Following Japan?

Here’s FT Alphaville’s take on the story, according to which a move to stricter capital standards for banks will now include a “transition period” of 10-20 years. That’s forever by politicians’ standards and quite a long time even for public officials.

By having the long-awaited Basel changes to capital rules punted into the long grass, banks will be under much less immediate pressure to raise capital, the thinking clearly goes.

When combined with the multiple government support programmes for banks and the relaxation of US accounting rules that was approved in April, it’s not hard to see why this sector has been one of the best-performing areas of the equity market this year.

Here’s the NAV history (in euros) of the db x-trackers DJ Stoxx 600 Banks ETF from the end of 2008. The fund’s NAV nearly tripled from its March lows, although the share prices of the fund’s constituent banks have recently fallen back from their highs, today’s boost notwithstanding.

Longer-term, can regulatory forbearance like this help the banking sector to recover, or are regulators and politicians making a mistake by turning a blind eye to bad debt problems and hoping that banks can grow themselves out of a hole?

According to John Makin’s 2008 study of Japan’s lost decade for the American Enterprise Institute, it was precisely “a lack of transparency in the balance sheets of Japanese banks and a passive approach by the Japanese government to restructuring those balance sheets [that] contributed substantially to the prolonged period of economic stagnation.”

Christopher Wood, equity strategist for CLSA in Hong Kong, drew out more similarities between the current US economic situation and that in 1990s Japan in a recent Wall Street Journal article. “With the US government stepping in to keep markets from clearing, today’s US economy in many ways resembles the post-bubble Japanese economy. Ultra-loose monetary policy and low demand for credit, combined with high unemployment and consumer deleveraging, could lead to a prolonged slump.”

While Wood then goes on in his article to predict an asset price bubble in emerging Asian stock markets, if he is correct in his comparison between post-bubble Japan and the current post-credit crunch Western economies then the implications for US (and UK) equities are presumably much bleaker.

True, the US and UK stock markets post-2007 have followed a different trajectory to that of Japan post-1989 – Japan’s Nikkei average fell for three successive years in 1990, 1991 and 1992, whereas 2009 has seen a sharp recovery in most Western equity markets after a traumatic 2008.

But if today’s news on a likely loosening of capital requirements for banks is indeed a sign that we are following in Japan’s footsteps, then 2010 may well be a much tougher year for equity investors.

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