Global Financial Crisis Could Push Japan's Falling Stocks Further

Last week, the US government was finally forced by rapidly deteriorating financial market conditions to “go to the well” and ask Congress for, a) an historic $700 billion or so of funding to address cancerous mortgage-backed assets on and off financial institution balance sheets, and b) an approximate $800 billion increase in the US debt ceiling.

While it is despicable that the unmitigated expansion of debt within and outside the formal banking system was allowed to swell far enough to threaten the very viability of the global financial system, regulators, the government and investors now have to go beyond moral hazard and schadenfreude (a sense of satisfaction or pleasure felt at someone else's misfortune) to focus on stabilizing the global financial system.

As all efforts have heretofore failed, we can only hope Hank Paulson’s plan works. If not, investors will need to prepare for the next Great Depression while looking for plan B.

What is desperately needed is transparency on level three and off-balance sheet liabilities of financial institutions, and a system to orderly unwind these liabilities. Providing emergency central bank funds or banning short selling are but short-term band-aids, as indeed are bail-outs of selected financial institutions.

While Japan is largely an innocent bystander in this drama, the global credit crunch continues to play a large role in falling Japanese stock prices and the reversal in Japanese property prices from mini-boom to recession, as well as the evolving recession in Japan’s economy.

Even if global financial markets begin to stabilize, we have yet to experience the full impact of this crisis on the real economy. Tight credit conditions could well continue, and even result in the failure of several small or medium-sized financial institutions in Japan, as well as two-digit declines in Japanese corporate profits. 

As a result, after a sharp “short-cover” rally, the Nikkei 225 could continue searching for sustainable downside support somewhere between 12,000 and 10,000 until the end of this year.

Stock Position: None