Wall Street's continued exuberance prompts the thought that Federal Reserve Chairman Alan Greenspan might finally move to tighten 10 years after former Bank of Japan Governor Yasushi Mineo moved to deflate the Japanese asset bubble. The Bank of Japan's tightening actually began at the very end of 1989. Will Greenspan move before the new millennium?

Greed & Fear used to feel that Wall Street was not a Tokyo-style bubble. That view holds no longer. Massive use of employee options and related share buybacks are prompting creative accounting fiddles, which will result in a future torrent of lawsuits.

Meanwhile, the interesting question is whether the Tokyo stock market can finally move into a sustained bull phase as and when Wall Street expires. The

Dow Jones Transport Index

has still failed to confirm the

Dow Jones Industrial Average's

new high, while the advance-decline trend remains far from healthy.

In Japan, this week's announcement of

Sony's

(SNE) - Get Report

restructuring, combined with talk of further public-sector recapitalization of the banking system, provides more confirmation that the Japanese are out of denial, as discussed

here last month.

This is obviously positive. Still, Greed & Fear's view is that the current Japanese stock market rally will peter out with the end of the Japanese financial year. Critical developments in coming months in Japan will be the pace of corporate restructuring and the resulting impact on consumer sentiment.

Greed & Fear has not been in Malaysia for nearly a year. To return to a place now ignored by most pundits because of its self-imposed isolation is to realize that conditions are not so dire in economic terms.

The reinclusion of Malaysia in the

IFC

indices from Nov. 1 provides a good opportunity to reinclude a 4% out-of-the-index bet (relative to the

MSCI

) in Malaysia. This should be seen in the context that if Malaysia were fully weighted, it would have an 8.7% neutral weighting based on present stock-market capitalizations in the MSCI Far East Free ex-Japan Index.

The reinclusion of Malaysia in the MSCI would seem only a matter of time, since capital controls have effectively been dropped. The Malaysian stock market is down by 9.9% in U.S. dollar terms year to date.

Greed & Fear is making another asset allocation switch this week. The weighting in Thailand is being raised by 4 percentage points to 6%.

The Thai stock market is down 8.9% year to date in U.S. dollar terms. The reason for moving from the underweight position held since the beginning of the year is that the laws of probability suggest we will get progress tomorrow on the bankruptcy legislation. A trading rally therefore beckons.

The asset allocation is being funded in part by taking our out-of-the-index bet in India off the table and in part from cash.

India has proved a good wager since the Bombay stock market has outperformed this year, growing 22.5% in U.S. dollar terms year to date.

Still, the latest budget has again proved a disappointment. It was tactically positive for the stock market, but structurally negative in that nothing has again been done about the endemic fiscal deficit. The failure to deal with India's longstanding fiscal problems raises the danger of a currency blow at some future date. The asset allocation continues to favor Southeast Asia and South Korea over China.

Returning to Malaysia, the story has gone full circle. Two years ago, few doubted Malaysia's political stability as this society grew ever more self-contentedly bourgeoisie under the combination of rapid economic growth and the expedient redistribution of wealth via the New Economic Policy. The bear story then was the domestic leverage and the serious linkage of the stock market to the financial system via the widespread use of shares as collateral.

Consensus analysts argued, as they do in Taiwan today, that the listed corporate sector was not leveraged.

The reality was, however, that the private side of these corporate empires borrowed heavily using their listed shares as collateral. Such is history, and it explains why the stock market exceeded even the biggest bears' downside targets, including Greed & Fear's target of 400 on the

KLSE

index.

Now politics is the issue, since Malaysia faces a succession vacuum. More on this later. But the economic outlook in many respects is quite promising, especially in the relative sense.

Malaysia seems to have used the capital controls, resulting in sharply lower interest rates and exchange-rate stability, wisely in one key policy area. The authorities have embraced what can only be described as a textbook restructuring of the banking system. The result has been to avert what last summer threatened to turn into a full-scale breakdown of the banking system.

Malaysia's restructuring of the banking system is focused on two key institutions. The first,

Danaharta

, buys nonperforming loans from the banks and issues paper in exchange. Significantly, the original shareholders are being forced to take a discount with the average discount at 40% to the face value of the loan. Banks are given an incentive to sell NPLs because if they sell, they have the option to amortize the loss over five years. But if they do not sell, they have to write the loan off immediately.

If Danaharta focuses on the asset side of the balance sheet,

Danamodal's

job is recapitalization. It will invest in troubled banks via a combination of subordinated loans (tier 2) and convertible preference shares or, if need be, common equity (tier 1). Since these institutions were only set up last summer, it is encouraging that they have actually started doing things. Danamodal has so far injected RM4.6 billion into nine banks. Danaharta has issued enough zero-coupon bonds to acquire an estimated RM5.9 billion of NPLs and taken over management of RM7.6 billion (mostly of

Sime Bank

).

This is just a start. Still, Malaysia's banking problem is fixable. Total loans in the financial system are about RM420 billion. Assuming 25% NPLs, the nominal recapitalization is around RM80 billion, though the actual number is lower than this, since the goal is to reduce banks' NPLs to 10%, after which Danamodal becomes involved.

These are relatively small numbers to the scale of banking problems seen in Korea, Thailand and Indonesia. In the latter two countries, NPL problems are now endemic. The collapse in interest rates as a result of capital controls (though it may well have happened anyway given trends elsewhere in the region) has prevented that from happening in Malaysia. Also, the quality of bank management and bank regulation in Malaysia was infinitely superior going into the crisis than in these other three countries.

Renong Cloud

Political developments over the past year raise the issue of whether the central bank is now hopelessly politicized. The answer is that loan growth targets and the like have not been as draconian as first feared.

Loans actually grew 1.3% (including loans sold to Danaharta), compared with the formal target of 8% as banks turned understandably cautious. Loan approvals are now rising, however, up 56% year on year in January. Credit growth is strongest in low- to medium-cost housing where demand remains strong.

This is not to suggest there is no political interference.

The Renong recapitalization is a case in point. Domestic banks will only get repaid on the assumption that Renong is able to sell the PLUS bonds. PLUS is issuing RM8.4 billion in seven-year zero-coupon bonds to repay part of Renong and

UEM's

debts. Renong is also significant in the context of the whole NPL problem, since the loans being dealt with represent about 11% of total NPLs.

Still, political pressures are not preventing the authorities from dealing with the worst of the banking problems. The four biggest threats to the bank system have already been addressed, with the NPLs of Sime Bank (the result of

Sime Darby's

disastrous folly into banking),

Bank Bumiputra

,

Arab Malaysia Bank

and

Mbf

having been transferred to safe hands, be they those of Danaharta or

Bank Negara

. These represent an estimated 43% of total NPLs.

If the banks get healthier, Malaysia's economy should continue to show signs of stabilization, since where credit growth goes, so will the economy.

External developments will also prove key, not least Japan, given the Malaysian economy's huge gearing to trade. Total trade, in terms of exports and imports of goods, accounted for 185% of

GDP

in 1998. At this point, then, the major issue becomes political.

Prime Minister Mahathir Mohamad

is clearly a wily politician who has won the power struggle with his sacked deputy

Anwar Ibrahim

for now. Having groomed his chosen successor for so many years, the PM was clearly incensed at what he saw as his efforts to undermine him. This irritation finally climaxed with Anwar's championing by the foreign press.

Still, the power struggle has come at a huge cost, the consequences of which are not yet clear.

First, Malaysia now has no clear successor, with the present Deputy PM

Ahmad Abdullah Badawi

being viewed as very much a transitional candidate. General elections are due to be held by June 2000 and

United Malays National Organization

elections thereafter.

The dangers of succession vacuums are now clear from the disaster in Indonesia. Like the

Golkar

party in Indonesia, UMNO is now bereft of any ideological

raison d'etre

. Its sole function is to try and stay in power for the benefit of money politics, which highlights the potential for huge infighting. That potential suggests that any premature departure of Mahathir from the scene, in terms of voluntary resignation, might not be as bullish as many foreign investors believe.

The second problem for Mahathir is that he has significantly alienated large sections of the

Bumiputra

vote by mistreating Anwar. This view is held by many who were not even Anwar supporters. This is largely because of the nonsubtle confrontation tactics employed.

There is also a religious dimension, which cannot be ignored. To accuse someone of specific sexual misdeeds and then to be seen avoiding proving them are perceived as a sin against Islam.

The dropping of the sexual charges against Anwar is therefore significant in this regard. The result is ironically that Mahathir will be relying heavily on the non-Bumiputra vote in forthcoming general elections, since non-Bumiputras value stability above all else, especially when they look at Indonesia and appreciate the secularist bent of Mahathir's policies. This is a viable strategy, since the Chinese account for 25% of the population and Indians 7%. Still, past gerrymandering by UMNO of electoral districts means that the non-Bumiputra vote does not count as much as it should.

None of the above is to suggest that Malaysia will sink into an Indonesian-style chaos or that the social fabric of the country is called into question. The reason is that this is a dominantly middle-class country. But for this very reason, political opposition will also grow, which is being reflected in new Internet sites that contain the stories and rumors that the official-controlled print media dare not run.

The final positive point that should never be ignored about Malaysia is its positive demographic profile. A total of 62% of Malaysia's population is below 30 years of age and 83% below 44. This should, at a minimum, promote healthy consumption trends. Our favored sector for investment is the small-ticket consumer sector in areas such as food and beverage, cigarettes and lotteries. This suggests stocks such as

Rothmans

,

Tanjong

and

B-Toto

. The banking sector by contrast is not relatively attractive because the interests of shareholders will be subordinated to the national recapitalization effort. Significant dilution would therefore seem inevitable.

Thai Trading Opportunity

Turning to Thailand, Greed & Fear is of the view that the draft bankruptcy bill can be passed despite

Senate

opposition. This is also the view of

ABN-Amro's

Bangkok office. This therefore presents a trading opportunity in a stock market seemingly stuck in a trading range from 300 to 420 on the

SET

index.

The legal issue is important because foreign investors will view this as a litmus test as to whether Thailand remains on a reform path.

Growing doubts about the stalled reform momentum have justified our underweight stance since the beginning of the year.

Immense problems remain in Thailand. The government's voluntary approach to the recapitalization of the banking sector is in stark contrast to the compulsory closure adopted with the finance companies.

Thus far, this voluntary approach cannot be considered a success. Systemwide, NPLs are running at about the 50% level and ABN-Amro forecasts they will reach 60% by the end of 1999. Reflecting this grim picture, banks can barely break even at the operational level, even though the gross spread between lending and deposit rates is more than 5 percentage points.

The threat is clear. If these laws are not passed or amended as required, and Thai banks remain without workable bankruptcy or foreclosure rules, the Thai banking system could suffer an Indonesian-style collapse. At that point, it becomes easier to start afresh since wholesale nationalization will be required. The raising in the asset allocation this week suggests this disastrous outcome can still be avoided, but it is a close call and will in part hinge on external developments in terms of stabilization in the region or lack of it.

The Thai government therefore risks suffering the boomerang effect from having been too lenient on the private banks, most of which are desperately trying to retain majority control. It remains unclear, for example, why the government has not established any bad-bank agency to carve out the NPLs as both Malaysia and Korea have done.

It is also dubious in the extreme to allow Thai banks to raise debt instruments misleadingly described as equity from their depositor base.

The only bank stock ABN-Amro recommends in its Thai asset allocation is

Bangkok Bank

, which is the cheapest on both a price-adjusted book-value basis and on a recovery PER basis.

Another point worth mentioning on Bangkok Bank is that by shrewd Treasury management operations, it has an estimated B10 billion in unrealized capital gains on its domestic bond portfolio. Government bonds have declined by about 800 basis points from peak levels.

Still, such problems in Thailand do not negate the potential for a significant trading rally if there is progress on the legal front. A further major positive is that debts are being restructured. Financial institutions had restructured B187 billion worth of debt by the beginning of January, based on data submitted to the

Bank of Thailand

.

The pace of restructuring will now accelerate as practical experience grows. Clearly, laws alone cannot change the dire situation overnight.

The problem in Thailand, as in Indonesia, is that confidence in the entire financial system has been obliterated, including the culture of personal guarantees. It will take years, not months, to rebuild that confidence.

On Indonesia, the latest word is that the authorities are about to bite the bullet on bank closures. Any progress on this front, combined with legislative progress in Thailand, would further buoy investor sentiment toward the region, at least in the short term.

Hong Kong-based Christopher Wood is the global emerging market strategist for ABN-Amro. Wood, a former bureau chief for The Economist, has written three books on Japan and global markets, including The End of Japan Inc. (Simon & Schuster, 1994). At time of publication, he held no positions in the securities or instruments mentioned in this column, although holdings can change at any time. Under no circumstances is this to be used or considered as an offer to sell, or a solicitation or recommendation of any offer to buy. While Wood cannot provide investment advice or recommendations, he welcomes your feedback at

commentarymail@thestreet.com.