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Holly LaFon
Holly LaFon
Articles (7942) 

Harvard Business School Report on Kyle Bass

May 30, 2012 | About:
Kyle Bass, founder of Dallas-based Hayman Capital, has been enormously successful. The below Harvard Business School report explores Bass' money management history and current views on Japan:

Hayman Capital Management

Rating: 2.3/5 (6 votes)


Mcwillia - 5 years ago    Report SPAM
Bass' analysis is good, but he fails to factor in several 'gears' which will both delay the implosion and make only the yen short really work. Japan's average JGB is 7.7 years duration. So it is helpful to keep in mind that each year, approximately 1/8 of the debt must be rolled, and that the Bank of Japan (BOJ) is presently monetizing about 40 Trillion yen (trillion yen is the handy unit of measure for Japan analyses, so it helps to get used to it.) This amount is almost exactly the amount of interest the Government of Japan spends on debt service. Note that this means that Japan is now essentially an 8 year negative amortization Arm type loan. Now, here are the missing gears...

  1. Japan will continue to a) monetize indefinitely and fund the purchase of foreign assets, b) push out its average bond duration, (c) buy in all floating rate debt, and d) sell yen aggressively into periods of strength, until the world wakes up. Japan has no reason to cease this so long as the world considers Japan the most credit-worthy nation in the history of world finance, which is what its rate curve says. Every month this continues is potentially many months or even years of breathing room. This matters when one is paying to wait in a short trade.
  2. When the crisis hits, the yen will begin falling first, as it is more sensitive to international supply and demand than JGB's, threatening to pull down JGB's and hike rates. Japan will NOT intervene to support the yen, rather it will then rig the JGB auctions and permit the yen to fall. How? If most buyers are domestic, it turns out to be very easy to rig these auctions. In essence 'allocate' JGB's at pegged rates to certain buyers, who in turn are promised regulatory and financial favors elsewhere in the system. The result is a good bid to cover ratio, all the bonds get sold at the target interest rate, and the buyers pay the full price but get kicked back some of the cost in the form of tariff and quota favors, legal exemptions, monopoly permissiveness, and other favors which are back-room items outside the public scrutiny, resulting in WTO cases perhaps, but not a Sovereign default. This will keep rates low, despite its eventual acceleration of the yen fall.
  3. The falling yen will stoke the export economy and soak up slack capacity throughout Japan, while no import price appreciation will harm the economy, as METI, and the Ministry of Finance, via the FILP accounts, has already supervised a comprehensive commodity and raw material hedging and outright purchase program. Witness Mitsui's recent oil field purchases, financed indirectly by, of course, the Government of Japan, who borrowed at 1% to finance the purchase.
  4. Next, the labor shortage caused by manufacturing upticks will be met largely by issuing work visas to Southeast Asia and India. This will require workers to contribute into, but take nothing from, the social security system. Japan is always willing to engage in this kind of anti-foreigner labor regime. They are indeed xenophobic, as Mr. Bass notes, but this does not manifest itself as he concludes. Japan will enact discriminatory policies which boost its economy.
  5. Finally, fiscal reform will come from an increase in retirement age, reduction of national health copay, elimination of certain coverage within the Social Security programs, increased premiums, higher VAT and excise taxes, especially on oil and LNG, and the usual spate of protectionism. The return of the LDP to power will deliver most of this, unless the DJP reconciles with Ozawa, in which case they will do it instead.
  6. Last, the yen fall will be permitted until the prevailing wage rate in Japan is competitive with South Korea and possibly Taiwan. Say, 250. Then Japan will deploy its warchest forex reserve and shore up the yen. They could prevent a further slide by pegging and even a partial metallic system. The recent swap deals with other Asian nations will have a huge impact on mitigating this fall as well. Note that this could be done without a huge rate hike, and any rate hikes could be met or offset with present forex and other reserves for up to nearly two years, or more if a bailout is orchestrated.
  7. Speaking of bailouts, the U.S. would be actively bailing them out in the final stages prior to any JGB collapse, since Japan would certainly make the point that Japan had to sell all US Treasury holdings in order to buy yen and stem the crash otherwise. This would put intolerable rate pressure on the U.S., and a grudging partial bailout would be forthcoming.

These are a few of the gears Kyle Bass is missing. They delay his crash-thesis and show why the yen short is far better than the CDS play.

Meanwhile, remember the above has been an economics argument. The political realities are even more reason to fear that Bass' crash thesis will be delayed and softened. There is little chance America would willingly permit Japan to default for geopolitical reasons. The Japan alliance serves as the cornerstone of America's counterpoise to China and Russia in the region. The STATE Department would bail out Japan, even if Treasury wouldn't. Moreover, Japan could always stoke a military episode in the area, conducing to increased Japanese GDP, particularly since this has been Japan's modus operendi for handling excessive debt on several occasions in the past, directly or indirectly, such as (roughly) in 1895, 1905, 1950, and 1966. We have also not spoken of the nationalistic Peronist evolution Japan would be going through during the yen fall. These forces would impel the United States to be more proactive and protective financially, and more forgiving in a regulatory sense, of Japan during a real crisis.

Bottom line, the yen falls, JGB's don't default, Japan winds up a bit more fascist, but finally emerges in good financial shape. And it probably happens slower than Kyle Bass thinks.

(disclosure, Long Aflac, and long 4 year yen/dollar at 100 strike. Those who know Aflac will understand)

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