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22-02-2013, 10:14 AM
China is a stack of cards, ponzi scheme and whatever names you call it... The only blessing in disguise in my opinion - its financial sector remains close to foreigners and hence no outsiders can expose the ills...
http://www.afr.com/p/national/china_risk...AYmAF1kS8O
China’s risky real estate game
PUBLISHED: 02 FEB 2013 00:33:00 | UPDATED: 03 FEB 2013 10:40:20
SHARE LINKS:email print-font+fontReprints & permissions
The Chinese economy is like a junkie in need of an ever-bigger fix of credit, US fund manager GMO warns.
ANGUS GRIGG Shanghai
Those looking for a reason to hoard gold and build an underground bunker should read a recent white paper from global asset manager GMO.
Over 14 pages Edward Chancellor and Mike Monnelly forensically unpick China’s financial system and leave readers with the frightening conclusion that the world’s second biggest economy is like a junkie who requires increasingly large hits of credit to achieve the same fix.
“China scares us because it looks like a bubble economy,” they write.
China’s addiction to credit is what worries the sober Boston fund manager, which has $US104 billion under management and a 36-year track record.
The authors see China as a cross between Indonesia in the last days of the Suharto regime and Japan in 1990.
That’s not a good place to be. As most would know, Indonesia went broke, overthrew its authoritarian leader and was bailed out by the International Monetary Fund, while Japan has seen more than two decades of stagnation.
Yet, while doomsayers like GMO and short-seller Jim Chanos line up to predict the fall of China, credit markets are taking exactly the opposite view.
They can’t get enough of China.
Indeed, the hottest asset class on the planet in recent months has been Chinese corporate debt, most particularly in the real estate sector.
In just three years this sector has gone from zero to 25 per cent of the Asian high-yield bond market and is worth billions. Such is the demand that there were 15 US dollar bond-raisings in the sector over the first 20 days of January.
This rush of money has caused yields to halve in just six months.
The result is that speculative Chinese property firms, which are already highly leveraged and often have low levels of corporate governance, can raise money at rates between 6.5 per cent and 12 per cent.
Most would agree this is too cheap for the risks involved.
“In a world of zero yield these things look good to some people,” says Hayden Briscoe, director of Asia-Pacific fixed income at AllianceBernstein in Hong Kong.
“But I think they look very expensive relative to the risk. I’d want at least 20 per cent yield before I’d invest in those products.”
Such a mismatch between risk and return is driving anxiety about these products, but the far bigger problem is that Briscoe and many others believe there will be a sizeable default over the next 12 months. “What we’ve learnt from the financial crisis is that highly leveraged property firms will get into trouble at some stage,” Briscoe says.
The big question is what effect any default may have.
If it simply closes down this funding channel and bond owners take a big haircut, then the issue will be confined to the back pages of the business sections.
Alternatively, if such a default becomes contagious then suddenly China is confronting a US-style credit crisis and the scenario outlined by GMO comes into play.
It be should noted, however, that the likes of Briscoe, CLSA China strategist Andy Rothman and HSBC’s chief China economist Qu Hongbin don’t believe a credit crisis is imminent.
None of them dispute that China does have some serious imbalances which need to be addressed.
Still, they and many others argue Beijing has the will and financial muscle – $US3.3 trillion in foreign reserves – to handle any problems that arise.
GMO and long-time China bull Stephen Roach are less optimistic.
Roach, an economist and former chairman of Morgan Stanley Asia, said in a recent article that China had become increasingly vulnerable and its ability to recover from any external shock had been weakened.
“China’s growth model has become stretched as never before,” he wrote.
“And like a piece of fabric, the longer it remains stretched, the longer it will take to return to its former resilient state – and the greater the possibility it won’t spring back the next time something goes wrong.”
GMO is more explicit than Roach, believing that just such a shock could come from the dangerous credit bubble which is forming in China.
The fund manager said China’s ratio of credit to GDP climbed by 60 percentage points to 190 per cent of GDP between 2007 and 2012. “The expansion of credit relative to GDP is considerably larger than the credit booms experienced by Japan in the late 1980s or the United States in the years before the Lehman bust,” GMO said.
Such an expansion only becomes a problem if the credit markets suddenly freeze and firms can’t refinance their debts – as happened in 2008.
This requires a shock.
That could be delivered through a well-publicised default in the Asian high-yield bond market, where Chinese real estate firms have been liberally raising US dollar loans.
If such a “credit strike” came onshore then the situation could turn nasty very quickly.
The first area to come under pressure would be China’s burgeoning market for wealth management products.
This so-called shadow banking market emerged in recent years as Chinese savers tired of receiving negative real interest rates from local banks and began looking for higher yield products.
“The worst investment decisions are generally made when dumb money is chasing yield,” GMO says.
Ratings agency Fitch estimates the sector had extended 13 trillion yuan ($2 trillion) in loans by the end of December, a 50 per cent increase on the previous year.
These products, which are funnelled through investment trusts, are big lenders to the property sector, but also to businesses that are considered too risky by China’s big four banks.
Traditionally the trusts mature every quarter, yet they invest in longer term projects. This is what the credit markets call a “duration mismatch” and means they must continually come back to the market to raise fresh loans.
Up until now this has not been a problem, but it could be a major one if the Chinese public suddenly lost its appetite for these products.
“A loss of confidence in China’s shadow banking arrangements could threaten a full blown credit crunch,” GMO says.
In recent months there have already been signs of such loss of confidence described by GMO.
In the lead-up to Christmas three of these wealth management products effectively defaulted, exposing the myriad problems within the sector.
The most high profile of these happened at the Shanghai branch of Huaxia Bank, which was surrounded by protesters in December after a product sold by its staff failed to meet scheduled payments.
In recent days investors are believed to have received their principal back from this investment trust, but not the promised interest of between 11 per cent and 13 per cent.
And it has emerged that the trust was hardly investing in what would be described as low-risk assets, as the sales pitch claimed.
Local media reports say the $21.5 million trust invested in a pawn shop, an entertainment company and two car dealers.
“In our view the wealth management trusts are providing a lifeline for the most marginal borrowers,” GMO says.
That’s certainly true in this case, but the bigger question is why the bank or trust felt the need to bail out the investors.
One theory is that such a tightly wound system couldn’t sustain even a small default without sparking a loss of confidence in the whole structure.
Since the Huaxia default became public the central government has moved to improve disclosure and tighten regulations.
But at the same time there have been numerous claims that these poorly regulated trusts often use money from new investors to pay out existing ones.
Indeed, the chairman of the Bank of China, Xiao Gang, used the words “Ponzi scheme” to describe some of the practices of the shadow banking market. “There is the possibility of a liquidity crisis if the markets were abruptly squeezed,” he wrote in the China Daily.
Adding an extra layer of concern is that many of the products being offered resemble the collateralised debt obligations (CDOs) that were being sold before the global financial crisis.
Chinese savers can expect to have their money put into a common pool then invested in assets right across the risk spectrum. The problem is that these products are sold as low risk, just like CDOs, even though many of their investments are at the spicy end of the credit spectrum.
And just like CDOs, there is the possibility that the entire product could go bad if a couple of the more risky investments contained within them were to fail.
In the event of mass defaults the central government could be expected to stand behind the banks and investment trusts, but such support would have a very high price.
According to Société Générale, which has gamed out a hard landing for China, economic growth could fall below 4 per cent in the months after a crisis.
This would mainly result from a drop-off in investment in fixed assets, which accounts for half the economy.
“Our commodity analysts believe metal prices could drop 45 per cent,” Société Générale said in a presentation to clients.
The French bank also said the Hong Kong sharemarket could lose half its value in such a crisis, while other markets in the region, including Australia’s, would fall by around 40 per cent.
For a global economy which has begun the year with a sense of optimism, this is a scary scenario. And there appears to be no easy or quick fix.
The Australian Financial Review
ANGUS GRIGG
Angus is a China correspondent, based in Shanghai.
http://www.afr.com/p/national/china_risk...AYmAF1kS8O
China’s risky real estate game
PUBLISHED: 02 FEB 2013 00:33:00 | UPDATED: 03 FEB 2013 10:40:20
SHARE LINKS:email print-font+fontReprints & permissions
The Chinese economy is like a junkie in need of an ever-bigger fix of credit, US fund manager GMO warns.
ANGUS GRIGG Shanghai
Those looking for a reason to hoard gold and build an underground bunker should read a recent white paper from global asset manager GMO.
Over 14 pages Edward Chancellor and Mike Monnelly forensically unpick China’s financial system and leave readers with the frightening conclusion that the world’s second biggest economy is like a junkie who requires increasingly large hits of credit to achieve the same fix.
“China scares us because it looks like a bubble economy,” they write.
China’s addiction to credit is what worries the sober Boston fund manager, which has $US104 billion under management and a 36-year track record.
The authors see China as a cross between Indonesia in the last days of the Suharto regime and Japan in 1990.
That’s not a good place to be. As most would know, Indonesia went broke, overthrew its authoritarian leader and was bailed out by the International Monetary Fund, while Japan has seen more than two decades of stagnation.
Yet, while doomsayers like GMO and short-seller Jim Chanos line up to predict the fall of China, credit markets are taking exactly the opposite view.
They can’t get enough of China.
Indeed, the hottest asset class on the planet in recent months has been Chinese corporate debt, most particularly in the real estate sector.
In just three years this sector has gone from zero to 25 per cent of the Asian high-yield bond market and is worth billions. Such is the demand that there were 15 US dollar bond-raisings in the sector over the first 20 days of January.
This rush of money has caused yields to halve in just six months.
The result is that speculative Chinese property firms, which are already highly leveraged and often have low levels of corporate governance, can raise money at rates between 6.5 per cent and 12 per cent.
Most would agree this is too cheap for the risks involved.
“In a world of zero yield these things look good to some people,” says Hayden Briscoe, director of Asia-Pacific fixed income at AllianceBernstein in Hong Kong.
“But I think they look very expensive relative to the risk. I’d want at least 20 per cent yield before I’d invest in those products.”
Such a mismatch between risk and return is driving anxiety about these products, but the far bigger problem is that Briscoe and many others believe there will be a sizeable default over the next 12 months. “What we’ve learnt from the financial crisis is that highly leveraged property firms will get into trouble at some stage,” Briscoe says.
The big question is what effect any default may have.
If it simply closes down this funding channel and bond owners take a big haircut, then the issue will be confined to the back pages of the business sections.
Alternatively, if such a default becomes contagious then suddenly China is confronting a US-style credit crisis and the scenario outlined by GMO comes into play.
It be should noted, however, that the likes of Briscoe, CLSA China strategist Andy Rothman and HSBC’s chief China economist Qu Hongbin don’t believe a credit crisis is imminent.
None of them dispute that China does have some serious imbalances which need to be addressed.
Still, they and many others argue Beijing has the will and financial muscle – $US3.3 trillion in foreign reserves – to handle any problems that arise.
GMO and long-time China bull Stephen Roach are less optimistic.
Roach, an economist and former chairman of Morgan Stanley Asia, said in a recent article that China had become increasingly vulnerable and its ability to recover from any external shock had been weakened.
“China’s growth model has become stretched as never before,” he wrote.
“And like a piece of fabric, the longer it remains stretched, the longer it will take to return to its former resilient state – and the greater the possibility it won’t spring back the next time something goes wrong.”
GMO is more explicit than Roach, believing that just such a shock could come from the dangerous credit bubble which is forming in China.
The fund manager said China’s ratio of credit to GDP climbed by 60 percentage points to 190 per cent of GDP between 2007 and 2012. “The expansion of credit relative to GDP is considerably larger than the credit booms experienced by Japan in the late 1980s or the United States in the years before the Lehman bust,” GMO said.
Such an expansion only becomes a problem if the credit markets suddenly freeze and firms can’t refinance their debts – as happened in 2008.
This requires a shock.
That could be delivered through a well-publicised default in the Asian high-yield bond market, where Chinese real estate firms have been liberally raising US dollar loans.
If such a “credit strike” came onshore then the situation could turn nasty very quickly.
The first area to come under pressure would be China’s burgeoning market for wealth management products.
This so-called shadow banking market emerged in recent years as Chinese savers tired of receiving negative real interest rates from local banks and began looking for higher yield products.
“The worst investment decisions are generally made when dumb money is chasing yield,” GMO says.
Ratings agency Fitch estimates the sector had extended 13 trillion yuan ($2 trillion) in loans by the end of December, a 50 per cent increase on the previous year.
These products, which are funnelled through investment trusts, are big lenders to the property sector, but also to businesses that are considered too risky by China’s big four banks.
Traditionally the trusts mature every quarter, yet they invest in longer term projects. This is what the credit markets call a “duration mismatch” and means they must continually come back to the market to raise fresh loans.
Up until now this has not been a problem, but it could be a major one if the Chinese public suddenly lost its appetite for these products.
“A loss of confidence in China’s shadow banking arrangements could threaten a full blown credit crunch,” GMO says.
In recent months there have already been signs of such loss of confidence described by GMO.
In the lead-up to Christmas three of these wealth management products effectively defaulted, exposing the myriad problems within the sector.
The most high profile of these happened at the Shanghai branch of Huaxia Bank, which was surrounded by protesters in December after a product sold by its staff failed to meet scheduled payments.
In recent days investors are believed to have received their principal back from this investment trust, but not the promised interest of between 11 per cent and 13 per cent.
And it has emerged that the trust was hardly investing in what would be described as low-risk assets, as the sales pitch claimed.
Local media reports say the $21.5 million trust invested in a pawn shop, an entertainment company and two car dealers.
“In our view the wealth management trusts are providing a lifeline for the most marginal borrowers,” GMO says.
That’s certainly true in this case, but the bigger question is why the bank or trust felt the need to bail out the investors.
One theory is that such a tightly wound system couldn’t sustain even a small default without sparking a loss of confidence in the whole structure.
Since the Huaxia default became public the central government has moved to improve disclosure and tighten regulations.
But at the same time there have been numerous claims that these poorly regulated trusts often use money from new investors to pay out existing ones.
Indeed, the chairman of the Bank of China, Xiao Gang, used the words “Ponzi scheme” to describe some of the practices of the shadow banking market. “There is the possibility of a liquidity crisis if the markets were abruptly squeezed,” he wrote in the China Daily.
Adding an extra layer of concern is that many of the products being offered resemble the collateralised debt obligations (CDOs) that were being sold before the global financial crisis.
Chinese savers can expect to have their money put into a common pool then invested in assets right across the risk spectrum. The problem is that these products are sold as low risk, just like CDOs, even though many of their investments are at the spicy end of the credit spectrum.
And just like CDOs, there is the possibility that the entire product could go bad if a couple of the more risky investments contained within them were to fail.
In the event of mass defaults the central government could be expected to stand behind the banks and investment trusts, but such support would have a very high price.
According to Société Générale, which has gamed out a hard landing for China, economic growth could fall below 4 per cent in the months after a crisis.
This would mainly result from a drop-off in investment in fixed assets, which accounts for half the economy.
“Our commodity analysts believe metal prices could drop 45 per cent,” Société Générale said in a presentation to clients.
The French bank also said the Hong Kong sharemarket could lose half its value in such a crisis, while other markets in the region, including Australia’s, would fall by around 40 per cent.
For a global economy which has begun the year with a sense of optimism, this is a scary scenario. And there appears to be no easy or quick fix.
The Australian Financial Review
ANGUS GRIGG
Angus is a China correspondent, based in Shanghai.