One of my favorite former students (from Tsinghua University) quit his job at a major SOE not too long ago and joined a large Chinese investment fund that purchases distressed assets. He recently wrote me an email discussing what he does.
Among other things he says: "The distressed asset sector is really a dark side of financial market where there are full of thieves and robbers who spent much efforts to make public or state-owned assets into distressed ones."
Two years ago I met a partner at another Chinese distressed asset fund who told me that his firm never participates in NPL auctions. They preferred to go directly to provincial and municipal authorities to buy NPLs (not all NPLs are held by banks -- municipalities and provinces, whose borrowings are guaranteed by the central government, have also made lots of non-collectible loans) because, in his words, there was more "discretion" about pricing. I interpret "discretion" to mean something a little shadier -- perhaps fraud or bribery.
I haven't seen any serious study (and I doubt any exists) but there is a lot of evidence that looting and pillaging are taking place on a massive scale under the guise of resolving non-performing loans. Aside from the social implications, there are also of course banking implications because I suspect a lot of the accumulated wealth inevitable represents transfers from the banks.
After all, as Willy Sutton said, "That's where the money is."
I don't doubt that there are huge amounts of shady things going on in the NPL sector. When the government transfered all of the bad loans to the asset management companies the assumption was that most of the companies were worthless so there wasn't as far as I can tell any real effort to maximize value for sale of the assets. You had an old worthless factory with huge social welfare liabilities to workers, and the government was begging people to take control of those.
Those are still old worthless factories..... sitting on prime real estate......
Also, about provincial and municipal borrowing. I think that this might be why we disagree about the Chinese government having much "hidden debt" since I don't think it does. Chinese provinces and municipalities often own investment and trust companies, and people often incorrectly assume that these quasi-banks have their deposits guaranteed by the central government. They don't. Provincial and local quasi-banks have been shut down and their depositors left holding next to nothing. The most notable example of this was GITIC in 1998, but there have been others. The same goes true for state-owned enterprises whose debts are absolutelynot guaranteed by the government.
There is safety in numbers. The PRC dares not let the big banks fail because that would case millions of people rioting in the street. Similarly, the rural credit cooperatives are a total mess, but since the depositors are large numbers of peasants, those will not be allowed to fail. By contrast, people who lose their money in ITIC's and provincial SOE's are small in number, and tend to be rich, and get as much public sympathy as hedge fund investors.
For the amount of continingent liabilities arising from municipal and provincial borrowing I use a study produced two years ago by a Chinese academic (I forget his name) who argued that the portion that could not be collected added debt equal to about 10% of GDP. These are direct borrowings, and are guaranteed by the central government (as are all direct provincial and municipal borrowings, as I understand it). The figure does not include the borrowings of the trusts which, and I think you are right, are not likely to be guaranteed in a crisis.
The bigger chunk of contingent liabilities in my "national balance sheet", however, arises from the banking sector, from which I estimate (using secondary sources) that the hole in the banks' balance sheets to be equal to anywhere from 20-40% of GDP. Although these are not explicitly guaranteed, I think you are certainly right to assume, as I do, that for political reasons the governemtn would have to cover their deposits.
The truth is that none of us can really know the true extent of government liabilities. There is a really useful book published by the IADB earlier this year on Latin American financial crises. It made a very strong case that two biggest causes of the debt build-up that led to crises were not sustained fiscal deficits, as we are usually taught in economics courses, but rather "balance sheet residuals", by which they mean the kinds of balance sheet mismatches that cause asset and liability values to move in opposite directions (which I call "inversion"), and the sudden appearance of previously hidden contingent liabilities.
These things are rarely understood during the gogo periods and become unexpectedly large during the crunch. These are the things I really worry about in China.
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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Comments (2) for "The dark side of finance"
- 8/29/2007 10:08 AM
December, 2007