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Three from Israel's Financial Expert -
The Harsh Reality behind China’s Growth Story
Second item
China’s Shark Loan Ponzi Finance- Understanding China’s Shadow Banking System
China's Shark Loan Ponzi Finance -Peter Navarro on China's Shark Loan Phenomenon
The Harsh Reality behind China’s Growth Story
Many people argue China has an amazing long term growth story, and that the fact that there might be a rough path ahead as economic conditions slow down doesn’t alter the fact that China will grow much faster than most emerging markets and all developed markets since it has a large population which has just discovered the wonders of capitalism and a very low GDP per capita.
But the harsh reality is that after decades of double digit GDP growth, average house hold income still trail miles behind many emerging economies. Furthermore, wealth disparity is accelerating at an alarming speed. In order to maintain certain level of GDP growth and employment rate, the Chinese government turned to a fix capital investment model, but that has sunk China into an economic black hole, and a vicious cycle where in order to maintain more GDP growth it needs to waste more resources and further increase the mal-investments in the economy. The waste of natural resources, human capital, and financial capital in China is staggering. The more China depends on fixed investment as a growth engine the more it will create wealth disparity, thus increasing the potential for social instability.
Other sustainable growth models simply can’t be pursued under the current system. The strikes in the last few months, with latest in Honda, are signs of a population who is tired of waiting for its standard of living to catch up with GDP growth.
As we have mentioned before, China is stuck in a classic Price/Wage Spiral:
“Well, China has been printing a lot of money for a long time in order to keep the Yuan low which befitted their export sector. As a result of their policy they accumulated massive foreign exchange reserves, and had giant trade surplus. Since China over one billion people and since most of them where farmers up until the 1990's the money printing didn't cause wages to rise dramatically. (Money flows to places where supply is tight and China had abundant labor)
So the money went in to commodity, real estate, and stock prices in China. But now something totally different is happening. China trade surplus is shrinking, food prices are raising and wages too. This, combined with weak exports, and a weak euro is killing China’s corporation’s margins at a time when we have a classic wage and price spiral.
Since China produces simple products and since China has focused on quantity and not on quality there is no significant productivity growth to offset the money printing. Once the movement to the cities was exhausted (there is no demand for more Chinese peasants producing more Nike shoes…)
As the strikes in Honda have shown, the Chinese population has had it. From Zero-hedge:
The strikes are a symptom of a broader trend that many investors will have to consider: a Chinese workforce becoming more assertive and selective, and sometimes inclined to protest by strikes, slow-downs and, most often, quitting.
“The chance of more strikes increases the more successful the previous strikes are. There’s been more and more communication between workers and advocacy groups,” said Duncan Innes-Kerr, Beijing-based China analyst for the Economist Intelligence Unit.
“The workers have networks to exchange information even when there has been a state media blackout. The example set in one place tends to encourage others.”
The wave of current unrest hit a peak in June, but reports tapered off at the end of the month. The last reported stoppage, at Japanese-owned Tianjin Mitsumi Electric, ended on July 3.
Domestic media have been largely mute about the strikes, apparently due to state censorship. But Xinhua has issued reports about the unrest on its English-language service.
Labor costs in China have been rising, partly encouraged by a government that wants to turn farmers and workers into more confident consumers, even as it tries to keep a lid on strikes.Earlier strikes disrupted production at carmakers Toyota and Honda, and have laid bare the rising demands of China’s 150 million migrant workers, especially younger ones wanting to secure a foothold in urban areas.
It should be clear that central planned, or command economic systems are very efficient in resource allocation, and that the infrastructure can be built at a breath taking pace. But they are inferior at achieving a return on investment. In other words, they are good at the inputs side of economics, but poor at the output per input, the capital return side of the economic equation.
China has a huge real estate bubble, perhaps the largest in human history, and it is a direct result of command economic. (Exactly like the bubble in the United States was a direct result of command elements in its system such as the Federal Reserve, Fannie Mae and Freddie Mac.)
The government has been trying to promote another economic development model, the so called “Scientific Development Model” for the last 5 years, but so far they have failed to deliver. On the contrary, in the past five years, this reliance on fix capital investment is accelerating. China has more and more ghost shopping centers, more and more vacant skyscrapers, high speed trains with lower passenger occupancy, and wind and nuclear power facilities with dropping electricity demand.
Many people will claim that China did use technology to transfer its economic development model, mentioning the use of wind power and high speed rail, but, what is the rate of the return for these capital investments? Does China really need all those green energy projects if current electricity generation is more than sufficient to meet the demand?
And who is paying for all of this? Well, the workers in Honda factories of course. It doesn’t matter if the Chinese government is paying for the megalomaniac infrastructure projects by taxing the population, by borrowing or by printing money; it is doing so at expense of the ordinary Chinese.
I listed following the malaise of a command economic system, and these deficiencies can be contributed to lack of accountability and interest representation in a non democratic society. Regarding the vast areas where the United States and other Western Economies are suffering from similar problems, they are a direct result of deficiencies of their own democratic system, which are far from perfect, and in many cases fail to achieve the goal of representation and accountability of elected officials.
In a democratic representative system, various interest groups can voice their various interest concerns, and the final action will be balanced and the decision maker will be held accountable. During this transparent process, the cost and price of each action is tested. But in China, the cost of any political or economic decision is distorted. .
China is responsible for the largest waste of the natural resources in human history, many times with no economic rational. The land, the mines, the wild animals, the plants, the forests, the rivers, all those natural resources have been depleted without the consideration of sustainability or economic sense. It not by chance that command economies, such as Soviet Russia and China have destroyed nature at a much larger scale then the United States. The reason is the lack of property rights in such countries. In a free market, those resources were owned by someone, and wouldn’t have allowed such waste without receiving a high compensation. The compensation mechanism would have increased the costs to a level that reflects the true cost of developments. It is true that in western democracies vast areas are still “owned” by the government. But a lot are not, and in any case the residents can still use the court systems in order to reveal the cost of development.
Such is the case with BP. It a huge and tragic disaster. But at least the people that suffer can use the court system. In future, oil companies will take measures to prevent such outcomes since they know the cost they will need to pay if they are held responsible for the destruction of nature and the lives of the people who depend on it.
It is well known in China that the organized crime is engaged in sea bed sand excavation in the northern parts of China. The underground group dug out the sand from the sea bed, and shipped it hundreds of miles away in order to supply port building material (by the way, China already has oversupply of port facilities). Now I ask you, if you where the owner of that sand (not the government) would you give it away that cheaply? And if you lived in a district where such activities are happening, wouldn’t you call your local elected politician and scream?
The local government sea supervisory agency turned a blind eye since the leader is shareholder of this operation. So after all the destruction at the ground level and underground level, they are devastating the sea bed. The cost consideration for environment and the welfare of local communities will never be a legitimate issue that can be represented by a legitimate interest group in China, not in its political circles and especially through market forces. So even if there is an environment protection committee, the implementation of law and justice doesn’t exist. Not even by Western standards, which as mentioned before are far from perfect.
Another sad element of the Chinese growth story is the abuse of the most important resource- human capital. Nobody seems to ask- Why the labor is so cheap in China? It is cheap because China has stolen most of their hard earned money through the printing trillions and trillions of Yuan that were used to finance infrastructure project and to maintain cheap labor through a cheap currency. Did the same thing happen in the United States? Yes, to some extent. The Federal Reserve is an immoral organization that mostly represents the interests of the banks that own it. And don’t forget the political system, where politicians many times represent that interest of the lobbyists and not of the people who their votes brought them to power. But at least in the West they are up for election. There is hope and honest politicians may be elected. Moreover, part of the politicians may change part of their policies once they feel the heat. Under democracy, politicians do the right thing after they have tried all the rest. In China, and in other totalitarian regimes, there is no hope, only revolution. That was the case in 1789 in France, and in 1776 in the United States. A violent revolution was needed to bring the people their freedoms.
China totalitarian mindset has caused an unprecedented waste of the financial capital. The waste is much larger than the Federal Reserve and other crony capitalists in the West could ever dream of creating. Why is that? Simply because the United States hasn’t become as of yet an authoritarian country. Does it have authoritarian and totalitarian elements? Sure. But part of the constitution is still implemented and the banks, the consumers, and the corporations are still free to refuse to lend or borrow. That is what has happened since September 2008. The Fed wants them to borrow, and if it could it would have forced them but it can’t. The federal government is forcing debt on the population but they can cast their votes in November of this year and elect people like Rand Paul and Peter Schiff who block any rise in the debt ceiling. If the United States goes bankrupt it is the fault of the voters as much that of the elected officials. And that is true in any democratic society.
Going back to the Chinese version of crony capitalism, (be sure- what we have witnessed since the end of Breton Woods is not capitalism), their banks are in a deep hole. 50% of their lending is directly linked to real estate projects, while other loans to businesses that finance capital investment and R&D are shrinking. Facing the ever diminishing marginal rate of return, the cash flow from those fix capital investments are not sufficient enough to cover the interest expenses, nonetheless to pay back the principal.
The banks have to keep issuing new loans to those borrowers to keep them afloat, and let the role over for years. In an economic crisis, a prudent banking risk management practice is to entrench, to withdraw and preserve the capital, but in China, it is just the opposite. The banks have to loosen up in order to prevent the dismantling of the entire system. And I am not talking solely about the financial system. That was true also in the United States. They are ordered to lend, by the government, as are the state owned corporations ordered to borrow in order to keep the regime alive.
The root of the problem is the same: more loan growth can benefit the borrower, the banking executive, and the local government officials. The return of capital and the potential loss of the principal is always a secondary consideration, especially when the loan are issued to the state owned enterprises or well connected “too big to fail” private businesses. Who cares? The banks are state owned banks, and the capital is state capital.
With the waste of financial capital, the abuse of human capital and of natural resources, China is over-drafting its future. But many will argue that China has been doing this for decades, why this time is different? What are the signs that the day of reckoning is approaching?
As I have written before, the Chinese banks and authorities are in a dilemma now, they can’t step on the brakes; otherwise, whole system will collapse. The huge growth of a market for shark loan finance is one of last escapes before a financial system failure. Just as subprime loan were in the United States credit and housing bubble. Soft landing can be wished for, but a hard landing is the reality.
The Chinese workforce is fighting with its own life. The migrant workers are committing suicide in order to get a raise, but a 20 percent minimum wage increase will not solve the wealth disparity problem, and besides the lucrative Joint ventures with Western corporations, how many Chinese private businesses can afford a decent raise?
Their condition has nothing to do with the “evils” of capitalism, and these are not signs of a communist revolution, as I’m sure a lot in left will love to believe. China is one big jail and use of the labor in China is a use of slaved labor. They are fighting for their freedoms.
China is not a communist state anymore. Their labor unions are part of the government, as were the unions under Mussolini in Italy. They represent the interests of a selected group of people and of the corporations. The Chinese are demanding independent labor unions. And as a libertarian I insist that they have a right to demand that. As long as they don’t insist that the state defends them as is the case in Western democracies. We don’t know if they will successes but just imagine what will happen if China had independent labor unions?
So what is the future for a sustainable development of China? We only can hope that it is not too late for China to change.
But the harsh reality is that after decades of double digit GDP growth, average house hold income still trail miles behind many emerging economies. Furthermore, wealth disparity is accelerating at an alarming speed. In order to maintain certain level of GDP growth and employment rate, the Chinese government turned to a fix capital investment model, but that has sunk China into an economic black hole, and a vicious cycle where in order to maintain more GDP growth it needs to waste more resources and further increase the mal-investments in the economy. The waste of natural resources, human capital, and financial capital in China is staggering. The more China depends on fixed investment as a growth engine the more it will create wealth disparity, thus increasing the potential for social instability.
Other sustainable growth models simply can’t be pursued under the current system. The strikes in the last few months, with latest in Honda, are signs of a population who is tired of waiting for its standard of living to catch up with GDP growth.
As we have mentioned before, China is stuck in a classic Price/Wage Spiral:
“Well, China has been printing a lot of money for a long time in order to keep the Yuan low which befitted their export sector. As a result of their policy they accumulated massive foreign exchange reserves, and had giant trade surplus. Since China over one billion people and since most of them where farmers up until the 1990's the money printing didn't cause wages to rise dramatically. (Money flows to places where supply is tight and China had abundant labor)
So the money went in to commodity, real estate, and stock prices in China. But now something totally different is happening. China trade surplus is shrinking, food prices are raising and wages too. This, combined with weak exports, and a weak euro is killing China’s corporation’s margins at a time when we have a classic wage and price spiral.
Since China produces simple products and since China has focused on quantity and not on quality there is no significant productivity growth to offset the money printing. Once the movement to the cities was exhausted (there is no demand for more Chinese peasants producing more Nike shoes…)
As the strikes in Honda have shown, the Chinese population has had it. From Zero-hedge:
The strikes are a symptom of a broader trend that many investors will have to consider: a Chinese workforce becoming more assertive and selective, and sometimes inclined to protest by strikes, slow-downs and, most often, quitting.
“The chance of more strikes increases the more successful the previous strikes are. There’s been more and more communication between workers and advocacy groups,” said Duncan Innes-Kerr, Beijing-based China analyst for the Economist Intelligence Unit.
“The workers have networks to exchange information even when there has been a state media blackout. The example set in one place tends to encourage others.”
The wave of current unrest hit a peak in June, but reports tapered off at the end of the month. The last reported stoppage, at Japanese-owned Tianjin Mitsumi Electric, ended on July 3.
Domestic media have been largely mute about the strikes, apparently due to state censorship. But Xinhua has issued reports about the unrest on its English-language service.
Labor costs in China have been rising, partly encouraged by a government that wants to turn farmers and workers into more confident consumers, even as it tries to keep a lid on strikes.Earlier strikes disrupted production at carmakers Toyota and Honda, and have laid bare the rising demands of China’s 150 million migrant workers, especially younger ones wanting to secure a foothold in urban areas.
It should be clear that central planned, or command economic systems are very efficient in resource allocation, and that the infrastructure can be built at a breath taking pace. But they are inferior at achieving a return on investment. In other words, they are good at the inputs side of economics, but poor at the output per input, the capital return side of the economic equation.
China has a huge real estate bubble, perhaps the largest in human history, and it is a direct result of command economic. (Exactly like the bubble in the United States was a direct result of command elements in its system such as the Federal Reserve, Fannie Mae and Freddie Mac.)
The government has been trying to promote another economic development model, the so called “Scientific Development Model” for the last 5 years, but so far they have failed to deliver. On the contrary, in the past five years, this reliance on fix capital investment is accelerating. China has more and more ghost shopping centers, more and more vacant skyscrapers, high speed trains with lower passenger occupancy, and wind and nuclear power facilities with dropping electricity demand.
Many people will claim that China did use technology to transfer its economic development model, mentioning the use of wind power and high speed rail, but, what is the rate of the return for these capital investments? Does China really need all those green energy projects if current electricity generation is more than sufficient to meet the demand?
And who is paying for all of this? Well, the workers in Honda factories of course. It doesn’t matter if the Chinese government is paying for the megalomaniac infrastructure projects by taxing the population, by borrowing or by printing money; it is doing so at expense of the ordinary Chinese.
I listed following the malaise of a command economic system, and these deficiencies can be contributed to lack of accountability and interest representation in a non democratic society. Regarding the vast areas where the United States and other Western Economies are suffering from similar problems, they are a direct result of deficiencies of their own democratic system, which are far from perfect, and in many cases fail to achieve the goal of representation and accountability of elected officials.
In a democratic representative system, various interest groups can voice their various interest concerns, and the final action will be balanced and the decision maker will be held accountable. During this transparent process, the cost and price of each action is tested. But in China, the cost of any political or economic decision is distorted. .
China is responsible for the largest waste of the natural resources in human history, many times with no economic rational. The land, the mines, the wild animals, the plants, the forests, the rivers, all those natural resources have been depleted without the consideration of sustainability or economic sense. It not by chance that command economies, such as Soviet Russia and China have destroyed nature at a much larger scale then the United States. The reason is the lack of property rights in such countries. In a free market, those resources were owned by someone, and wouldn’t have allowed such waste without receiving a high compensation. The compensation mechanism would have increased the costs to a level that reflects the true cost of developments. It is true that in western democracies vast areas are still “owned” by the government. But a lot are not, and in any case the residents can still use the court systems in order to reveal the cost of development.
Such is the case with BP. It a huge and tragic disaster. But at least the people that suffer can use the court system. In future, oil companies will take measures to prevent such outcomes since they know the cost they will need to pay if they are held responsible for the destruction of nature and the lives of the people who depend on it.
It is well known in China that the organized crime is engaged in sea bed sand excavation in the northern parts of China. The underground group dug out the sand from the sea bed, and shipped it hundreds of miles away in order to supply port building material (by the way, China already has oversupply of port facilities). Now I ask you, if you where the owner of that sand (not the government) would you give it away that cheaply? And if you lived in a district where such activities are happening, wouldn’t you call your local elected politician and scream?
The local government sea supervisory agency turned a blind eye since the leader is shareholder of this operation. So after all the destruction at the ground level and underground level, they are devastating the sea bed. The cost consideration for environment and the welfare of local communities will never be a legitimate issue that can be represented by a legitimate interest group in China, not in its political circles and especially through market forces. So even if there is an environment protection committee, the implementation of law and justice doesn’t exist. Not even by Western standards, which as mentioned before are far from perfect.
Another sad element of the Chinese growth story is the abuse of the most important resource- human capital. Nobody seems to ask- Why the labor is so cheap in China? It is cheap because China has stolen most of their hard earned money through the printing trillions and trillions of Yuan that were used to finance infrastructure project and to maintain cheap labor through a cheap currency. Did the same thing happen in the United States? Yes, to some extent. The Federal Reserve is an immoral organization that mostly represents the interests of the banks that own it. And don’t forget the political system, where politicians many times represent that interest of the lobbyists and not of the people who their votes brought them to power. But at least in the West they are up for election. There is hope and honest politicians may be elected. Moreover, part of the politicians may change part of their policies once they feel the heat. Under democracy, politicians do the right thing after they have tried all the rest. In China, and in other totalitarian regimes, there is no hope, only revolution. That was the case in 1789 in France, and in 1776 in the United States. A violent revolution was needed to bring the people their freedoms.
China totalitarian mindset has caused an unprecedented waste of the financial capital. The waste is much larger than the Federal Reserve and other crony capitalists in the West could ever dream of creating. Why is that? Simply because the United States hasn’t become as of yet an authoritarian country. Does it have authoritarian and totalitarian elements? Sure. But part of the constitution is still implemented and the banks, the consumers, and the corporations are still free to refuse to lend or borrow. That is what has happened since September 2008. The Fed wants them to borrow, and if it could it would have forced them but it can’t. The federal government is forcing debt on the population but they can cast their votes in November of this year and elect people like Rand Paul and Peter Schiff who block any rise in the debt ceiling. If the United States goes bankrupt it is the fault of the voters as much that of the elected officials. And that is true in any democratic society.
Going back to the Chinese version of crony capitalism, (be sure- what we have witnessed since the end of Breton Woods is not capitalism), their banks are in a deep hole. 50% of their lending is directly linked to real estate projects, while other loans to businesses that finance capital investment and R&D are shrinking. Facing the ever diminishing marginal rate of return, the cash flow from those fix capital investments are not sufficient enough to cover the interest expenses, nonetheless to pay back the principal.
The banks have to keep issuing new loans to those borrowers to keep them afloat, and let the role over for years. In an economic crisis, a prudent banking risk management practice is to entrench, to withdraw and preserve the capital, but in China, it is just the opposite. The banks have to loosen up in order to prevent the dismantling of the entire system. And I am not talking solely about the financial system. That was true also in the United States. They are ordered to lend, by the government, as are the state owned corporations ordered to borrow in order to keep the regime alive.
The root of the problem is the same: more loan growth can benefit the borrower, the banking executive, and the local government officials. The return of capital and the potential loss of the principal is always a secondary consideration, especially when the loan are issued to the state owned enterprises or well connected “too big to fail” private businesses. Who cares? The banks are state owned banks, and the capital is state capital.
With the waste of financial capital, the abuse of human capital and of natural resources, China is over-drafting its future. But many will argue that China has been doing this for decades, why this time is different? What are the signs that the day of reckoning is approaching?
As I have written before, the Chinese banks and authorities are in a dilemma now, they can’t step on the brakes; otherwise, whole system will collapse. The huge growth of a market for shark loan finance is one of last escapes before a financial system failure. Just as subprime loan were in the United States credit and housing bubble. Soft landing can be wished for, but a hard landing is the reality.
The Chinese workforce is fighting with its own life. The migrant workers are committing suicide in order to get a raise, but a 20 percent minimum wage increase will not solve the wealth disparity problem, and besides the lucrative Joint ventures with Western corporations, how many Chinese private businesses can afford a decent raise?
Their condition has nothing to do with the “evils” of capitalism, and these are not signs of a communist revolution, as I’m sure a lot in left will love to believe. China is one big jail and use of the labor in China is a use of slaved labor. They are fighting for their freedoms.
China is not a communist state anymore. Their labor unions are part of the government, as were the unions under Mussolini in Italy. They represent the interests of a selected group of people and of the corporations. The Chinese are demanding independent labor unions. And as a libertarian I insist that they have a right to demand that. As long as they don’t insist that the state defends them as is the case in Western democracies. We don’t know if they will successes but just imagine what will happen if China had independent labor unions?
So what is the future for a sustainable development of China? We only can hope that it is not too late for China to change.
China’s Shark Loan Ponzi Finance- Understanding China’s Shadow Banking System
From China's Shark Loan Ponzi Finance- Fitch Reports That the Size the "Trust Fund" Credit Growth is 28% of the Total Market Credit Growth:
A new report came out of Fitch Yesterday, stating that Informal Securitization is increasingly distorting credit Data, and has been under representing the actual amount of new loans in the first half of 2010: "Adjusted for informal securitization activity, Fitch estimates that the net amount of new CNY loans extended in H110 was closer to CNY5.9trn, or 28% above the official figure of CNY4.6trn...
So what exactly is Fitch referring to when mentioning “Informal Securitization”?
The trust products that Fitch is referring to are investment products that are sold by the banks, and packaged by the trust companies. There are two kinds of trust products, the first being products that are sold by the bank to local investors and represent loan that the bank has made directly to homebuyers. In fact, a lot China’s local government debt were packaged in as well. Up until two years ago most of the products were of this nature.
The second type started to be popular at the later part of 2009. In essence, this type is a high interest loan (often 15% plus annual rate) to real estate developers. Since the real estate developers have difficulty to raise funds through offering, they began to work with the banks in order to sell these products. The 10 fold growth in trust products that Fitch referred to came mostly from these kind of loans.
The marketing of the products is not very honest to say the least (who said China doesn’t import anything from America), and many buyers believe that they are guaranteed by the bank. But in reality, they are lending money to high risk new real estate projects.
The shark loan industry is mostly underground, and it’s sources can be low interest loan from banks, cash from state owned enterprises, and private savings. The shark loan operator then lends the money out to real estate developers or other domestic private firms.
There are two major pourposes for shark loans. One is to flip flop the real estate, and another is to lend to private firms with maturing bank loans. As mentioned in previous posts, the common lending practice of Chinese banks has a maturity of one year, and so the borrowers need to renew the loans every year if the old loan are to be paid. So many private firms that can’t pay back their loans since the cash flow from their regular business will not be enough to pay back the principal, are borrowing from shark loan operators at extreme high interest rates with very short durations. They then turn to the bank, repay the old loan and get a new loan for the next year.
Every day there are more and more real estate developers and other businesses that are resorting to loan sharks to manage through the hard times .But this is a short term solution for a long term problem. And like every drug addict, one day comes rehab or death.
If the real estate market remains stagnated for long enough, or if the banks stopped to issue new loans at an ever accelerating pace, many businesses will collapse. Even today, some relatively tight lending standards are causing some ponzi schemes to collapse, like the one of Tang long.
A larger percentage of China’s real estate sales are in reality fake since they are made with the purpose of obtaining the flow of bank loans before real sales happen. Through this arrangement, the developer and the shark lender make sure that the bank will bear the ultimate risk.
Western investors doubt this criminal activity since they do not understand the true nature of China’s society, or any totalitarian regime for that matter. But China is not a democracy; it is semi communist, semi fascist regime that is running a planned economy. All the banks are state owned, and as I mentioned in The Harsh Reality behind China’s Growth Story:
The root of the problem is the same: more loan growth can benefit the borrower, the banking executive, and the local government officials. The return of capital and the potential loss of the principal is always a secondary consideration, especially when the loan are issued to the state owned enterprises or well connected “too big to fail” private businesses. Who cares? The banks are state owned banks, and the capital is state capital.
I have explained the principal of these operations in the secret engine behind China housing bubble- China’s shark loan ponzi finance:
This is how this ponzi scheme works:
Local governmental officials that are demanded from the government to produce double digit GDP growth numbers give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurisdiction. Some of them are active partners in shark loan businesses. For example, a party secretary of legal affairs, that controls the public security bureau, which is a court and prosecutor division of government in yongkang city, in zhe jiang province tired to run abroad using a passport in 2009 after he found out he can’t repay 60million Yuan. Every scheme has a ring leader whose job is to collect money from all the participants in the ponzi scheme. When some of these ponzi schemes blow up, the party leaders always get bailed out first, and some even ask local business owners to lend them money, and then bail out their own personal fund. After that the ring leader turns himself in and gets protection from the local government.
Most of the funds that are collected in this classic ponzi finance go to local land purchases and real estate development. Part of the funds is used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.
The five steps of a fake housing sale in China
1. Before the construction, loan shark operators provide initial finance to small or middle size developers in 2 and 3 tier cities in order to begin the construction.
2. After the construction is complete, and before the official sale to the public begins, loan shark operators will provide resident IDs and other fake documents for mortgage application to real estate developers and make together a fake sale contract.
3. The real estate developer brings the fake contracts to the bank in order to obtain a loan. That can explain why in China, many houses already get sold before they are opened to the public for sale, and why there are so many vacant houses already sold, which no one lives in. (According to the report by Fitch, that was mentioned above there are 64 million unoccupied homes in China)
4. A secret agreement is made between the shark loan operator and the real estate developer. The shark loan operator will get more bank loans through this fake sale, as will the real estate developer. They will use the bank loan in order to engage in another ponzi scheme.
4. The real estate developer shark loan operator will hire people to fake sale frenzy in order to attract real buyers, and if there are enough sales the fake contract will be cancelled out.
5. During the time of the real estate bubble frenzy these ponzi schemes and fake sales were mostly covered, since real buyers could be found. But when the market slows down there will be a thin transaction volume, and the fake sales will be exposed. Then the real collapse will happen.
China’s central government actually knows the massive extent of NPL in the banking system, and they are watching real estate market very closely. All the so called policy action is more of a show off to calm down the angry public than a real measure to tackle the problem. No lethal weapon such as a property tax or an interest rate hike will be used. Simply because the central government knows that they have to maintain the housing prices at a certain level to prevent a panic sale, the will bring down the whole banking system. The train can’t be stopped and it is heading towards a very big wall.
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A new report came out of Fitch Yesterday, stating that Informal Securitization is increasingly distorting credit Data, and has been under representing the actual amount of new loans in the first half of 2010: "Adjusted for informal securitization activity, Fitch estimates that the net amount of new CNY loans extended in H110 was closer to CNY5.9trn, or 28% above the official figure of CNY4.6trn...
So what exactly is Fitch referring to when mentioning “Informal Securitization”?
The trust products that Fitch is referring to are investment products that are sold by the banks, and packaged by the trust companies. There are two kinds of trust products, the first being products that are sold by the bank to local investors and represent loan that the bank has made directly to homebuyers. In fact, a lot China’s local government debt were packaged in as well. Up until two years ago most of the products were of this nature.
The second type started to be popular at the later part of 2009. In essence, this type is a high interest loan (often 15% plus annual rate) to real estate developers. Since the real estate developers have difficulty to raise funds through offering, they began to work with the banks in order to sell these products. The 10 fold growth in trust products that Fitch referred to came mostly from these kind of loans.
The marketing of the products is not very honest to say the least (who said China doesn’t import anything from America), and many buyers believe that they are guaranteed by the bank. But in reality, they are lending money to high risk new real estate projects.
The shark loan industry is mostly underground, and it’s sources can be low interest loan from banks, cash from state owned enterprises, and private savings. The shark loan operator then lends the money out to real estate developers or other domestic private firms.
There are two major pourposes for shark loans. One is to flip flop the real estate, and another is to lend to private firms with maturing bank loans. As mentioned in previous posts, the common lending practice of Chinese banks has a maturity of one year, and so the borrowers need to renew the loans every year if the old loan are to be paid. So many private firms that can’t pay back their loans since the cash flow from their regular business will not be enough to pay back the principal, are borrowing from shark loan operators at extreme high interest rates with very short durations. They then turn to the bank, repay the old loan and get a new loan for the next year.
Every day there are more and more real estate developers and other businesses that are resorting to loan sharks to manage through the hard times .But this is a short term solution for a long term problem. And like every drug addict, one day comes rehab or death.
If the real estate market remains stagnated for long enough, or if the banks stopped to issue new loans at an ever accelerating pace, many businesses will collapse. Even today, some relatively tight lending standards are causing some ponzi schemes to collapse, like the one of Tang long.
A larger percentage of China’s real estate sales are in reality fake since they are made with the purpose of obtaining the flow of bank loans before real sales happen. Through this arrangement, the developer and the shark lender make sure that the bank will bear the ultimate risk.
Western investors doubt this criminal activity since they do not understand the true nature of China’s society, or any totalitarian regime for that matter. But China is not a democracy; it is semi communist, semi fascist regime that is running a planned economy. All the banks are state owned, and as I mentioned in The Harsh Reality behind China’s Growth Story:
The root of the problem is the same: more loan growth can benefit the borrower, the banking executive, and the local government officials. The return of capital and the potential loss of the principal is always a secondary consideration, especially when the loan are issued to the state owned enterprises or well connected “too big to fail” private businesses. Who cares? The banks are state owned banks, and the capital is state capital.
I have explained the principal of these operations in the secret engine behind China housing bubble- China’s shark loan ponzi finance:
This is how this ponzi scheme works:
Local governmental officials that are demanded from the government to produce double digit GDP growth numbers give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurisdiction. Some of them are active partners in shark loan businesses. For example, a party secretary of legal affairs, that controls the public security bureau, which is a court and prosecutor division of government in yongkang city, in zhe jiang province tired to run abroad using a passport in 2009 after he found out he can’t repay 60million Yuan. Every scheme has a ring leader whose job is to collect money from all the participants in the ponzi scheme. When some of these ponzi schemes blow up, the party leaders always get bailed out first, and some even ask local business owners to lend them money, and then bail out their own personal fund. After that the ring leader turns himself in and gets protection from the local government.
Most of the funds that are collected in this classic ponzi finance go to local land purchases and real estate development. Part of the funds is used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.
The five steps of a fake housing sale in China
1. Before the construction, loan shark operators provide initial finance to small or middle size developers in 2 and 3 tier cities in order to begin the construction.
2. After the construction is complete, and before the official sale to the public begins, loan shark operators will provide resident IDs and other fake documents for mortgage application to real estate developers and make together a fake sale contract.
3. The real estate developer brings the fake contracts to the bank in order to obtain a loan. That can explain why in China, many houses already get sold before they are opened to the public for sale, and why there are so many vacant houses already sold, which no one lives in. (According to the report by Fitch, that was mentioned above there are 64 million unoccupied homes in China)
4. A secret agreement is made between the shark loan operator and the real estate developer. The shark loan operator will get more bank loans through this fake sale, as will the real estate developer. They will use the bank loan in order to engage in another ponzi scheme.
4. The real estate developer shark loan operator will hire people to fake sale frenzy in order to attract real buyers, and if there are enough sales the fake contract will be cancelled out.
5. During the time of the real estate bubble frenzy these ponzi schemes and fake sales were mostly covered, since real buyers could be found. But when the market slows down there will be a thin transaction volume, and the fake sales will be exposed. Then the real collapse will happen.
China’s central government actually knows the massive extent of NPL in the banking system, and they are watching real estate market very closely. All the so called policy action is more of a show off to calm down the angry public than a real measure to tackle the problem. No lethal weapon such as a property tax or an interest rate hike will be used. Simply because the central government knows that they have to maintain the housing prices at a certain level to prevent a panic sale, the will bring down the whole banking system. The train can’t be stopped and it is heading towards a very big wall.
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Peter Navarro gave an interview to Yahoo Finance and The Street.com where he explains China's Shark Loan Finance.
Contributor Peter Navarro examines the "shark loan" phenomenon in China, its effect on the Chinese real estate market and why investors should be concerned.
This is the first time where China's Shark Loan Ponzi Finance went mainstream. Israel's Finacial Expert was the first to report about these schemes outside of China.
This is what we wrote about China's Housing bubble and Shark Loan Finace in June 17th, 2010:
This is how this ponzi scheme works:
Local governmental officials, that are demanded from the government to produce double digit GDP growth numbers give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurastiction. some of them are active partners in shark loan businesses. For example, a party secretary of legal affairs, that controls the public security bureau, which is a court and prosecutor division of government in yongkang city, in zhe jiang province tired to run abroad using a passport in 2009 after he found out he can’t repay 60million Yuan. In li Every scheme has a ring leader who's job is to collect money from all the participants in the ponzi scheme. When some of these ponzi schemes blow up, the party leaders always get bailed out first, and some even ask local business owners to lend them money, and then bail out their own personal fund. After that the ring leader turns himself in and gets protection from the local government.
Most of the funds that are collected in this classic ponzi finance go to local land purchases and real estate development. Part of the funds are used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.
Read More about China's Shark Loan Ponzi Schemes that are the engine behind China's housing bubble:
China’s Shark Loan Ponzi Finance- Understanding China’s Shadow Banking System
China’s Shark Loan Ponzi Finance- As Chinese Banks Tighten Lending Standards, More Real Estate Developers and Households Take on Shark Loans
China Shark Loan Ponzi Finance- Local Chinese Sell Their Kidneys to Repay Shark Loans
Special Report- The Secret Engine Behind China’s Housing Bubble- The Ponzi Shark Loan Finance
A list of all the stories regarding China's Shark Ponzi Finance can be found at the special section:
Contributor Peter Navarro examines the "shark loan" phenomenon in China, its effect on the Chinese real estate market and why investors should be concerned.
This is the first time where China's Shark Loan Ponzi Finance went mainstream. Israel's Finacial Expert was the first to report about these schemes outside of China.
This is what we wrote about China's Housing bubble and Shark Loan Finace in June 17th, 2010:
This is how this ponzi scheme works:
Local governmental officials, that are demanded from the government to produce double digit GDP growth numbers give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurastiction. some of them are active partners in shark loan businesses. For example, a party secretary of legal affairs, that controls the public security bureau, which is a court and prosecutor division of government in yongkang city, in zhe jiang province tired to run abroad using a passport in 2009 after he found out he can’t repay 60million Yuan. In li Every scheme has a ring leader who's job is to collect money from all the participants in the ponzi scheme. When some of these ponzi schemes blow up, the party leaders always get bailed out first, and some even ask local business owners to lend them money, and then bail out their own personal fund. After that the ring leader turns himself in and gets protection from the local government.
Most of the funds that are collected in this classic ponzi finance go to local land purchases and real estate development. Part of the funds are used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.
Read More about China's Shark Loan Ponzi Schemes that are the engine behind China's housing bubble:
China’s Shark Loan Ponzi Finance- Understanding China’s Shadow Banking System
China’s Shark Loan Ponzi Finance- As Chinese Banks Tighten Lending Standards, More Real Estate Developers and Households Take on Shark Loans
China Shark Loan Ponzi Finance- Local Chinese Sell Their Kidneys to Repay Shark Loans
Special Report- The Secret Engine Behind China’s Housing Bubble- The Ponzi Shark Loan Finance
A list of all the stories regarding China's Shark Ponzi Finance can be found at the special section:
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