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April 10, 1998
In a holiday-shortened week with little economic data mortgages and bonds continued to trade on news from Japan.
Bad news last Friday and Monday (government paralysis) took mortgages to the bottom of the December-April range; good news yesterday (Hashimoto proposes tax cuts, Bank of Japan supports yen vs. dollar), and mortgages approached the top of their trading range.
It may seem crazy to say that American home buyers are betting their discount points every night on events in Japan, but it will stay this way until market fears of a deflationary spiral abateŠ or are realized.
If realizedŠ how? What would be the sequence of events, and the effect here?
First, at least one thing a meltdown would not do: collapse the market for American Treasurys. There are weeks when I think more people have asked about mass-selling of Treasurys than have asked about mortgage rates.
There is no reason to fear such liquidation. Japanese investors hold less than 10% of the outstanding $4 trillion or so of outstanding marketable Treasurys; and even if they dumped half their holdings, the bonds would be soaked up with minor disruption. Besides, ever since last Fall, bad news in Japan has created net buying of Treasurys, which reduces mortgage rates here.
A real panic in Japan -- one to be feared -- would almost undoubtedly begin in its stock market. Some bank, corporation, or insurance company on the verge of bankruptcy would break from the massive, phony cross-ownership of stock, and sell, trying to save itself. Others would join the every-bankrupt-for-itself flood until the Nikkei fell below about 12,000, when every bank and insurance company in Japan would be broke.
The government in Japan has hardly been fast-moving, and much would depend on how quickly they could close markets and guarantee all deposits.
The effect of such a panic on us would likewise depend on a speedy move to guarantee the obligations of Japan's banks to foreign banks worldwide: the enormous bank-to-bank swap market ($10 trillion?Š nobody wants to say), loan guarantees, loan commitments, and lines of credit.
If Japan moved fast, she herself would suffer a terrible recession, joined by much of the rest of Asia; but the rest of the world -- from which Japan buys practically nothing -- would have a relatively minor downturn.
If Japan ditheredŠ tried to pile more band-aids on the stackŠ very bad. So bad that there isn't any point in worrying about it. Just play the game every night: MSNBC's bedtime report on the Nikkei will tell you which way mortgage rates are likely to move in the morning.
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