On this episode of China Uncensored,
China’s next financial crisis is lurking in the shadows...
of shadow banking.
It’s like China stacked up 9 trillion dollars...
on the edge of a cliff.
Hi, welcome to China Uncensored.
I’m Matt Gnaizda.
I’m in today for Chris Chappell,
who’s on vacation,
possibly in the South China Sea.
Today, we’re going to talk about shadow banking.
It’s like the evil twin of regular banking.
Shadow banking involves lots of money,
and lots of risk.
And it’s tied to China’s crazy investment boom.
China’s economic boom
and its reliance on shadow banking
is similar in some ways
to the US economic boom in 2007.
Remember:
A lot of great things happened in 2007.
Apple released the iPhone 1.
The last Harry Potter book was published...
which Chris still has not read.
And the US economy had its last...good...year.
Because then this happened.
“Stocks all around the world are tanking
because of the crisis on Wall Street.”
“The stock market is now down 21%”
“We have armageddon.
In the fixed income markets we have armageddon.”
“No, but...”
“We have armageddon.”
“Armageddon”—thanks Jim Cramer—
happened after the failure
of a single investment bank had a domino effect
on the entire global financial system.
Trillions of dollars were lost,
and so were millions of jobs.
Well, it’s been ten years since then.
These guys have recovered,
but these guys...not so much.
But now, this same kind of
boom and crash could happen in China—
and for the same reason.
As Bloomberg puts it,
China is playing a 9 trillion dollar game of chicken
called Shadow Banking.
And like a game of chicken,
some investors will get out in time.
But others will plunge off the cliff,
bursting into a ball of flames on the rocks below.
So what is this totally legit
and trustworthy sounding “shadow banking”?
To put it simply,
shadow banking is when banks—
or companies that are not banks—
lend money outside of the normal structure
of bank deposits and loans.
Here’s a simplified explanation.
In the traditional banking system,
if a business owner wants to grow his business,
he goes to a bank, and that bank loans him money.
Over time,
he repays that money to the bank,
plus interest.
Let’s say a single bank makes 100 loans.
It’s pretty careful about who it loans to.
But even so,
some of the businesses will fail,
so Chinese regulations require
that the bank set aside money
to cover potential losses.
But shadow banking operates
outside that traditional system.
Let’s say 100 businesses want loans.
A shadow bank packages those 100 potential loans
into what’s called a Wealth Management Product.
Then it goes to investors and is like,
“Hey, buy our Wealth Management Product.
It has a high interest rate.”
When the businesses repay,
the investors will get their investment back
plus a lot of interest.
This is shadow banking.
It can also get more complicated.
Because sometimes the bank isn’t a bank,
but just a regular company
that packages investments.
And sometimes the businesses
that want to borrow money
aren’t regular businesses.
They might even be a local government
that wants money to build a bridge or whatever.
All these things can be packaged
into Wealth Management Products,
or other types of financial products,
and then sold to investors—
or sold to investment companies,
which then re-package them
before selling to individual investors.
A lot of times,
shadow bank loans get so complicated
that no one understands
exactly what the risk is.
According to this article,
“The repackaging of credit is so complex
that bankers often have to resort to
line drawings that look like schematic plans
for a Rube Goldberg device
to explain to clients what's going on.”
A Rube Goldberg device.
Like when you pull a lever,
that sets a wheel in motion,
that knocks down some dominoes,
that ends up destroying the economy.
But all this shadow banking
and Wealth Management whatevers
are so complicated!
Investors don’t want to know details!
That’s why companies involved in shadow banking
put out feel-good ads like this:
“Everyone holds sunshine at their hearts
Everbright your life
China Everbright Bank”
See?
Give us your money,
and you’ll have sunshine in your heart!
That bank, Everbright,
is actually a legit commercial bank.
It makes regular loans, too.
But recently it’s also been selling
a lot of shadow banking products to investors,
because that allows Everbright
to maximize profit without putting
so much of its own money on the line.
Basically, it sells the risk to investors.
But a lot of Chinese investors
don’t think risk matters that much,
because the Chinese government will probably
bail everyone out if things go badly.
Like this investor in this Bloomberg article,
who explains that the Chinese government
would never let a big wealth management product fail,
because it’s just not Chinese culture.
Sounds like wishful thinking, right?
But the Chinese government has
bailed out banks in the past.
Like the $45 billion dollar bailout in 2004.
So assuming they’ll do it again seems reasonable.
Although if you’ve ever read the terms and conditions
on any investment product ever,
you’ve seen that “past performance
is no guarantee of future results.”
Sure, the Chinese government may have done
a small 45 billion dollar bailout in the past.
But it doesn’t want to do a 9 trillion dollar bailout now.
Besides, back then,
there was almost no shadow banking in China.
It only started happening on a large scale
after the global financial crisis ten years ago.
Authorities tried to stimulate China’s economy
by having banks lend more money.
But soon, demand for borrowing got so high
that banks didn’t have enough money to lend people.
So banks started packaging loans
and selling them to investors to get the cash.
And it became such a big market,
other companies that aren’t even banks
got into the game.
According to a 2016 report,
shadow bank loans now make up
57 percent all loans in China.
In other words,
more than half of all lending in China now
is actually done through shadow banking!
And this is a big problem
because shadow bank loans are usually
a lot riskier than traditional loans.
Once companies start packaging and repackaging,
it’s easy to lose track of what the risk actually is.
It even starts to seem like a good idea,
like jumping out of a plane without a parachute.
The problem is,
it only works if you’re you’re Keanu Reeves, dude.
Oh, and there’s another problem.
Shadow banking loans don’t get recorded
on banks’ balance sheets.
That makes banks look
healthier than they actually are—
and that also increases the risk.
And guess what?
That’s exactly what happened in the US
leading up to the 2007 crisis.
Banks had been packaging
and repackaging home loans,
then selling and reselling the packages,
and eventually even the nerds at Lehman Brothers
had no idea how to calculate the risk anymore.
Shadow banking in the US was the lever
that set the global financial crisis in motion,
and ironically, its domino effect
is what led to the rise of
shadow banking in China.
And now Chinese authorities are getting worried
about what’s coming next.
In fact,
“Zhou Xiaochuan, the head of China’s central bank
has openly warned that authorities
need to curb financial risks
that might lead to a ‘Minsky Moment’—
a sudden collapse of asset prices,
sparked by debt or currency pressures,
after a long period of growth.”
Basically, bad debt in shadow banking
could end up wrecking the Chinese economy.
And if the Chinese economy gets wrecked,
it could lead to serious consequences
for the Chinese Communist Party.
You know, because no one
believes in that communism stuff anymore,
so they tell people to go make money
and don’t talk about politics.
But if people start losing their money
on a massive scale,
people might start talking about politics again—
like who’s to blame.
That’s why, at a top level conference in July,
Xi Jinping declared that financial security
was vital to national security.
“National security” is of course code for the CCP
securing its power over the nation.
But it’s not 2007 anymore.
It’s 2018.
We have iPhone 10s,
Johnny Depp is a Harry Potter villain,
and Chinese shadow banking has swelled
to more than $9 trillion.
The Chinese government can’t afford
to bail everyone out
when things go south.
They’re trying to rein in shadow banking.
But once you let the tiger out of the cage,
well, it...
I guess it runs around and eats people.
So what do you think of China’s shadow banking?
Leave your comments below.
Once again I’m Matt Gnaizda.
Now it’s time for that thing we do at the end.
You’re still here?
Good.
Don’t worry,
I haven’t taken over China Uncensored.
Chris will be back soon.
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