Capitalists Vs The Free Market

Capitalists Who Fear Free Markets

By FLOYD NORRIS

Capitalism is supposed to produce losses on bad investments.

But all too often it has not.

In Tokyo this week, corporate executives were outraged when a Japanese government official suggested that banks might have to take losses on loans to the company that produced a nuclear catastrophe.

Yukio Edano, the chief cabinet secretary, had the temerity to say “the public will not support” the injection of government money into Tokyo Electric Power, also known as Tepco, unless banks share in the pain. Tepco says it would like to pay compensation to victims, but needs government cash to do so.

The president of Japan’s largest bank, Mitsubishi UFJ Financial, was shocked by the very idea that a bank should lose money if it lent to a company that could not meet its obligations. Mr. Edano’s remarks “came out of the blue,” said the executive, Katsunori Nagayasu. “I felt there was something wrong about them.”

To Yasuchika Hasgawa, the chief executive of the Takeda Pharmaceutical Company and chairman of the Japanese Association of Corporate Executives, the idea violated basic tenets of society. Mr. Hasgawa said he “cannot help but question how this country’s democracy can be made to work with free-market-based capitalism.”

His definition of “free-market-based capitalism” seems to assume that lenders should escape without pain, at least if they are lending to major institutions. It is an idea that has become remarkably pervasive.

“We consider banks and Tepco systemically important institutions,” wrote Tetsuya Yamamoto, a Moody’s analyst based in Tokyo. “Debt forgiveness undermines the systemic importance of the bank and utility sectors in the national economy.” These are, he added, “developments we did not anticipate.”

It has been more than two months since an earthquake and tsunami caused radiation leaks at the Fukushima nuclear power plants. Residents have been forced to evacuate a large area, and there is no assurance when the plants will be brought under control.

Tepco is clearly to blame. In hindsight, the plant should have had better protection against both earthquakes and tsunamis, or it should have been built in a region less vulnerable to them.

Yet it is deemed shocking to suggest those who financed the company should suffer losses.

In “free-market-based capitalism” — or at least the version they used to teach when I went to business school — lenders and shareholders were supposed to monitor the risks taken by companies. They would benefit if the company prospered and suffer if it failed.

By not spending more money on safety, Tepco was taking a risk. That risk did not work out. The question now is who will pay the bill. If it is the investors, that would serve as a powerful incentive to the other nuclear plant operators to make changes. If it is the government, with investors protected, we are left with only the hope of better regulation to prevent a recurrence.

Tepco shareholders have suffered, but the shares are still worth something, if you believe the stock market. Tepco lenders seem to think they should be allowed to collect every yen they would have received if nothing had happened. Maybe even more, since this could serve as a reason to charge higher interest rates to utilities.

That is, more or less, what happened to most bank investors in the financial crisis. The American government chose not to rescue Lehman Brothers, a fact that stunned investors and precipitated a panic. In the aftermath, it was considered too dangerous to even question the safety of bonds issued by banks. A suggestion they could bring losses might have caused more banks to fail. So while bank shares fell sharply, bank bonds did not default.

In Ireland, it was even more absurd. Bailing out collapsing banks left the Irish government unable to pay its bills without a bailout of its own, and forced it to embark on a bitter policy of austerity that has hurt every citizen. But senior bondholders of the failed banks are being protected, and it was considered a victory that subordinated lenders agreed to take partial — not complete — losses.

In the United States now, there is anger that few bank executives have faced criminal charges. Perhaps more charges should be filed, but excessive risk taking, in and of itself, is not illegal.

As Roger Lowenstein wrote in Bloomberg Business Week: “The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors and regulators were all blind to risk.”

The anger might be better directed at the fact that those whose bad decisions led to the crisis did not suffer, or that not enough of them did. Some bank bosses did lose their jobs, but the replacements usually came from the next level down, and were hardly uninvolved. Bondholders who financed the bubble were allowed to walk away.

When the bailouts were taking place, I thought protection of lenders to the banks was justified to keep the crisis from getting even worse. In hindsight — and with the memory of the terror of those days dulled by the passing of time and the knowledge that we did avoid Great Depression II — I am less certain.

If all the banks that were bailed out had been forced to restructure their debts — that is, make their bondholders suffer losses — then banks would have been more reluctant to take bailouts. Those that had to take them would have been the only ones scarred with what Jamie Dimon, the chief executive of JPMorgan Chase, later called the “scarlet letter.”

Instead, all were scarred, which in practice meant there was little public differentiation between those, like JPMorgan, that had been run well, and those, like Citigroup, that had not.

Without losses, why should we think investors will do a better job of monitoring what is being done with their money?

In Europe, it is becoming clear that Greece will have to default at some point. But that would hurt banks that were foolish enough to buy bonds from a country they knew had lied its way into the euro zone. Such an outcome is deemed unacceptable. So they go on pretending that Greece will someday be able to pay back its loans.

In this age of government austerity, it is deemed mandatory that important borrowers retain access to capital markets. That they have such access only because governments are thought to be the real lenders of last resort does not have to show up in government budget statements, and so can be ignored.

In Japan, the government may be backing down.

“Talk of debt write-offs is a bit too extreme,” Koichiro Gemba, the national strategy minister, told an interviewer on Asahi television a few days after Mr. Edano shocked the banks, “since that would mean that Tepco would not be able to borrow again.”