Japan Plans Its Own Stock Market Plunge Protection

In the U.S., there have been rumors of a so-called plunge protection team that steps in to prevent US stock prices from melt-down since Black Monday in 1987 when a white-faced John Phelan, chairman of the NYSE, stated on TV, "that is as close to melt-down as I ever want to get". This "team" is ostensibly the Working Group on Financial Markets -- the secretary of the treasury and the chairmen of the Federal Reserve Board, the Securities and Exchange Commission and the Commodity Futures Trading Commission. In the event of a financial crisis, each federal agency with a seat at the table of the Working Group has a confidential plan. At the SEC, for example, the plan is called the "red book" because of the color of its cover. It is officially known as the Executive Directory for Market Contingencies. The major U.S. stock markets have copies of the commission's plan as well as the CFTC's.

In a similar light, the Nikkei is reporting that the government and ruling coalition (LDP and Komeito) have solidified a plan to buy up to JPY50 trillion of Japanese stocks, mostly through index ETFs--i.e., Japan's very own stock market plunge protection plan. The program, to ostensibly last through March 2012, was included in the JPY15 trillion ($150 billion) stimulus plan announced by Prime Minister Taro Aso on April 10, 2009.

Under the plan, a new stock buying entity would be created with the backing of the government with funds for the purchase to be procured from the Bank of Japan and private-sector financial institutions. In the prior version, the government was considering issuing gov't-guaranteed (against losses to investors) bonds convertible into the underlying index ETFs. The entity will have a sunset clause, ostensibly disbanding after selling off the stocks it purchases in April 2012 or later. Under the final proposed version, the government would stand to receive any capital gains as well as shoulder any losses.

The condition for purchases of Japanese stocks by the entity would be "when the market's price-setting mechanism is believed to be under serious stress and posing a potential threat to the economy", such as cases where heavy (foreign) selling severely disrupts the supply-demand balance for stocks and indicators such as price-to-book ratios reach "abnormal" levels.

To ensure objectivity, the Prime Minister would decide, upon recommendations from a specially formed committee. The committee ostensibly would consist of the BOJ governor, the Finance Minister and other Cabinet Members in charge of economic and fiscal policies, and would make the recommendation to intervene if market conditions merit government intervention. While the entity's purchases would ostensibly be limited to stock index ETFs (based on benchmark indices like the Nikkei 225), the entity could also buy individual stocks or derivatives such as futures and options.

This is not the first time that the Japanese government has intervened to put a floor under stock prices. In the 1960s so-called "Brokerage Crisis", there were actually two government-sanctioned stock purchasing entities to buy up the excess supply of script from investment trusts, and the resale of most of this stock after the crisis to banks and other financial institutions was the beginning of Japan's infamous cross-holding shareholder structure that lingers today. During the height of the Heisei Malaise, the Bank of Japan also directly purchased stock held by the banks in order to alleviate the large valuation losses on these holdings that were depressing bank balance sheets. This program was recently revived, with the BOJ beginning such purchases in March of this year. In addition, there has been a long-held practice of the domestic pension funds (particularly public pension funds) purchasing stocks at the behest of the government under what came to be known as "PKO" (price-keeping operations. Such buying was evident over the past several months as the Nikkei 225 was pushed to new lows by heavy foreign investor selling.

Rumors of this plunge protection plan have been circulating for the past couple of months, so the Nikkei's article is no surprise, just more detail on the plan. What is ironic is that, if past experience is any guide, the program may finally be rolled out just as the stock market is undergoing an indigenous recovery in discounting the end of the current historically severe recession.

Comments

[CLH:]

Yes you are probably right. Protection after the fact is of little use.

Apr 16 03:39 PM