Provisional translation

Press Conference by FSA Commissioner Takafumi Sato

(Excerpt)

July 14, 2008

[Opening Remarks]

Good afternoon. Please feel free to ask me questions.

[Questions and Answers]

Q.

Last week, a U.S. regional bank specializing in mortgage loans was ordered to suspend its operations by the FDIC (Federal Deposit Insurance Corporation). The bank has thus virtually gone bankrupt, and I understand that it was the second largest bank to be ordered by the FDIC to suspend operations. Could you tell me what impact you expect this large-scale bankruptcy to have on the U.S. financial system? Also, do you expect that more regional and other banks will go bankrupt in the United States?

A.

I am aware of the FDIC'S announcement on July 11 that IndyMac Bank, a U.S. regional bank, has been closed and put under the control of the FDIC.

I would like to refrain from predicting the impact of this bankruptcy on the U.S. financial system or future developments related to U.S. regional banks. Generally speaking, I understand that the financial market turmoil triggered by the subprime mortgage problem is continuing, as shown by the emerging effects of the slumping U.S. housing market. As you know, the slumping U.S housing market is reflected in declining housing prices and the high level of the mortgage delinquency rate. In addition, liquidity has not been restored to the market for securitized products backed by residential mortgage loans, and confidence in the valuation (of securitized products) is still lacking. I suppose that these factors lie behind the bankruptcy. Therefore, my understanding is that the unfavorable effects will continue.

Q.

At an emergency press conference on July 13, U.S. Treasury Secretary Paulson announced a rescue package for the two government-sponsored mortgage financing institutions, Fannie Mae and Freddie Mac, which included the provision of additional funds to them as necessary and the direct purchase of their shares by the government. Shares in the two institutions have been dropping sharply recently amid worries about the deterioration of their financial conditions, fueling concern about a credit crunch. Meanwhile, the balance of bonds issued by these institutions is said to amount to about 2 trillion dollars, and Japanese megabanks are said to own bonds to the tune of trillions of yen. Could you tell me about your views on the U.S. government's response and the possible impact on Japanese financial institutions?

A.

This was announced yesterday, July 13, by the Treasury Department and the FRB (Federal Reserve Board). As a rescue measure, the Treasury Department will first increase the line of credit for these GSEs (government-sponsored enterprises). Secondly, they will purchase shares from them as necessary in order to strengthen their capital bases, and thirdly, they will strengthen the regulatory framework for the GSEs through measures such as assigning the FRB to be their regulator. The FRB also announced rescue measures for the GSEs. First, it will lend to them at the primary credit rate, or the discount rate, which currently stands at 2.25%. Secondly, such lending will be collateralized by U.S. government and federal agency securities. Thirdly, this scheme is positioned as a supplement to the Treasury Department's existing lending authority. These are the measures announced.

In relation to the global financial market turmoil, we have seen both positive and negative factors, and strains still remain as a whole, as I have been saying. The positive factors include the readiness of major financial institutions to quickly recognize and disclose losses, and raise fresh capital to strengthen their capital bases if they find themselves to be undercapitalized. Also, there are investors willing to provide capital when needed, and this mechanism works in a cycle. The authorities' strong commitment to preventing a global systemic risk from materializing has been demonstrated by the bailout of Bear Stearns and the provision of massive liquidity by central banks. These are the positive factors. Meanwhile, the negative factors include the housing market conditions that I mentioned earlier, the turmoil in the securitized product market and strains in the short-term money market. The announcement made at this time by the U.S. authorities is a clear indication of their strong commitment to preventing the market from plunging into a state of chaos and avoiding a systemic risk. Also, the (G-8) leaders' declaration issued at the Hokkaido Toyako summit included the following statement: "We are determined to continuously take appropriate actions, individually and collectively, to ensure stability and growth in our economies and globally." I strongly hope that a consensus will be quickly formed among the parties concerned in the United States about the measures announced at this time, and that the measures will be implemented promptly.

As there are various opinions in the market about the announcement made by the U.S. authorities, I would like to refrain from making any definitive comments at this time on the possible effects of the announced measures on Japan's financial system. However, as I have been saying since last autumn, Japan's exposure to subprime-related securitized products is limited compared with that of the United States and Europe, so the subprime mortgage problem is unlikely to produce a serious direct impact on Japan's financial system. I expect that this (the announcement regarding Fannie Mae and Freddie Mac) may lead to a situation in which we need to change our assessment of the impact.

I would like to remind you that, as was pointed out at the summit, it is extremely important that financial institutions holding subprime-related products or facing various other risks disclose data properly, including the extent of their exposures, in line with the leading disclosure practices. It is also important to steadily implement the recommendations by the FSF (Financial Stability Forum). These matters were pointed out in the summit declaration. Major Japanese financial institutions have made enhanced disclosures in the announcements of their financial results for the fiscal year ended in March 2008 and in their IR (investor relations) materials, in line with the leading disclosure practices specified by the FSF. I expect that Japanese financial institutions have gained a certain degree of market confidence through such disclosure efforts.

Q.

At a meeting of cabinet ministers regarding the monthly economic report, Minister (of Financial Services) Watanabe offered a very severe assessment regarding the condition of the global financial and capital markets, saying that the current situation is very close to a financial crisis, according to a briefing on the meeting by Minister (in charge of economic and fiscal policy) Ota. He apparently went so far as to say that moves to withdraw funds from Japan may increase. Although what he said has something in common with your comments, it appears to me that there is a slight difference in tone. What do you think?

A.

Regarding the condition of the global financial market, there are a number of negative factors as well as positive factors, as I have already pointed out. The recent bankruptcy of a U.S. regional bank occurred against the background of the slumping U.S. housing market that I spoke of earlier. Minister Watanabe and I share the opinion that optimism is not justified given that the effects (of the subprime mortgage problem) are thus emerging - or should I say continuing. Compared to a global situation like this, it is true that Japan's financial market and financial system are relatively stable.

Nevertheless, if the global market turmoil is prolonged, it could adversely affect Japan over time, so the FSA (Financial Services Agency) will need to remain vigilant, keep a close watch on various developments in the global market and examine their effects on Japan's financial market and system, while striving to maintain information exchanges and cooperation with overseas authorities.

Q.

Do you plan to check the extent to which Japanese financial institutions are exposed to bonds issued by Fannie Mae and Freddie Mac?

A.

As world-leading disclosure practice, the FSA has compiled and disclosed data regarding subprime-related securitized products as of the end of March 2008. As for the fiscal year ended in March, the FSA expanded the scope of disclosure to include securitized products not related to subprime mortgages, namely non-subprime CLO (collateralized loan obligations) and CDOs (collateralized debt obligations), as well as non-subprime RMBS (residential mortgage-backed securities), CMBS (commercial mortgage-backed securities) and leveraged loans. The FSA then compiled and disclosed nation-wide data regarding all Japanese financial institutions' holdings of securitized products with regard to each of these categories of securities. The total amount of the holdings of these securitized products, including subprime-related holdings, stood at slightly over 22 trillion yen as of the end of March, if I remember correctly. Of the total, subprime-related products accounted for only one trillion yen.

One notable feature of the RMBS arranged by Fannie Mae and Freddie Mac is that they are also guaranteed by these two institutions, and I understand that these securitized products are backed mainly by high-quality mortgages, namely prime mortgages. Therefore, I assume that the loss ratio and incidence of loss regarding them are different from those regarding subprime-related products.

In any case, the measures announced by the U.S. authorities are intended to support efforts to maintain the soundness of the financial conditions of the two GSEs, which guarantee these securities, so I think that this is positive news from the viewpoint of underpinning the value of mortgage-related securities like RMBS.

(End)