Shirakawa’s BOJ finally joins coordinated action

by Shinya Ajima

When the subprime crisis ran riot and U.S. and European central banks launched a series of coordinated assaults earlier this year, Bank of Japan Gov. Masaaki Shirakawa stood aside and merely released statements hailing his peers’ efforts.

Thursday, however, the BOJ announced it would take a role in an alliance of central banks, joining the battle against a drying out of liquidity in money markets — a move underlining the increased seriousness of the crisis.

“Growing tension on the dollar-funding market is causing storms in markets to raise funds denominated in other currencies,” Shirakawa told reporters, explaining why Japan was taking its place on the frontline.

The coordinated action, joined also by the U.S. Federal Reserve and the European Central Bank, could inject up to $180 billion in fresh dollar funds into world money markets, where borrowing costs have surged as banks have became increasingly cautious about providing short-term loans.

The BOJ had said the Japanese financial system was relatively safe, with major banks suffering less damage from the U.S. subprime mortgage crisis since last summer than their U.S. and European rivals.

Some BOJ officials even said it turned out that the Tokyo money market was the world’s most reliable funding source as many foreign banks tapped it after failing to raise capital elsewhere.

They also said the BOJ would welcome those customers because it has lots of monetary tools to adjust liquidity in the market, mostly invented amid bitter memories of the aftermath of the bubble economy in the late 1980s and early 1990s, and that foreign lenders tapping the market would not cause any serious problem by itself.

Those views seem to be losing their shine.

Tokyo was not immune when pressure mounted last week on world money markets following the bankruptcy of U.S. investment bank Lehman Brothers Holdings Inc.

The key lending rate for overnight call money shot up above the BOJ’s official target of 0.5 percent.

The BOJ was consequently forced to continue to inject ample liquidity into Japan’s banking system for four days running through Friday in an effort to calm interbank borrowing costs.

Under the central bank alliance, the BOJ is concluding a $60 billion currency swap agreement with the Federal Reserve Bank of New York, through which the BOJ will obtain necessary funds to directly supply dollars to financial institutions joining the Tokyo market, the first such operation in the bank’s history.

The ECB, the Bank of Canada, the Bank of England and the Swiss National Bank are each entering into similar deals with the New York Fed or expanding the scope of existing agreements.

The BOJ is expected to offer dollar funds starting Thursday through bidding.

Tighter credit conditions on dollar-funding markets are not good for other money markets around the world, Shirakawa stressed. “All we are going to do is enable a smooth funding of dollars and help solve the problem facing global financial markets as a whole.”

But analysts, and even Shirakawa, are skeptical of the action’s ability to completely solve the current financial crisis.

Masaaki Kanno, chief economist at JPMorgan Securities in Japan, said the move by the six central banks will be effective to some extent in easing high interest rates in dollar fund markets, but this is not the end of the story.

“The focus is now shifting from market liquidity to the solvency of financial institutions, or their lack of capital,” Kanno said.

Investors “may pay more attention to how (the U.S. government) will handle the financial institutions absolutely lacking capital rather than to those institutions themselves.”

Hiromichi Shirakawa, chief economist at Credit Suisse in Japan, echoed this view, saying the U.S. needs to establish a federally backed “garbage box fund” designed to purchase bad assets whose liquidity is extremely low from financial institutions.

U.S. “authorities are considering changing the way they respond to the crisis, shifting from micro to macro, or from supporting market liquidity to boosting (banks’) capital,” he said.