Means To Avoid Reverse Wealth Effect Caused By Asset Deflation

The Economic Model

Here is the economic model:
Every economic unit holds credits(assets) to other economic units, which relations that bring income to the former. The credit(assets) held by the economic unit is the debt(liability) carried by the other economic unit, and the debt(liability) carried by the economic unit is the credit(asset) of the other economic unit. When the credit and the debt take time to be settled, the value of the credit is appraised based on the debtor's current value accounting. The current value accounting of the economic unit is defined as the appraisal of the face value of the balance sheet(B/S) into current market value and it's reflection to the income statement(P/L). Those economic units who can maintain profit on the P/L continue to exist and those economic units who can not maintain profit go into liquidation. In recession(yield downward, money supply decreased, price deflation), generally many economic units reckon up the losses on the P/L. Furthermore, loss inflicted by assets deflation and with the effect multiplied by current value accounting, incur "spiral of insolvent" on quite a few economic units. We look over this phenomenon in the simplified case as follows:
Five economic units from A to E are abstracted among all economic units in the economy. Economic unit A holds loans for B(B carries loan payable to A), so does B for C, so does C for D, so does D for E, so does E for A for the face value, and each economic unit hold assets such as real estate for the face value(stated immovable account) as below.

Figure 1　

B/S of A

Loan 100	Loan Payable 100
Immovable a/c 100	Loan Payable 100

B/S of B

Loan 100	Loan Payable 100
Immovable a/c 100	Loan Payable 100

B/S of C

Loan 100	Loan Payable 100
Immovable a/c 100	Loan Payable 100

B/S of D

Loan 100	Loan Payable 100
Immovable a/c 100	Loan Payable 100

B/S of E

Loan 100	Loan Payable 100
Immovable a/c 100	Loan Payable 100

After fiscal(one) year, we assume the earnings of each economic unit is as below.

Figure 2

P/L of A

Earning 4

P/L of B

Loss 4

P/L of C

Earning 5

P/L of D

Loss 6

P/L of E

Earning 1

During the same fiscal year, assets deflation occurred and the face value of the real estate is revaluated from 100 to 96, on each economic unit as below.

Figure 3

P/L of A

Appraisal Loss 4

P/L of B

Appraisal Loss 4

P/L of C

Appraisal Loss 4

P/L of D

Appraisal Loss 4

P/L of E

Appraisal Loss 4

Concerning from A to E, we put two assumptions here. First, before the start of aforesaid fiscal year, due to asset deflation, the valuation of assets is so down for assets section to equal liability section (that is, on B/S the value of stockholders' equity section came to zero). Second, in appraising the loan by current value accounting of each economic unit, the total amount of earning(or loss) of the debtor must be divided by all the loan amount held by it's creditors, and we assume half the amount is the loan appraisal loss reckoned up on a single creditor. Hereinafter, we always apply this assumption to each economic unit. We must note that the same phenomenon occurs to the rest half. So, the loan held by A for B, asset deflation inflicts B for 4 and loss distress B for 4 so in total loan appraisal loss will be 8, and half the amount 4 is the loan appraisal loss reckoned up on A. The loan, held by B for C, though asset deflation inflicts C for 4, C earned 5 so no loan appraisal loss is to be reckoned up on B. The loan, held by C for D, D suffers Loss 6 and assets deflation 4 for total 10, so half the amount 5 is reckoned up as loan appraisal loss on C. The loan, held by D for E, though E suffers asset deflation 4, E earned 1, in summing up 3, so D reckons up half the amount 1.5 as loan appraisal loss. The loan, held by E for A, though asset deflation inflicts A for 4, A earned 4 so no loan appraisal loss on E(Phase Ⅰ). Each economic units' loan appraisal loss is as below.

Phase Ⅰ

P/L of A

Loan Appraisal Loss 4

P/L of B

Loan Appraisal Loss 0

P/L of C

Loan Appraisal Loss 5

P/L of D

Loan Appraisal Loss 1.5

P/L of E

Loan Appraisal Loss 0

And then, it moves on to next phase. E reappraises the loan for A by taking into account A's loan appraisal loss 4, and reckon up half the amount 2 as reappraisal loss. D reappraises the loan for E by taking into account the loan reappraisal loss 2 on E and reckons up half the amount 1 as reappraisal loss. C reappraises the loan for D by taking into account the loan appraisal loss 1.5 and loan reappraisal loss 1, in total 2.5, reckoning up half the amount 1.25 as loan reappraisal loss. B reappraises the loan for C by taking into account the loan appraisal loss 5 and loan reappraisal loss 1.25, in total 6.25, reckoning up half the amount 3.125 as loan reappraisal loss. A reappraises the loan for B by taking into account the loan reappraisal loss 3.125 on B and reckons up half the amount 1.5625 as loan reappraisal loss. And it circulates again. This proceeds lasts and spirally inflict the B/S of each economic unit as multiplier effect(Phase Ⅱ), and cause another asset deflation. This is "spiral of insolvency". Every single economic unit acts rationally, but on the whole economy fall into the fallacy of composition.
The spiral of insolvency is curbed by sufficient internal reserve that certain economic units hold. But in the possible case, spiral of insolvency is more effective to depress the economy than that, or the stimulation of the economy by lower rate or public investment. In that case there is little chance for the economy to recover. Perhaps it is difficult to tell the way how, and the extent to which, current value accounting affect economy under asset deflation.

Phase Ⅱ

P/L of A

Loan Appraisal Loss 1.5625

P/L of B

Loan Appraisal Loss 3.125

P/L of C

Loan Appraisal Loss 1.25

P/L of D

Loan Appraisal Loss 1

P/L of E

Loan Appraisal Loss 2

For this solution, Non-Performing Loan Bid System(hereinafter called "NLBS″) is necessary. Next, we look how NLBS basically functions among economic units X, Y and Z. NLBS's site is provided on net market. There are X1, X2, ･･･Xn who want to sell loan for Y1 at discount price, as Y1 is insolvent based on current value accounting. On the other hand there are Z1, Z2, ･･･Zn who want to buy loan for Y1, and offset it's debt to Y1. In this situation X1, X2, ･･･Xn and Z1, Z2, ･･･Zn input data of deal conditions(1)(discount price, amount, due et al. Generally the earlier the due is, the higher the price). Then the counterpart is found that most matches the conditions, and the deal done(2). The loan is assigned from X1 to Z1(3). Z1 disclaim the benefit of term of loan payable to Y1 and offset at face value, which leaves gains to Z1. Z1 pay to X1 for the price and immediately after the receipt by X1 the fund is deposited to escrow account(4). The fund remains in escrow account in the name of X1 and Z1(joint account) for certain period, until no chance exists for offset to be avoided(the term is to be politically variable), as right in act of Y1's bankruptcy, and then the fund is to be released finally to X1. Both assignment and offset are advised to Y1(5). In the case the offset is avoided as right in act of Y1's bankruptcy, the status quo ante is restored, and the fund is returned to Z1.
NLBS is a non-performing loan trading market itself. As NLBS function to adjust the B/S of Y1, it pressures Y1 to leave the market where Y1 stays now, and in fact, it forces to leave. To avoid driven out of the market, Y1 must take measures to dissolve the insolvency, by increasing capital, by debt-for-equity-swap, or by realizing enough profits, et al.

Figure 4

Seller X1	－data input(1)→	Net Site	←data input(1)－	Buyer Z1
	－deal(2)→		←deal(2)－
	―――――――――assign loan(3)――――――――→
	←―――――――――payment(4)―――――――――
	―assign notice(5)→	Y1	←―offset notice(5)―
↓deposit(4)
Escrow Account

NLBS works to improve the B/S of the economic units together with economic policy of government and central bank, in recession. Now we look at this:
We add central bank and bank to the aforesaid economic units. Bank holds loan for A. Bank's debenture or certificate deposit(CD) which the central bank have purchased beforehand for face value 100, is to be assigned to A(illustrated in red letter in later figure) found through NLBS, in the deal who offered the highest price 95. Because the deal between central bank and A is made as economic policy, authorities must declare that the deal is irrelevant to the corporate credit ratings of the bank. A offset the face value of the CD and the loan payable to bank. A assign the loan for B to C(illustrated in blue letter in later figure), and C offset the face value of the loan and debt. C assign the loan for D to E(illustrated in orange letter in later figure), and E offset the face value of the loan and debt. The initial offset gains provided to A bring about offset gains to C for 4 and E for 4, which make 12 "offset multiplier effect" in all. A and C don’t need to reckon up additional reappraisal loss because it disposed of non-performing loan. If E do not or can not find counterpart through NLBS, the offset gains remained on E will be charged tax,till the same amount, which becomes another fund to cause offset multiplier effect again. The offset gains and assigned loss are summed up, and exempt tax as a system(4 for A and 4 for C). The chance also exists for B and D to improve their B/S. As a whole, the situation phaseⅠ to move on further to phaseⅡ is avoided.

Figure 5

B/S & P/L of Central bank

CD 100
Cash 95	CD 100
Assign Loss 5

B/S of Bank

Loan 100

CD 100

B/S & P/L of A

Loan 100	Loan Payable 100
CD 100	Cash 95
	Offset Gain 5
Loan Payable(offset)100	CD(Offset) 100
Cash 96	Loan 100
Assign Loss 4

B/S of B

Loan 100

Loan Payable 100

B/S & P/L of C

Loan 100	Loan Payable 100
Loan 100	Cash 96
	Offset Gain 4
Loan Payable(offset)100	Loan(Offset) 100
Cash 95	Loan 100
Assign Loss 5

B/S of D

Loan 100

Loan Payable 100

B/S & P/L of E

Loan 100	Loan Payable 100
Loan 100	Cash 95
	Offset Gain 5
Loan Payable(offset)100	Loan(Offset) 100

As a result:
For A: disposal of non-performing loan completed, offset multiplier effect 4, offset gains 1 taxed all
For C: disposal of non-performing loan completed, offset multiplier effect 4, no tax to offset gains 0
For E: no non-performing loan, offset multiplier effect 4, offset gains 4 taxed all
The establishment of the NLBS means to acquire new channel for the government and the central bank to cope with B/S recession, which derived from B/S adjustment. The initial gains provided to the first economic unit by central bank diffuse to the other economic units, through NLBS, bringing about offset multiplier effect. The gains works like a catalyzer. Through the disposal of non-performing loan on economic units concerned, it directs assets to exceed debts substantially on B/S. Offset multiplier effect can cope with the case that spiral of insolvent is more effective to depress the economy than the curb by sufficient internal reserve that certain economic units hold, or the stimulation of the economy by lower interest rate or public investment. Because offset multiplier effect works directly to the B/S of economic units, it stimulates the economy together with lower interest rate or public investment, and it enables government to bring more effectiveness for less expenditure. NLBS must be put in operation before the majority of economic units become insolvent, and before the extent of insolvent become terrible.

posted by yamada @ 12:04 AM