Crisis Year 7 - The Japanization Of Credit

Tyler Durden's picture

2013 is likely to be the seventh year that the financial world operates under extreme conditions/stress and increasingly heavy intervention.

Via Deutsche Bank:

A holistic view of the crisis


Since the crisis first began in 2006, developed world equities are still lower, real GDP has struggled to grow above its pre-crisis peak in most countries, core bond yields are sharply lower with peripheral yields higher and with credit yields generally performing well albeit it with fairly extreme volatility. Credit has been helped by the fact that the authorities way of dealing with this crisis to date has been through money printing and liquidity facilities to help prevent mass defaults which, as is is clear in the chart below, has led to a weakening in the normal relationship between GDP and defaults. Defaults should have been a lot higher given the macro environment.


Default rates vs GDP - correlations have broken down...



Ripping up what we know on defaults – Could Japan be the template for credit?


One way central bank activity has made a dramatic impact on markets so far is in ensuring that defaults have remained significantly below where they would have been had central banks remained dormant. Up until the last two or three years, those of us that have spent our career looking at Western credit markets (US, UK and Europe) have generally assumed a reasonably strong correlation between GDP and defaults in each region. However through a combination of; i) divergent developed (weak) and EM (stronger) market growth but with increasingly global companies; ii) artificially low rates; and iii) most importantly the supportive action of the authorities, it’s fair to say that we’ve had to reappraise our default methodology and assumptions downwards. This is in spite of the fact we have a developed world where growth has ground to a halt across most countries with many in recession.


The correlation between GDP growth and defaults in both the US and especially in Europe seems to be weakening. In the US and in Europe it could be argued that the defaults were already artificially low prior to the financial crisis given the credit bubble (structured credit etc) and after re-coupling back to normality during the financial crisis it seems we again have much lower defaults than the anaemic growth environment suggests. This is perhaps even more extreme in Europe where we have a recession overall and a slump in some member countries, yet we still have very low default rates. One saving grace is that global activity has remained stronger than western growth.


So stronger global than domestic growth has clearly been a factor in lower defaults relative to the domestic growth environment but in 2012 global growth has dipped without an increase in defaults. This perhaps shows the impact that the authorities are having on defaults. It’s also fair to say that corporates have spent a decade terming out their debt which makes them more resilient to funding shocks than say financials and sovereigns.


Japan-isation of credit?


One of the features of the last 20 years in Japan’s post-bubble adjustment and lost growth period is that defaults have remained very low. It’s not easy to compare credit markets across borders as the rating compositions vary. Japan for example (as seen in the chart below) does not have a HY market on the same scale as the US and Europe.


5-Year average cumulative defaults since 1981 for All IG and Single-A Companies...



Over the past 30 years, it’s impressive that Japanese defaults have generally been below their international peers in spite of a couple of lost decades of growth. The Japanese way of propping up entities that would otherwise have succumbed to free market defaults has certainly spread to Europe and the US over the last five years.


We can’t help thinking that this has contributed to a lower default rate post-financial crisis and Japan shows that it is possible to keep this up for a very long period of time. So it seems likely that even if growth is as weak as we expect it to be, as long as money printing props up the debt market, defaults are likely to be much lower than the underlying economic environment suggests they should be.

This could carry on for some time.

However, as we noted previously, the mark-to-market volatility on the way may just become too much to bear for all but the most long-term bond rotators.

Source: Deutsche Bank

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saturn's picture

We are all Japanese!

Landotfree's picture

Japan has been lucky for 20 years as the world was demanding which they couldn't.  If Japan were a financial island, it would have sank into the Pacific or been in flames a long time ago.   

Once the world resumes it's collapse, so will Japan.  Japan hasn't seen anything yet, they are still living in the good times.  

I would imagine by the time it's all over Japan will have been in stages of collapse and collapse for 50-80 years, they are already 20 years, lucky for them they have an international lifeboat.   Last place I would want to be is on an island with 128 million others... no thanks, can't even imagine when the tshtf over there.

NotApplicable's picture

They'll survive their demographic cliff just in time to encounter an overwhelming mass of debt left behind.

Vampire squids, ftw.

NotApplicable's picture

Unless you're referring to Government Destruction of Production, any calculation concerning GDP will always break-down, as government consumption is NOT a productive factor, but rather, an exhaustive one.

All it does is measure the rate in which we eat our seed corn while borrowing to fund it.

LongSoupLine's picture

two words...Kyle Bass.

pods's picture

The game is over.  There is no continuation of what we had, nor should there be.

Too much funny money gushing around.  We have bought the lie that we can do things in a new way.  Basically non essential "work" and have it paid for by issuing debt.

Sorry, that only works until it doesn't.  Toss in the cheapening of products to below even acceptable quality and we are at the end of the line.

We are never going to get back to our debt ponzi lifestyle.

Even when we speak in terms of Japan it is a lie.  We compare how they are now in terms of how they were.

Sorry, we ain't going back.  Either things pop and we get to start clean or we keep issuing debt/printing to keep our banker masters afloat all while the masses slowly suffocate with debt, taxes and fees.

Sounds like a rosy future to me!


Caviar Emptor's picture

Japan's inflationary buffers are slowly being removed. The system that worked for so long is failing.

asteroids's picture

World Wars have been fought in less time and less cost than this "crisis". Come on folks, time for some independant critical thinking here. The FED must stop what it's doing. Everyone needs to Mark to Market, those that are solvent will survive. Those that are not will be  put to death. Life will go on, in any event.

Dr. Engali's picture

Even though we share a lot of the same qualities that Japan displays when it comes to the finacial crisis there is one major difference......the U.S is the worlds reserve currency and requires ever expanding debt to maintain that status. The world can't and won't support that need, and at some point in time the dollar will completley vaporize before people knows what hit them.

NoDebt's picture

I generally agree with you, Doc, but in this case I'm going with the argument in the article.  I have wrestled for some time with whether the US could pull off a Japan scenario and I think the answer is yes.  In part because it already seems to be happening.

I know the arguments about why Japan is unique in that respect, but I don't think uniqueness has anything to do with it.  I think they are, in fact, symptoms of the natural (and only??) course left when you balloon your debt well into the triple digits of GDP while collapse is simultaneously not permitted.

1.  Japan's debt is held mostly by it's own citizens.  Our own Fed is buying more of our own GBs every day (as well as every other systemically-important debt pool under the sun).  Which means we're owning more and more of our own debt.  Not quite the same, but you see the point.  It's being internalized- rather rapidly, too.

2.  Japan's citizens are naturally more conservative so they keep buying their own government's bonds (the crash of their stock market in the late80s/early 90s reinforcing that lesson).  Look around you.... what's mom-and-pop buying here in the US?  Not the risky stuff.  Lower and lower down the risk scale they go, complaining about the lousy returns the whole way.  Yet they do it.  They want it guaranteed and the only guarantee they accept these days is from the government or somebody backed by the government.

Our populations are both aging, too.  Never overlook the importance of demographics.

I think we may learn there was nothing really unique about the Japan scenario.  They were just earlier than everyone else!


ZackLo's picture

It could carry on for sometime, But. Japan doesn't have the primary world reserve currrency and comparing default rates in this sense is bad. Sure if the government keeping qe'ing Then unprofitable multinational corps can just borrow out the losses on the backs of the population,  What's the real benefit? Top heavy multinationals are good for intensive capex, but the real shattering growth is always out of the small garage. Big companies get beaurocratic and start getting risk averse in RnD Because they overspend, Small companies are make it or break it. If risk doesn't pay overtime, It will not be taken overtime. The mercantalist world can shoot finanancial bullets at each other for awhile but adventually the population will get disgusted and other nations get scapegoated. Everyone already knows what comes next. Nothing saying high default rates like a north/south war as an excuse to "consildate the union",in europes case anyway. Add in all the other macro instabilities it's a recipe for disastor. Space travel/colonies and infinite resources better come quick..

Getting Old Sucks's picture

Four uncontrolled, unstopable (forever) nuclear meltdowns.  Only a day trader's market.

nastaking's picture

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