S. government officials are bewildered by the move and, while awaiting further details, do not view it as a positive step. We are told they intend to raise the NPL issue at the bilateral meetings accompanying this weekend's IMF-World Bank meeting in DC.

5) In the period leading up to the Sept. 20 meeting, Hayami pressed Koizumi to take action on the NPLs, including a capital injection, and got nowhere. Meanwhile, pressure on the BOJ was building from both the LPD and Washington. Hayami did not want to walk into the Sept. 20 meeting empty-handed. The BOJ thought this dramatic action would put the onus back on the government.

6) The BOJ is de facto losing its independence and maneuvering room to pressure the government. The BOJ is pressing the government to do the right thing, but it cannot compel it to do so. On the other hand, the BOJ is responsible, not only for monetary stability, but also financial stability. Hence, the BOJ is almost forced to take actions it would prefer not to. Against its will, it ends up accommodating government actions with which it disagrees. For example, with the banks having put so much of their money into government bonds (JGBs), the BOJ faces immense pressure to keep the 10-year JGB rates from rising. Otherwise, the banks face a big capital loss. Similarly, the share purchase plan protects bank capital. We have said all along that the real reason for all the LDP pressure on the BOJ is not monetary ease per se, but the effort to enlist the BOJ in a Price-Keeping Operation for stocks, real estate and zombie borrowers. The latest announcement should be seen in that context.

Pressure Builds to Fire Yanagisawa

There is growing public and private pressure on Koizumi to fire Yanagisawa as part the cabinet reshuffle now scheduled to be made Sept. 30 (note: the date has been pushed back several times).

Here's the dilemma for Koizumi. If he fires Yanagisawa, the market will take this as a clear signal that Koizumi intends to change his policy on NPLs and that his public promise of accelerated disposable was real. Hopes for a capital injection will rise. If Koizumi fires Yanagisawa but doesn't follow up, the market reaction will be severe. It is also possible that he could fire Yanagisawa and then do just enough to make it look as if something is happening—but in substance it amounts to little. In that case, the market reaction will be delayed, but still negative. Therefore, unless Koizumi really intends to change his policy, or at least do enough to make it look that way, it doesn't make sense to fire Yanagisawa. On previous occasions, Koizumi has gone to the brink and then pulled back.

In any case, now that there is so much public pressure, anything Koizumi does will be taken as a signal. If he keeps him, that will be seen as a vote for the status quo that makes Koizumi's recent pledges ring false. If he fires him, that will be seen as a decision for change. That was not the case a week ago when everyone assumed the cabinet change would be minimal and therefore Yanagisawa's fate was a non-issue.

One final note. A capital injection is a necessary part of the solution, but hardly sufficient. Since the last capital injection, the banks have done less and less disposal with each passing year. An injection with weak conditions doesn't solve the problem.