JIJI PRESS/AFP/Getty Images Bank of Japan governor Masaaki Shirakawa

The exposures of various insurance companies to the economic devastation of the Tsunami may be dominating the financial discussions in the tragedy's wake – but Japanese banks may be at the most risk.

And that risk may become a tragic test case for an economic conundrum described by Warren Buffett.

Here's the background.

An Australian hedge fund manager named John Hempton has done analysis on a Japanese financial institution called 77 Bank.

The bank is located in Sendai, which is the Japanese city most affected by the tsunami.

Not only is the bank located in the city that sustained the most damage, it also has a near 50 percent market share in that metropolitan area.

Here's the rub. Hempton writes:

"Warren Buffett once said that Fannie Mae had more supercatastrophe risk in it than Berkshire Hathaway. He figured the really really big hurricane or earthquake could do more damage to Fannie than Berkshire even though Berkshire is the largest supercat insurer in the world.

Buffett was – I suspect – right.

We now unfortunately have a gruesome test of Buffett statement on finance and supercatastrophe. There is probably more uninsured damage in the destruction of North East Japan than in any other event in history – and uninsured damage falls sharply on banks.

77 Bank – deeply concentrated in the disaster zone – is the test. It is not a test I would want to repeat. But I think we will – at the end of this – be able to confirm Buffett’s observation that banks don’t like supercats."

The story comes to us via Tracy Alloway in the FT's Alphaville blog.

Alloway, in fact, links the Hempton story up with the broader macroeconomic picture in Japan:

"Up until now, 77 has very few loan losses because (dum dum dum) it made very few loans. And now, with Friday’s disaster, it will suddenly have to deal with loan losses on a potentially very wide scale without much pre-tax profitability to offset them. That’s Hempton’s theory anyway. And we would add that nervousness in the Japanese government bond market, where lots of regional and megabanks have upped their investment in recent months, has the potential to provide some ‘indirect exposure’ to the earthquake, even if they have no direct exposure to the area. No wonder the Bank of Japan is rushing to act."

The 15 trillion yen the Bank of Japan injected into the markets to stave off a severe financial panic has been struggling all the while struggling against the headwinds of two decades of stagnant growth.

The world is now watching Japan, as the Japanese government struggles to contain potential disaster at its damaged nuclear reactors.

If the Japanese are able to successfully manage that imminent crisis – as we all pray they will – the next round of discussion will be no less refractory to solution.

Fasten your seatbelt and strap yourself in for the coming debate in Japan: About bank solvency, short-term monetary relief – and the limits of Keynesian fiscal policy in reconstruction.

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