The financial crisis – and loansharks in Japan and NZ

[Originally posted, with full hyperlinks, at]
In Japanese banking, the big boys are back, as I explained last week: The Economist now confirms it. Indeed, the latter suggests that “if Japanese banks have any unique skill, it may well be in coping with crisis”. Not an obvious point, as evidenced by the collective dithering after Japan’s financial markets collapsed in the early 1990s or the almost completely unexpected 1995 Kobe earthquake. But I suppose the Japanese can be very good at responding systematically, once they establish the broad parameters of the problem.
Anyway, Mitsubishi UFJ has now proceeded to take 21% of Morgan Stanley, and is now considering further integrating its securities subsidiary (involved in US$18.3b of M&A advisory work involving Japanese companies in 2007) with Morgan’s Japanese arm (which did $17.9b). This would challenge Nomura, which did $34.2b (“Aiming to Rival Nomura”, Asahi Shimbun, 4-5 October, p 25); but the latter has also snapped up Lehman’s operations in Asia (mostly Tokyo), hoping to retain many staff to grow its own business.
And on Friday, the US government finally agreed on a public bailout plan for up to $700b, which I reviewed critically earlier in the week. Along with $85b for AIG and $29b for Bear Stearns, this amounts already to 5.8% of GDP, “well above the 3.7% of the savings-and-loan bail-out in the late 1980s and early 1990s” and significantly less than the 24% of GDP committed by Japan after 1997.

But Paul Krugman persuasively maintains his critique that buying up distressed loans is a hastily drawn up and politically-charged plan that is unlikely to be enough – “a much better-conceived rescue of the financial system … will almost certainly involve the US government taking partial, temporary ownership of that system, the way Sweden’s government did in the early 1990s”.
The editorialist in the Kyoto Shimbun agrees, drawing parallels also with nationalisation in Japan in the late 1990s, concluding that the US “needs to implement comprehensive crisis management, in line with the true situation and without excluding any possible scenarios”.
Again, an intriguing remark about how different countries’ policy-makers respond to actual and potential crises – an issue that the Australian Network for Japanese Law has therefore decided to make a theme for its next annual conference, planned for Tokyo on 14 February 2009. Anyway, in the context of the current financial crisis, I believe we also need to examine broader risks and responses in our Asia-Pacific region – including revisiting how we approach consumer over-indebtedness in countries as seemingly diverse as Japan and New Zealand.
Ongoing economic upheaval seems likely in the US. The Economist acknowledges the danger of a “second-round effect” as the financial crisis affects the economy, leading to further problems in finance: “Mortgages may be the problem asset of the moment but next year the worry may be about credit cards, car loans and corporate debt”. Other media are already reporting problems in those areas. And then we have the risk of a boomerang effect back from countries with their own problems of weak banks and underlying over-indebtedness. The UK has already seen a big bailout of Northern Rock, plus HBOS forced into a merger with Lloyds. But two banks have also recently been bailed out in Belgium, and things are not looking good either in Denmark, Spain and even Germany. In our region, there was run on the biggest Chinese bank in Hong Kong (the Bank of East Asia), triggered by exposure to AIG – with creditors lining up like they did for the AIG subsidiary in Singapore.
I agree with Cornell University’s Robert Frank that a more comprehensive solution requires us to Limit Credit Before Bubbles Start Bursting. The root problem is not just inadequate information, which is demanding better disclosure. It stems from two conditions: (1) people confronting “a gamble that offers a small gain with near certainty and a significant loss with only a very small probability”, plus (2) “rewards received by market participants depend[ing] strongly on relative performance”. Those conditions also explain why we get too many dwellings built in earthquake zones and excessive workplace safety risks in unregulated housing and labour markets, as well as athletes who persistently take performance-enhancing drugs. Frank concludes that “asset bubbles cause real trouble only when investors can borrow without restriction to expand their holdings”, so we must restrict such borrowing. We also need better enforcement of such a new regime, and the International Herald Tribune carried a disturbing expose on failures by the SEC especially from around 2004.
Again, though, I would go further in re-aligning incentives. I propose also re-regulating the ability of financial institutions to readily offload any and all funds they do raise from investors through certain financial services to consumers, especially those that have negative externalities or exploit information and behavioural biases. This covers much more than mortgage loans where borrowers were actually “lied to by brokers about the reset rates on adjustable-rate mortgages and other elements of their loans”: cf Bethany McLean. Ronald Mann details how credit card loans are a potentially much bigger problem area not only in the US, but also other economies such as the UK and Australia. The way they are marketed and drafted is also likely to become a growing problem on Japan, somewhat ironically, after it clamped down in 2006 on its own unsecured consumer credit boom – hitherto mostly driven by cash advances through increasingly ubiquitous ATMs. In addition, however, we find an analogous problem with cash advances through “payday lender” in the US (recently partially re-regulated) and some “predatory lenders” in Australia.
For a recent public lecture in New Zealand, I also discovered some interesting parallels between fringe lending particularly in rural Japan, and that involving Pacific Islanders in South Auckland. As part of its routine monitoring of the Credit Contracts and Consumer Finance Act 2003 (in force from 2005), the Consumer Affairs Ministry’s qualitative study in 2007 found that they turned to fringe lenders for (1) everyday household expenses, then (2) large items (especially cars, involving the most potentially exploitative lender practice), but also (3) to meet social and cultural obligations (such as funerals). The latter area, like the first, often required access to “instant cash” and “were usually for events for which people cannot easily plan, so increasing their potential susceptibility to unreasonable and oppressive credit provider practices … The researchers concluded that experiences and perceptions expressed by the interviewees challenged the notion that, if certain information is available (through improved disclosure), consumers will use it to make the decisions that will shape the development of a competitive credit market. Even those Pacific consumers with reasonably high levels of financial literacy and awareness of the high costs involved in the fringe credit market felt they had limited choice about the conditions under which they accepted the credit they sought. The research report also suggested that the ways in which information is provided (small print, technical language, etc.), and by whom, can prevent the consumer arriving at the understanding needed to make an informed decision. The research noted that Pacific consumers expressed a fear that questioning or complaining about the credit contract would prevent them from being able to borrow at all. Furthermore, seemingly important questions appear not to be asked by Pacific consumers because of the trust placed in the credit provider, especially when the credit provider is a member of the same ethnic community.”
Despite this, the NZ government’s response identified only the following priority work areas:
* continued enforcement effort where traders are not complying with the law
* providing a means by which consumers can work their way out of debt
* an information and capability building programme to address consumers’ lack of access to information about their rights in a transaction or how to get redress
* addressing overly-aggressive marketing practices
* engaging at the government, community and business level to develop potential solutions to the problems
* completing the review of the CCCFA.
If this problem is so serious, NZ probably needs a stronger policy response, along the lines of that in Japan from 2006 and emerging in some fields in the US. Credit suppliers could be subjected to suitability rules (requiring assessments of consumers’ ability to repay, and/or certain bright line rules based on net income), or interest caps (set high enough to cut out the worst suppliers, even at the cost of some excess demand – some demand which seems to be heavily manipulated anyway). Another possibility, not yet found anywhere but drawing from recent re-regulation in consumer product safety (at least in Canada, Japan, the EU, and earlier the US), is to require suppliers to notify regulators when a particular type of marketing practice and/or credit contract leads to abnormally high levels of socio-economic stress to borrowers and their communities (eg insolvency, imprisonment, etc).
The aim is to change both the economics and the social norms of market segments that are deemed too destructive or risky for most individuals and/or broader communities. In both South Auckland and increasingly poor parts of Japan, for example, this means encouraging borrowers either to go without a luxury item or to turn more quickly to a social welfare net, rather than (mostly) prolonging the agony for the benefit of the lenders. Such measures to address consumer over-indebtedness, across many credit markets, could collectively also help to minimize the risk of the huge financial meltdown now facing the US and potentially the world economy.

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.