Tuesday, July 22, 2014

"China has a history of recurring and traumatic financial crises since liberalization"

A member of VIC dishes out some realtalk about China's financial system:

Although most China bulls may not be aware of this, China has a history of recurring and traumatic financial crises since liberalization, most of which have seen levels of loan losses that would make the worst fraud riddled S&Ls of the J.R. Ewing era blush (loss ratios >50% recovery ratios <20%).  This speaks to the problematic political incentives facing capital allocators in Chinese finance, and while there have have been some reforms and incremental professionalization since the last crisis, this incentive structure is still demonstrably visible in the lending preferences of the big state banks (still really the only game in town).  Given how enriching this has been for the Party, this is more of a feature than a flaw of Chinese finance.  This is still something that most Western observers fail to understand, who mostly seem to view China as being some sort of high-functioning, monolothic technoractic corporate state combining the best features of Western capitalism with an understanding of how to "get things done".  At least academics understand that property rights are important...  Anyways, returning to loss resolution:

The most recent example would be the post-Asian Financial Crisis GITIC blow-up in 1999.  GITIC's blow-up featured a lot of the same exotic trust and 'wealth management' products which have returned to popularity, and the bank was significant enough to have issued a lot of offshore debt.  The treatment of foreign creditors here is instructive - they were only allowed to see a list of claimants years later, they mostly never found out who got what, and the decision of the court was final.  Foreign creditors ended up receiving literally pennies on the dollar, despite generally having purchased debt 'guaranteed' by the government and initially receiving assurances that foreign creditors would be made whole.  This was more at the level of Cuba than Argentina given a ready ability to pay, as the financial system was of quite a manageable size at that time, and losses could have readily been made whole in one form or another.  I would wager that if more EM bond managers in the market today had a memory of GITIC, China wouldn't garner quite the same level of investor interest that it does today.

And yet, you have plenty of professional investors today talking about how the China bear thesis hasn't played out, China is different because of this or that, 'urbanization' will drive growth (and not the other way around), and that shares look 'cheap'.   I shudder to think of the well meaning investment professionals in this country allocating to funds raising capital to invest in distressed assets, credulously believing that this is a fair market system that respects the interests of private investors.  China was a one-way bet for a long time and I think a lot of current market participants have the idea that China=Growth hardwired into their heads.

Perhaps China's greater exposure to the global financial system will make them behave better this time, but they arguably needed the West much more back then then they do now (the old joke about the difference between owing the bank $100 and $100 million comes to mind).  Post GITIC there was something of a reform drive in order to prevent these problems from recurring, but reform was largely aborted as a buouyant global economy and the embrace of the 'BRICs' narrative ushered in the era of explosive growth which drowned out the pedantic voices of technocrat reformers within the PBOC and other regulators.  Will a resurgance of problems bring back desire for reform? 

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