Tables turned in Japanese and US financial markets

[Originally posted, with full hyperlinks, at]
In 2003, financial journalist Gillian Tett wrote a book with a self-explanatory title: Saving the Sun: How Wall Street Mavericks Shook Up Japan’s Financial World and Made Billions (Harper Collins). It epitomized a school of thought proclaiming a dramatic shift in Japan towards US-style corporate governance more generally. On 24 September, still writing for the Financial Times, Tett concluded that if she were writing her book again, she “would give it a more upbeat slant. Anyone know the Japanese for ‘eating humble pie’?”. The Japan Society of Scotland has already suggested “sunao ni ayamaru (to apologise obediently without protesting)” or “memboku wo ushinau (to lose face)”! Japan’s big financial institutions are certainly now back on the world stage, picking up some big pieces from America’s own financial crisis. And Japanese policy-makers and other commentators now want to lecture the US on how to deal with it.
Who would have thought, even a year ago, that Nomura Securities would be buying up the now-insolvent Lehman Brothers’ operations in Asia (including those in Australia, involving a total 3000 employees – with half in Tokyo) and then Europe (2500 employees)? And for just US$225m and “a nominal sum”, respectively, out of cash reserves of almost $6b Nomura has raised since April? Or that Mitsubishi UFJ, which spent $3.5b to buy out the Union Bank of California, would now be committing up to $9b to take 10-20% of Morgan Stanley, another precarious “Big Five” Wall Street investment bank? Or that Sumitomo Mitsui, which recently spent $1b for 2% of Barclays bank in the UK (which in turn has bought Lehman’s US operations), is prepared to invest US$1-3b in Goldman Sachs if requested by that other precarious Wall Street firm? Or that Mizuho would have recently pumped $1.2b into Merrill Lynch, another troubled firm that took refuge with the Bank of America in a $50b merger announced on 15 September?

Morgan Stanley and Goldman Sachs have also become bank holding companies, subjecting themselves to stricter regulation (including lower leverage requirements) to try to regain some trust in the marketplace. Bear Stearns, the other “Big Five” investment bank, had already failed and was sold to the JPMorgan Chase banking group in March. The editorial in the Wall Street Journal proclaims all this “The End of Wall Street”. Only much smaller pure investment banks remain, such as Rothschild (which advised Lehman on disposing of its Asian operations) and Lazard (which advised on its US operations sale). Eschewing involvement in complex financing deals, and relatively untainted by cross-selling and conflicts of interest, they hope to have preserved reputations for more independent strategic advice in M&A.
One implication of such dramatic events for Japan has not yet been fully appreciated. They should complicate the possible tension between those more likely to promote rules constraining hostile takeovers (including some investment bankers, as well as Japan’s “main banks”) and those more likely to favour more liberal rules (requiring informed shareholder consent to defensive measures, rather than deference to target management discretion). But anyway these events, tied to a much broader financial crisis in the US, will dampen aggressive M&A activity there and world-wide for quite some time.
These developments are also significant in other ways for the Asia-Pacific region. A few months ago, Nomura was reportedly interested in purchasing the investment banking operations of ABN AMRO in Australia. Could they or another Japanese financial institution now be interested in Macquarie Bank? The latter must be feeling the pinch as well, which in turn should impact on that group’s interest in Haneda Airport and other infrastructure investments (and hence concerns about appropriate FDI regulation) in Japan and throughout the region. And where in all this are Chinese financial institutions or the China Investment Corp sovereign wealth fund set up last year with $200b in China, Japan’s “rival”? They had made some large foreign investments, such as CIC’s $5b purchase of Morgan Stanley shares at $50.08 each, but are now looking at big paper losses. CIC was reportedly interested in buying more shares in Morgan Stanley as well as in Lehman, but bowed out to Japanese investors: “The lesson China’s cautious leaders seem to have taken from the worsening global crisis is similar to the one they took away in Beijing at the start of the decade – do not mess with things you do not understand” (Jamil Anderlini, Prudence Guides China’s Outlook).
Japan’s financial institutions, by contrast, are hoping they have learned enough about more complex financial products as a result of financial deregulation and foreign investment in Tokyo since the late 1990s to be able to invest profitably now in Wall Street, and to learn (and earn) even more. The mega-banks, in particular, have finally cleaned up their Non-Performing Loans and regained strong capital asset ratios. They have accumulated ever-more deposits as the Japanese public becomes concerned about investing in the US, as well as likely slowdowns in the world and Japanese economies, and are looking to boost profitability in some offshore markets. Even Japanese insurance companies, hard hit by Japan’s “lost decade” over the 1990s, may find the time is ripe to diversify overseas. Tokyo Marine Holdings had already spent $4.7b in July to buy out Philadelphia Consolidated in the US. Presumably it and others are considering the broader ramifications of the US government recently taking 79.9% equity in exchange for a $85b lifeline to the American International Group (AIG). The latter’s liquidity crisis, resulting from providing too many credit default swaps (guaranteeing debts owed by third parties), triggered panic as far away as Singapore. Thousands of that nation’s 2.6 million policy holders lined up to cash in their investments, even at significant cost, and despite the announcements from the US.
Already by mid-September, 20% of Japan’s outbound FDI over the previous year had been into financial services. Perhaps they are moving too quickly, or paying too much (eg Mitsubishi UFJ to become Morgan Stanley’s largest shareholder) for too little (only one board seat, apparently). But Sumitomo realised handsome profits from a $0.5b investment in Goldman Sachs when it was struggling back in 1986, unlike many Japanese firms that invested in US or Australian real estate in those heady times (remember Mitsubishi Real Estate’s disastrous acquisition of the Rockefeller Centre in 1989?). Japanese financial institutions stopped investing abroad over the 1990s, instead often finding themselves bought out from the late 1990s. Merrill Lynch bought Yamaichi Securities when it collapsed in 1997, and invested in (Mitsubishi) UFJ Bank in 2003. Ripplewood made a handsome profit from acquiring in 1999 the Long-Term Credit Bank of Japan (now the Shinsei Bank), nationalized in 1998. Goldman Sachs invested in Mitsui Sumitomo in 2003, and Citigroup turned Nikko into a wholly-owned subsidiary as late as 2007. How the tables seem to have turned this year!

Author: Luke Nottage

Prof Luke Nottage (BCA, LLB, PhD VUW, LLM LLD Kyoto) is founding co-director of the Australian Network for Japanese Law (ANJeL), Associate Director (Japan) of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS), and Professor of Comparative and Transnational Business Law at Sydney Law School. He specialises in international dispute resolution, foreign investment law, contract and consumer (product safety) law.