Lehman Shock and the Japanese Financial Markets

I have been visiting Tokyo this week. The U.S. financial turmoil that started last week following the failure of the Lehman Brothers is clearly felt here as well. The most direct impacts of the failure came from the bankruptcy filing of the Lehman Brothers Japan, which was a major player in the Japanese Government Bond market. For example, Nikkei News on Sept. 23 reported:

Lehman’s bankruptcy filing is also wreaking havoc in the bond repo market, where brokerages traditionally procure short-term funding. Because of an absence of transactions by major participant Lehman, activity in the market is at a standstill, says senior strategist Tatsuo Ichikawa of RBS Securities Japan Ltd.

And because banks are unwilling to lend out cash in bond repo transactions, the Tokyo repo rate calculated by the Bank of Japan has shot up. The rate for transactions taking effect on the second business day was hovering at 0.746% on Monday. This means that it has jumped about 20 basis points in just half a month.

So the failure of Lehman produced serious problems in credit markets not only in the U.S. but also in Japan. The Japanese repo market has collapsed.

In my recent blogs, I have been arguing that a mechanism to deal with insolvency of systematically important financial institutions (not just commercial banks) in an orderly manner (such as the one involving temporary nationalization, for example) would be useful (although it may be too late for the U.S. crisis this time). Given the multi-national nature of many of these financial institutions and the operations in different countries are all related, “orderly” resolution of insolvency seems to require coordination among the resolution processes in different jurisdictions.

In response to the current crisis, the central banks have been coordinating their efforts to provide more liquidity in various short-term credit markets all over the world. The current episode may suggest a similar coordination may be required for resolution and restructuring processes.