Srinivas_K
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Anatomy of China's credit bubble
China's credit bubble bears an eerie similarity to the US housing bubble with common underlying causes at work
China's wall of credit has begun to crumble. Last Friday, a high-yield investment product that attracted funds worth 289 million Yuan from clients of China Construction Bank (CCB)—China's second largest lender—turned sour as the Chinese coal company that received loans through the product defaulted on its obligation.
Last month, after initial reluctance, the Industrial and Commercial Bank of China (ICBC) bailed out investors in a similar investment product (named "Credit Equals Gold #1") that was clearly on its way to default.
The blame for the brewing credit crisis in China has been squarely laid on inadequate regulation of the shadow banking industry, which has been known to make risky loans in search of high yields. As calls for more regulation grow louder, it is worth comparing China's credit crisis to the US housing bubble to understand the common underlying causes of both.
The US housing boom was fuelled by two factors: the government's push to provide affordable housing to the poor, coupled with easy funding provided by the Federal Reserve under Alan Greenspan.
US mortgage debt as a percentage of gross domestic product (GDP) increased from less than 50% in the 1990s to close to 75% in 2008, giving an idea of the easy money policy adopted by the Fed.
And much of the lending was done indirectly through Fannie Mae and Freddie Mac—government sponsored enterprises (GSEs) buying mortgages in the secondary market—that provided financing for up to 75% of new housing mortgages by 2007, including much of the sub-prime mortgages.
Taken together, this translated to an asset bubble fuelled by the central bank and worsened by loose lending standards promoted by the government.
When the Fed finally reversed its easy money stance, higher interest rates—combined with falling housing prices due to lower volume of credit creation—led to a series of defaults. The willingness of GSEs to take the risk posed by mortgage-backed securities linked to sub-prime borrowers, who didn't make for great borrowers even under normal circumstances, did not help much either.
China has witnessed something similar, with an unsustainable boom fuelled by easy credit made worse by government-sponsored shadow banks. As far as the credit binge is concerned, private credit in China has jumped from $9 trillion in the wake of the crisis to $23 trillion in 2013. The increase in Chinese banking assets has surpassed the monetary easing of other countries, including the US, by many times over.
This has clearly fuelled the massive property boom that the country has witnessed over the years.
The fact that Cinda Asset Management Company, the largest shadow bank in China, is actually a creation of the Chinese Ministry of Finance (MoF) gives it an eerie similarity to Fannie and Freddie.
Initially created to bail out Chinese banks through the purchase of distressed assets, Cinda—with great push from the government to increase lending to businesses—later expanded its operation to become a regular buyer of risky assets from Chinese banks. Many such shadow banks created by the government have magnified the risk of moral hazard in the system, as banks can simply make risky loans and offload them on shadow banks which are pushed to purchase them. They are also a major source of funding for unsound investment projects.
Today, China grapples to contain the credit-fuelled boom made worse by aggressive lending pushed through shadow banks. But credit booms are sustained through continued expansion of money supply, failing which mal-investments begin to be exposed. China's M2 money supply growth failed to keep pace with historic trends starting late 2011—when the figure clocked its slowest growth in a decade. Also, ever since the Chinese government announced its intention to soft land the economy, money market rates have pointed to signs of a liquidity squeeze. The series of defaults China currently witnesses clearly points to an economy that is faltering, as credit expansion fails to achieve the increasing pace required to sustain phony investments, and a major underlying reallocation of resources in progress.
After the US housing bubble burst, much of the blame was shifted to the lack of regulations scrutinizing the purchase of mortgage-backed securities by Fannie and Freddie—of course, conveniently ignoring that these GSEs were patronized by US governments over many decades to subsidize housing. More importantly, that easy funding through Fannie and Freddie was made possible only through the Fed's loose monetary policy under Alan Greenspan was not reflected upon sufficiently either.
Mainstream reaction to China's crumbling credit bubble, which has the same underlying causes at work, shows quite clearly that policymakers have still not learnt the right lessons and will probably continue to prescribe the same old wrong-headed solutions to the current Chinese mess as well.
Anatomy of China's credit bubble - Livemint
China's credit bubble bears an eerie similarity to the US housing bubble with common underlying causes at work
China's wall of credit has begun to crumble. Last Friday, a high-yield investment product that attracted funds worth 289 million Yuan from clients of China Construction Bank (CCB)—China's second largest lender—turned sour as the Chinese coal company that received loans through the product defaulted on its obligation.
Last month, after initial reluctance, the Industrial and Commercial Bank of China (ICBC) bailed out investors in a similar investment product (named "Credit Equals Gold #1") that was clearly on its way to default.
The blame for the brewing credit crisis in China has been squarely laid on inadequate regulation of the shadow banking industry, which has been known to make risky loans in search of high yields. As calls for more regulation grow louder, it is worth comparing China's credit crisis to the US housing bubble to understand the common underlying causes of both.
The US housing boom was fuelled by two factors: the government's push to provide affordable housing to the poor, coupled with easy funding provided by the Federal Reserve under Alan Greenspan.
US mortgage debt as a percentage of gross domestic product (GDP) increased from less than 50% in the 1990s to close to 75% in 2008, giving an idea of the easy money policy adopted by the Fed.
And much of the lending was done indirectly through Fannie Mae and Freddie Mac—government sponsored enterprises (GSEs) buying mortgages in the secondary market—that provided financing for up to 75% of new housing mortgages by 2007, including much of the sub-prime mortgages.
Taken together, this translated to an asset bubble fuelled by the central bank and worsened by loose lending standards promoted by the government.
When the Fed finally reversed its easy money stance, higher interest rates—combined with falling housing prices due to lower volume of credit creation—led to a series of defaults. The willingness of GSEs to take the risk posed by mortgage-backed securities linked to sub-prime borrowers, who didn't make for great borrowers even under normal circumstances, did not help much either.
China has witnessed something similar, with an unsustainable boom fuelled by easy credit made worse by government-sponsored shadow banks. As far as the credit binge is concerned, private credit in China has jumped from $9 trillion in the wake of the crisis to $23 trillion in 2013. The increase in Chinese banking assets has surpassed the monetary easing of other countries, including the US, by many times over.
This has clearly fuelled the massive property boom that the country has witnessed over the years.
The fact that Cinda Asset Management Company, the largest shadow bank in China, is actually a creation of the Chinese Ministry of Finance (MoF) gives it an eerie similarity to Fannie and Freddie.
Initially created to bail out Chinese banks through the purchase of distressed assets, Cinda—with great push from the government to increase lending to businesses—later expanded its operation to become a regular buyer of risky assets from Chinese banks. Many such shadow banks created by the government have magnified the risk of moral hazard in the system, as banks can simply make risky loans and offload them on shadow banks which are pushed to purchase them. They are also a major source of funding for unsound investment projects.
Today, China grapples to contain the credit-fuelled boom made worse by aggressive lending pushed through shadow banks. But credit booms are sustained through continued expansion of money supply, failing which mal-investments begin to be exposed. China's M2 money supply growth failed to keep pace with historic trends starting late 2011—when the figure clocked its slowest growth in a decade. Also, ever since the Chinese government announced its intention to soft land the economy, money market rates have pointed to signs of a liquidity squeeze. The series of defaults China currently witnesses clearly points to an economy that is faltering, as credit expansion fails to achieve the increasing pace required to sustain phony investments, and a major underlying reallocation of resources in progress.
After the US housing bubble burst, much of the blame was shifted to the lack of regulations scrutinizing the purchase of mortgage-backed securities by Fannie and Freddie—of course, conveniently ignoring that these GSEs were patronized by US governments over many decades to subsidize housing. More importantly, that easy funding through Fannie and Freddie was made possible only through the Fed's loose monetary policy under Alan Greenspan was not reflected upon sufficiently either.
Mainstream reaction to China's crumbling credit bubble, which has the same underlying causes at work, shows quite clearly that policymakers have still not learnt the right lessons and will probably continue to prescribe the same old wrong-headed solutions to the current Chinese mess as well.
Anatomy of China's credit bubble - Livemint
