Maybe Chinese exposure to complex instruments is limited
By Michael Pettis
I was in Hong Kong earlier this week and one of the things I like to do while there is to meet as many of my former students involved in banking and trading as possible. On Sunday and Monday I had dinner and drinks with about twenty to thirty students and I met several others during my meetings at their banks. I like to think that it is a testament to my teaching that many of my students are as skeptical and anxious as I am about financial systems in general, and are always looking for the bad news out there. I am very close to some of these students and can usually rely on them to give me valuable information about things taking place in the financial markets.
Since many of them are involved in structuring and selling products to Chinese institutions, it was a good opportunity for me to glean perceptions and gossip about the exposure Chinese institutions may have to very complex insturments that may have suffered large – and as yet still concealed – losses in the recent market turmoil.
The results of our conversations were frankly quite comforting. At least according to my students there isn't yet a major concern among bankers that there is lots of hidden toxic stuff out there in Chinese balance sheets waiting to be revealed at the worst possible time. Conversations on the same subject with senior trader friends were also relatively placid (although many are increasingly worried about the Chinese banking system and about monetary policy). This doesn't prove anything, of course, but as a general rule traders gossip about the existence of problems long before they are sprung onto the rest of the world, and there doesn't seem to be much worrying gossip just now.
Michael, I don't agree at all, maybe ur sales students don't understand risks at all.
How could it be possible that Chinese banks are much more smart or experienced than CAO or the state copper reserve? while they are trading much more complex products. Take a look at simple Vanila products, like FX SWAP or BOND, the trading books are not marked to market on a daily basis.
The chinese are experts in hiding problems, for example, if they lose money in trading bonds, they will just put the bond into some so-called "investment book". The "investment book" is priced on a accriue interest basis, and wont' suffer from interest rate move at all.
By Ali - 9/18/2007 9:40 PM
Too bad you weren't at the dinner, Ali. Can you write a little more about what you are hearing and what kinds of instuments Chinese institutions are buying that might be underwater? I agree that we have seen, and will continue to see, big trading losses caused by fololish trading or poor risk management, but I don't just want to assume that Chinese einstitutions have filled up on toxic paper that they don't understand without checking with you guys.
By Michael Pettis - 9/19/2007 11:30 AM
Ali: How could it be possible that Chinese banks are much more smart or experienced than CAO or the state copper reserve?
They aren't, but they know they aren't smart.
The basic rule of investing is don't trade what you don't understand.
Being stupid won't get you in trouble. It's thinking that you are smarter than you really are that will cause major problems. In the case of banks, the orders from on high were probably *DON'T TOUCH THIS STUFF*. Banks are also *much* more tightly regulated than CAO or the state copper reserve. The incentives are also different. CAO and state cooper were under orders to make money. Banks are under orders not to fail thereby bringing down the Party.
People to have the tendency to hide problems why there are hideable, and it would not surprise me at all that somewhere in China there is a bank with tens of millions of dollars of exposure to these instruments. But tens of millions is economically insignificant, and we need tens of billions before there is a major issue. Also hiding stuff is much harder when there is a lack of places to hide. If the orders were *don't touch this* then its very hard to have places to hide things.
By Twofish - 9/19/2007 9:57 PM
Hey Mike, I never sold any structure products to any of the chinese banks, and actually I don't know wot exactly they are buying that cld bust them.
My simple logic is that if the trading side is so bad at risk management, there is no reason I would believe the ppl who "invest" the money are doing a much better job, and sometimes it's the same group of ppl doing both.
The GOSSIPs on the street, Chinese banks are famous for their punting, and even SAFE trades G7 FX very actively to speculate. Bank of China and ICBC had big loss in Sub-prime, almost every single Chinese Banks lost money on their USD asset as they didn't hedge the USD/CNY FX expersure, we don't see any big blow ups yet doesn't mean we are not going to see them.
By Ali - 9/25/2007 9:05 PM
TwoFish:
1st, ppl are afraid that if banks fail it might bring down the party, but I nvr hrd or read that banks are givn the odas not to fail; if even they are given such an oda, it just simply wont' work as the banks don't listen! it the oda works, we just won't see such a rapid loan growth.
2nd, once the problem is too big to hide, the collaspe will come. it will be too late for us to find out. I wonder who are in the postion to give the banks the oda "don't touch them". The odas liek this i hv seen are more from a political reason, for example, the chinese banks are given odas not to trade USDCNY NDF, which is a very profitable flow biz and relatively low risk for Chinese banks.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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October, 2007
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