The Chinese are so good at copying, they’ve taken Keynesian stimulus to new dimensions. Those vacant cities, unused superhighways and empty malls were all built with debt issued by the government controlled banks. Loans get repaid based upon the cash flow of the projects built. No cash flow – no repayment. No repayment = DEFAULT.
How about loan losses of $1 trillion? The governments of the world can try to hide the debt, shuffle the debt, disguise the debt, rename the debt and pretend the debt doesn’t exist. But in the end, someone takes the loss. The ponzi scheme is eventually revealed and the house of cards collapses.
China’s Bank Reckoning Approaches
A large part of China’s economic miracle was built on ill-considered lending and accounting sleight-of-hand.
By CARL E. WALTER
AND FRASER J.T. HOWIE
The first wave of problem loans originating from the 2009 economic stimulus is about to hit the banking system. If the reports citing anonymous officials are true, Beijing is considering assuming responsibility for some 2-3 trillion yuan ($300-450 billion) of these loans that were made to local government borrowing vehicles.
The scale of such a rescue is staggering–at about 7% of GDP it is bigger than the U.S. TARP program. It also comes out of the blue; the banks’ audited accounts still show that their nonperforming loans have fallen dramatically. Yet the bailout would nearly equal the total amount of bad loans spun off from the four major state banks during their restructuring in the early 2000s.
Ironically the proposed bailout also approximates the size of the original 4 trillion yuan stimulus of 2008. China survived that disease, but it’s now clear that the cure made it sicker.
Reuters
How did this happen? When the global financial crisis impacted China’s exports in 2008, Beijing ordered its banks to support a massive credit expansion to create jobs and stimulate growth. The banks eagerly went into action and in 2009 and 2010 made new loans amounting to a total of 20 trillion yuan ($3.1 trillion). Of these a significant amount went to local government borrowers. Estimates of how many of these loans would go bad range from 25% to 30%, which suggests a total figure of 8-9 trillion yuan.
The machinery to remove bad loans from the banking system is already in place. In 1999 Beijing created four asset management companies to acquire nonperforming loans. These “bad banks” were supposed to exist for only 10 years, during which the government expected them to complete the sale or disposal of their portfolios.
The results didn’t go according to plan. After a decade, the AMCs were able to achieve only about a 20% recovery rate across their entire portfolios, almost entirely loans to state enterprises. Since more than one-third of the bad loans were acquired at face value, the AMCs from the start were bankrupt; their modest recovery rate was far too little to repay the financing extended by the central bank and commercial banks.
Any write-off of these worthless “assets” would either have forced the Ministry of Finance to assume the AMCs’ debts or forced the banks, which hold AMC bonds, to take losses large enough to wipe out big chunks of their capital. So for political reasons nothing happened. In 2009, bank financing to the AMCs was rolled forward for another decade and the AMCs have survived.
If these vehicles are pressed into service to buy these local government loans, the scale of new financing required makes this shell game ever more precarious. The 2-3 trillion yuan in bad loans would require an equal amount of financing if banks are to avoid loan losses. But the major “commercial” banks don’t have spare capital; they have only just finished another round of fundraising to offset the stress put on their balance sheets by the lending binge. The China Development Bank, also an aggressive local lender, is in the midst of restructuring in search of its own successful IPO.
But Beijing has a second choice of techniques. Instead of using the AMCs the Ministry of Finance might establish special “co-managed accounts,” as was done in the restructuring of Agricultural Bank of China. The special account would acquire at face value the bad loans, using only the ministry’s IOU as payment. These IOUs are carried as “restructuring receivables” on bank balance sheets.
From the ministry’s viewpoint these are only contingent liabilities and so not part of China’s national budget; repayment comes from bank dividends rather than tax revenues. As such, they are likely approved only by the Standing Committee of the National People’s Congress. One can imagine the embarrassing questions about the national debt that would be asked if such arrangements were put before the full NPC.
China’s national debt narrowly defined is 20% of GDP, but if all obligations of the sovereign were added up it is closer to 80%. This is before this round of local government loan acquisition and before considering the other 70% of the stimulus loans made to state enterprises, which history has repeatedly shown are bad credits.
With few voices able to question its actions, it seems that Beijing will continue along the path of increasing systemic financial leverage. The weight of its inability to halt profligate spending by local governments and state enterprises will be put squarely on the backs of future generations.
The fact that China may have just wasted $400 billion should put an end to reflexive praise for Beijing’s great economic planners. If that money had been added to the National Social Security Fund China might be several steps further along the path of creating an economy driven by domestic consumption rather than infrastructure investment.
Perhaps Beijing’s willingness to assume a portion of local government debt shows the political will to act decisively. But it must be remembered that the central government approved these loans in 2008 and 2009 in the knowledge that many projects were of questionable quality. The experience of these two years shows that a large part of the Chinese economic miracle has been built on a foundation of ill-considered lending and accounting sleight-of-hand.
Messrs. Walter and Howie are coauthors of “Red Capitalism: The Fragile Financial Foundations of China’s Extraordinary Rise” (Wiley, 2010).
StuckInNJ says:
My inner Reverse Engineer says this;
The Chinese are ….
Well-loved. Like or Dislike:
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20th June 2011 at 12:39 pm
Administrator says:
Stuck
Now just post 45 pictures in a row and it will be like RE never left.
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20th June 2011 at 12:45 pm
howard in nyc says:
aww, you miss RE so much, you laid this bait for him.
call me old fashioned, but i hold a strong bias that sic semper centrally planned economies.
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20th June 2011 at 12:50 pm
Administrator says:
HONG KONG (MarketWatch) — Credit Suisse on Monday downgraded its rating on China’s banking system and lowered its projections for Chinese economic growth.
Credit Suisse cut its outlook for China’s gross domestic product next year to a rise of 8.5% from its previous forecast of a 8.9% gain, and cut the full-year growth outlook this year to 8.7% from 8.8%.
“We believe persistent inflation, slowing growth and continued tightening is likely to play out, not only in the second half of 2011, but well into 2012,” said Credit Suisse economist Dong Tao.
The bank also lowered its view on the banking sector to underweight, swinging all the way from a previously overweight view.
It cited concerns that the credit-to-GDP ratio has risen to “alarming” levels because of risks associated with off-balance-sheet financing over the last two years.
It said the gravity of the situation didn’t show up in regular lending-to-GDP data, and that a closer look at difficult-to-track lending was a “red flag for future asset-quality problems in banks.”
Central bank data showed new lending by banks was equivalent to 31% and 21% of GDP in 2009 and 2010, respectively. However, when off-balance-sheet lending is factored in, the ratios rise to 39% and 34% of GDP in 2009 and 2010, respectively.
The surge in lending means China’s credit expanded 71% during a two-year period, or by 26.7 trillion yuan ($4.12 trillion), while the credit-to-GDP ratio rose to 166% by March 2011, from 120% at the end of 2008.
“Even if CPI inflation genuinely comes down, room for credit relaxation will be much smaller,” wrote Credit Suisse’s Vincent Chan.
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20th June 2011 at 12:56 pm
StuckInNJ says:
Confuscious say; one picture worth thousand words
Chinese Economic Policy
.
.
I know what yo’all are thinking. That’s USA policy as well. Sho’ nuff !!
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20th June 2011 at 1:01 pm
StuckInNJ says:
Jim — one pic down … 44 to go
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20th June 2011 at 1:01 pm
Buckhed says:
I hope they don’t crash and burn until next summer…I’m looking forward to a trip to Shanghai.
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20th June 2011 at 1:48 pm
Jiggerjuice says:
@Buck
Shanghai is nice. Great view on the Bund.
Ask any Muslim (majority from Xinjiang) you see on the street for blonde hash. It’s just powdered kief. 10 bucks a gram max. Or just hit any bar/club and ask a white person. Everyone knows someone who knows someone.
Pink barbershops are nice too. Shop around for services you are looking for though. Some have certain things, some don’t. 20-30 bucks. Stripping is illegal – prostitution is not.
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20th June 2011 at 2:56 pm
jmarz says:
Did I miss something this week? Did RE leave the site or something? I have been without internet for the past week so I haven’t been on the web much other than for work.
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20th June 2011 at 4:10 pm
StuckInNJ says:
jmarz
There are two theories.
There was an earthquake in Alaska last week. RE’s cabin was covered in seven million tons of dirt. No one has heard from him since. We believe he is eating his students to stay alive. I myself tried to organize a rescue party but noone volunteered to help. So I said fuckit. But I am praying for him.
The other possibility is that he got his feeewings hurt again. He was doppleganged pretty damn good last week. He went on some insane rant, and hasn’t been heard from since.
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20th June 2011 at 4:28 pm
Axel says:
Hope we didn’t lose RE. We already lost Smokey. Damn, this place will soon be all hugs and kisses and butterflies and rainbows.
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20th June 2011 at 8:19 pm
llpoh says:
Axel – never fear – many of us remain to wreak mayhem and destruction. Personally, I have already commenced developing a new list of adversaries. Surly1, that means you (Awholedr – I am keeping an eye on you. Sometimes you say good shit, but the stuff you said re SSS was out of line. You do not have to agre with him, but respect is mandatory. He is an old alpha dog around here, and is worthy.). We the survivors will be as strong and malevolent as ever.
Jmarz – Yes indeed, we pissed RE off. We found a weak spot and went after it like ants after a sugar cube. He started ranting about doppelgangers and how they shouldn’t be allowed, as there had been some good-natured doppelganging going on the previous day to liven things up a bit, and it offended his delicate sensibilities that the Admin would allow such on his site.
Surprise surprise surprise, everyone and their brother then began posting as doppelgang RE, and he lost it. Also, the Admin may have said something about him being a virus to the site or somesuch, and I think that kinda pissed him off too. It was a good day. A fine day indeed.
I have been careful not to rejoice too hard, though, as I expect he will see and will come back just to spite me.
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20th June 2011 at 8:55 pm
crazyivan says:
Hope we didn’t lose RE. We already lost Smokey. Damn, this place will soon be all hugs and kisses and butterflies and rainbows.
No, not with Admin and Stucky incessantly butt-fucking in the background.
Now, I know they are going to exploit my limited itelligence for that remark by trying to make me feel bad or ignoring my comment.
That would be so cool!
If I could, I would explain
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20th June 2011 at 9:25 pm
Administrator says:
jmarz
RE disappeared on the day of the Great Alaskan Earthquake. We’ve sent a search party.
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20th June 2011 at 9:28 pm
llpoh says:
Re lost in the wilderness:
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20th June 2011 at 9:40 pm
jmarz says:
Stuck/LLPOH/Admin
I guess I missed the party.
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20th June 2011 at 9:46 pm
jmarz says:
It is never too late to celebrate a happy occassion
.
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20th June 2011 at 9:49 pm
Administrator says:
llpoh
Should we have a vote about begging RE to return?
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20th June 2011 at 9:49 pm
llpoh says:
Jmarz – it is never too late to celebrate:
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20th June 2011 at 9:50 pm
Administrator says:
crazydouchebag
Did your hat arrive yet?
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20th June 2011 at 9:52 pm
llpoh says:
Admin – For fuck sake, let me enjoy the moment.
In all honesty, I never asked him to leave, and said so many many times.
But I will be damned if I will stroke his massive ego and beg or even ask him to stay or return.
You have provided him a free forum to distribute his way-out shit for a very long time, and it is an incredibly gracious thing, in my opinion. Gratitude and common decency are not part of his make-up.
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20th June 2011 at 9:53 pm
Administrator says:
llpoh
Only a picture can describe the last few days for me.
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20th June 2011 at 10:00 pm
newsjunkie says:
OK, dammit, we lose too many people on this site. This is for RE.
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20th June 2011 at 11:02 pm
llpoh says:
Newsjunkie- their loss. For every lost RE we pick up severl John Angelos. Seems like a great swap to me.
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20th June 2011 at 11:19 pm
ecliptix543 says:
You know.. I was thinking that right about the time we gangfucked RE, he disappears, and a guy sets himself on fire. He’d have had enough time to make it to NH (if he was ever really in AK to begin with). Hmmm…
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20th June 2011 at 11:50 pm
ecliptix543 says:
John Angelo has yet to prove himself around here. For fuck’s sake, I’ve been here since before the string of denial of service attacks on the old servers and I still get my balls busted on a regular basis. RE was funny and/or useful more than half the time, as I see it. If he comes back, it wouldn’t bother me in the least and neither would Smokey if he came back. If not, so be it.
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20th June 2011 at 11:53 pm
Administrator says:
ecliptix
I know RE’s real name. It isn’t Tom Ball.
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20th June 2011 at 8:19 am
ecliptix543 says:
Damn..
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20th June 2011 at 12:11 pm