In 2010, as regulators tried to rein in the explosion in bank credit resulting from the country’s 4 trillion yuan economic stimulus plan, banks turned to trusts to help them comply with lending controls. Since then Wealth Management Products (WMPs) have grown at an exponential pace and currently amount to about 24 trillion yuan, the equivalent of $3.6 trillion, or over 1/3 of China’s GDP. Essentially trusts helped banks offload credit risk at the behest of the PBoC. Here’s the process:
1) Banks lend money to local governments for massive unnecessary construction
2) PBOC says get these risky loans off the books
3) Bank repackages the loan which is sold to a WMP manager
4) Small investors buy WMPs
5) Proceeds from sales redeposited in banks by WMP management co
6) Process of bad bank lending repeats, this time even more leveraged
Now here’s the problem as the WMP’s run out of those initial small investors: Interbank holdings of WMPs swelled to 3 trillion yuan as of December from 496 billion yuan a year earlier, according to figures released by the clearing agency last month. As much as 85% of those products may have been bought by other WMPs.
Hence the search for fantasy yield gets more frantic: Most WMPs have a duration of less than six months and some can be as short as one month. A search of 1,300 products listed on the website of government-run Chinawealth.com.cn showed the highest annual yield on offer was 8 percent, compared with a one-year deposit rate of 1.5 percent. Typical yields range from 3 to 5 percent.
“We’re starting to see layers of liabilities built upon the same underlying assets, much like we did with subprime asset-backed securities, collateralized debt obligations, and CDOs-squared in the U.S.,” Charlene Chu, a partner at Autonomous who rose to prominence in her former role at Fitch Ratings by warning of the risks of bad debt in China, said in an interview on May 17. She says that nonperforming loans may be 22%, instead of the official 1.8%.
So ZH talks of a Minsky Moment, much in the same way that George Soros spoke of things going parabolic, all of which is quite bad. But now there’s an additional element with the growth of the WMP’s through WMP managers buying the WMP’s down the street: for the first time, we see risks similar to the CDO’s and CDS’s of 2008, so well explained by Paddy Hirsch. It’s unclear how the bust will affect the US economy, but it is quite bearish for industrial commodities and the values of the apartment buildings in China’s Seven Empty Manhattans.