Hamartia Antidote
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http://www.barrons.com/articles/why-chinas-bailout-could-reach-10-trillion-1467770924
Beijing’s failure to honestly assess its growing toxic assets raises the risk of a bailout of epic proportions.
China’s central bank governor warned world markets not to underestimate the threats closing in on his economy from the outside. Little does Zhou Xiaochuan know the world is equally worried about conditions inside China.
As President Xi Jinping’s government prods state-owned banks to help reach this year’s 6.5% growth target, analysts are doing back-of-the-envelope calculations on the epic bailouts to come. It’s a wildly inexact science given Beijing’s chronic opacity and the universe of shadow banks and local-government officials also churning out untold mountains of fresh debt.
Celebrity short seller Kyle Bass puts the number at a staggering $10 trillion, an amount rivaling the size of its entire economy. Few took the Dallas-based founder of Hayman Capital Management seriously in February, when his numbers first circulated. Some of Bass’s other widely-publicized shorts of late, particularly on Japanese government bonds crashing, skeptics argue, haven’t really panned out. But the real reason is the seeming impossibility of a bailout the entire world could scarcely afford.
Getting the U.S. Congress to pony up $700 billion in 2007 proved tortuous, even as world markets plunged and banking’s biggest names teetered on the edge of collapse. That number seemed impossible enough at the time. A decade earlier, a privately financed support package for Connecticut hedge fund Long-Term Capital Management was, at the time, an unthinkable $3.6 billion.
As such, the conventional wisdom is low-balling estimates for a Chinese bank system aid package. How, analysts ask, could bad loans on the mainland dwarf Wall Street’s near-death experience? The most the majority of analysts are willing to say is that it might be at least $500 billion and come sometime within the next two years. The truth, of course, tends to lie somewhere in between. Still, low-balling is de rigueur. The highest analysts generally seem willing to go it $3 trillion - including those at Commonwealth Bank of Australia and Hamagin Research Institute.
But what if the number is closer to Bass’s $10 trillion? His own back-of-the-envelope estimates suggest China’s bank losses could exceed those of the subprime crisis by about 400%. Bass knows a thing or two about analysts’ tendency to underestimate bad loan risks. They did it in the late 1990s with Japan and a decade later in the U.S. Thanks to that skepticism, Bass made about $500 million as the biggest banks ate more than $80 billion in losses. Looking at China, Bass figures a 10% loss of banks related to non-performing loans would wipe out roughly $3.5 trillion in equity values.
Imagine the frantic calls to the International Monetary Fund and U.S. Treasury should Bass turn out to be even somewhat correct. This possibility, distant or not, circles back to Zhou’s warnings about global uncertainty. In a statement following the People’s Bank of China’s quarterly policy meeting Monday, Zhou’s team pointed to volatility caused by the U.K.’s vote to leave the European Union as a clear and present danger to his economy. In highlighting uncertainties from the external sector, one wonders if Beijing gets how much worries about China’s outlook are contributing to that anxiety.
China continues to plot the same dangerous path Japan did in the 1990s: obfuscate the magnitude of the crisis, dismiss all worst-case scenarios, circle the wagons and focus on growing its way to greater solvency. Twenty-five years on, Japan is still trying to grow its way back to a AAA credit rating - and still failing. There’s no reason to think Chinese officials, smart as they are, will do better.
Xi’s government should make an immediate and honest accounting of the true magnitude of the toxic assets festering in state-owned banks. Next, Beijing needs to take a page from the U.S. savings-and-loan crisis of the 1980s, creating Resolution Trust Corp.-like entities to collect and dispose of troubled debts. Admittedly, China has taken action before. In the late 1990s, when non-performing loan ratios hit 40%, Beijing sold bonds to pay for the recapitalization of the four biggest institutions, a move not completely unlike the Financing Corporation, or FICO, bonds Washington issued in the 80s. But the effort was small and narrowly focused.
A similar purge would be bigger, pricier and far more dangerous politically this time around. For one thing, Beijing allowed a post-Lehman-crisis credit surge of at least $28 trillion. That alone makes China’s official jump in non-performing loans - about $210 billion in the 12 months ended in March - questionable. In other words, add a couple of zeroes, at least. Also questionable is the idea that the PBOC can just print several trillion dollars worth of yuan with hyperinflation or other side effects.
The key lesson from Japan is to act sooner rather than later. Unfortunately, it’s a mistake China seems determined to repeat at great cost to its own trajectory and that of the world economy. This risk also is the 800 pound gorilla in the room as China’s Asian Infrastructure Investment Bank gets up and running. The giant fund effectively seeks to put the World Bank, Asian Development Bank and several arms of the IMF out of business. Why would leaders around the region bother with the conditions and accountability those institutions require when Beijing will chuck a few billion dollars your way with fewer strings attached.
Yet Beijing should look at its own books before writing big checks. In the years after Lehman, for example, local Chinese governments amassed a debt load bigger that Germany’s annual output (and that’s just what we know about). That kind of debt buildup in a nation at China’s level of development runs counter to Xi’s international aspirations. Before that, his team must raise its reform ambitions at home.
There’s a widely-held view that Beijing’s Communist Party knows what it’s doing and let’s not panic. That same mindset left many flatfooted when Japan imploded, Russia defaulted and Wall Street blew up. We’re navigating an era when the impossible has a knack for happening, from Brexit to Filipinos electing a self-confessed killer president to kooky Donald Trump being within reach of the White House. Can anyone really, truly say China’s bailout won’t be closer to $10 trillion than $500 billion?
I’d feel better about the answer if Xi’s team were working steadily to recalibrate growth engines away from investment and exports. The same goes for Governor Zhou, Beijing’s most reform-minded top official, pointing fingers at external risks that should be aimed at Beijing.
Beijing’s failure to honestly assess its growing toxic assets raises the risk of a bailout of epic proportions.
China’s central bank governor warned world markets not to underestimate the threats closing in on his economy from the outside. Little does Zhou Xiaochuan know the world is equally worried about conditions inside China.
As President Xi Jinping’s government prods state-owned banks to help reach this year’s 6.5% growth target, analysts are doing back-of-the-envelope calculations on the epic bailouts to come. It’s a wildly inexact science given Beijing’s chronic opacity and the universe of shadow banks and local-government officials also churning out untold mountains of fresh debt.
Celebrity short seller Kyle Bass puts the number at a staggering $10 trillion, an amount rivaling the size of its entire economy. Few took the Dallas-based founder of Hayman Capital Management seriously in February, when his numbers first circulated. Some of Bass’s other widely-publicized shorts of late, particularly on Japanese government bonds crashing, skeptics argue, haven’t really panned out. But the real reason is the seeming impossibility of a bailout the entire world could scarcely afford.
Getting the U.S. Congress to pony up $700 billion in 2007 proved tortuous, even as world markets plunged and banking’s biggest names teetered on the edge of collapse. That number seemed impossible enough at the time. A decade earlier, a privately financed support package for Connecticut hedge fund Long-Term Capital Management was, at the time, an unthinkable $3.6 billion.
As such, the conventional wisdom is low-balling estimates for a Chinese bank system aid package. How, analysts ask, could bad loans on the mainland dwarf Wall Street’s near-death experience? The most the majority of analysts are willing to say is that it might be at least $500 billion and come sometime within the next two years. The truth, of course, tends to lie somewhere in between. Still, low-balling is de rigueur. The highest analysts generally seem willing to go it $3 trillion - including those at Commonwealth Bank of Australia and Hamagin Research Institute.
But what if the number is closer to Bass’s $10 trillion? His own back-of-the-envelope estimates suggest China’s bank losses could exceed those of the subprime crisis by about 400%. Bass knows a thing or two about analysts’ tendency to underestimate bad loan risks. They did it in the late 1990s with Japan and a decade later in the U.S. Thanks to that skepticism, Bass made about $500 million as the biggest banks ate more than $80 billion in losses. Looking at China, Bass figures a 10% loss of banks related to non-performing loans would wipe out roughly $3.5 trillion in equity values.
Imagine the frantic calls to the International Monetary Fund and U.S. Treasury should Bass turn out to be even somewhat correct. This possibility, distant or not, circles back to Zhou’s warnings about global uncertainty. In a statement following the People’s Bank of China’s quarterly policy meeting Monday, Zhou’s team pointed to volatility caused by the U.K.’s vote to leave the European Union as a clear and present danger to his economy. In highlighting uncertainties from the external sector, one wonders if Beijing gets how much worries about China’s outlook are contributing to that anxiety.
China continues to plot the same dangerous path Japan did in the 1990s: obfuscate the magnitude of the crisis, dismiss all worst-case scenarios, circle the wagons and focus on growing its way to greater solvency. Twenty-five years on, Japan is still trying to grow its way back to a AAA credit rating - and still failing. There’s no reason to think Chinese officials, smart as they are, will do better.
Xi’s government should make an immediate and honest accounting of the true magnitude of the toxic assets festering in state-owned banks. Next, Beijing needs to take a page from the U.S. savings-and-loan crisis of the 1980s, creating Resolution Trust Corp.-like entities to collect and dispose of troubled debts. Admittedly, China has taken action before. In the late 1990s, when non-performing loan ratios hit 40%, Beijing sold bonds to pay for the recapitalization of the four biggest institutions, a move not completely unlike the Financing Corporation, or FICO, bonds Washington issued in the 80s. But the effort was small and narrowly focused.
A similar purge would be bigger, pricier and far more dangerous politically this time around. For one thing, Beijing allowed a post-Lehman-crisis credit surge of at least $28 trillion. That alone makes China’s official jump in non-performing loans - about $210 billion in the 12 months ended in March - questionable. In other words, add a couple of zeroes, at least. Also questionable is the idea that the PBOC can just print several trillion dollars worth of yuan with hyperinflation or other side effects.
The key lesson from Japan is to act sooner rather than later. Unfortunately, it’s a mistake China seems determined to repeat at great cost to its own trajectory and that of the world economy. This risk also is the 800 pound gorilla in the room as China’s Asian Infrastructure Investment Bank gets up and running. The giant fund effectively seeks to put the World Bank, Asian Development Bank and several arms of the IMF out of business. Why would leaders around the region bother with the conditions and accountability those institutions require when Beijing will chuck a few billion dollars your way with fewer strings attached.
Yet Beijing should look at its own books before writing big checks. In the years after Lehman, for example, local Chinese governments amassed a debt load bigger that Germany’s annual output (and that’s just what we know about). That kind of debt buildup in a nation at China’s level of development runs counter to Xi’s international aspirations. Before that, his team must raise its reform ambitions at home.
There’s a widely-held view that Beijing’s Communist Party knows what it’s doing and let’s not panic. That same mindset left many flatfooted when Japan imploded, Russia defaulted and Wall Street blew up. We’re navigating an era when the impossible has a knack for happening, from Brexit to Filipinos electing a self-confessed killer president to kooky Donald Trump being within reach of the White House. Can anyone really, truly say China’s bailout won’t be closer to $10 trillion than $500 billion?
I’d feel better about the answer if Xi’s team were working steadily to recalibrate growth engines away from investment and exports. The same goes for Governor Zhou, Beijing’s most reform-minded top official, pointing fingers at external risks that should be aimed at Beijing.
