China’s Ponzi At Work: After “Credit Equals Gold” Now Comes “Eternal Trust Number 37”

The Financial Times investigates China’s precarious shadow banking system. The first article in the series is Into the Shadows.

From the window of his office, Qiao Jingshan can look out across downtown Yuncheng and see signs of new construction everywhere. Half-built or empty apartment complexes are scattered across the cityscape bearing names like “Eastar Upward”, “Golden Riverside” or “Stars and River Mansion”.

As chief accountant for Yuncheng City Investment, a financing vehicle for the local government, Mr Qiao has played a crucial role in the development of this gritty steelmaking city in central China. His latest job is to sell his company’s “trust product” – a high-interest, deposit-like investment – with the proceeds going to a big public heating project for Yuncheng.

Despite paying a tempting 9.7 per cent annual interest rate, his product, marketed as “Eternal Trust Number 37”, is not catching on with investors.

The near-default of other Chinese financial products recently has set off alarms – inside China and in global markets – that the country is in the midst of a dangerous credit bubble.

Mr Qiao admits the Yuncheng heating project will not provide any re­turns for his company, a­n un­settling fact for any investor. But he is dismissive that this is the problem.

“All of our investments are public works that should actually be paid for by the local government so when the trust product matures the government should take this project off our hands and give us the money to repay investors,” he says. “Don’t worry, it is impossible for there to be any sort of financial crisis here in Yuncheng.”

Too Good To Be True Promise

Supposedly it’s impossible for an investment that yields 9.7% to lose any money. State Owned enterprises investing in economically nonviable projects will never lose money either. Yeah, right.

If it looks too good to be true, it is.

Credit Equals Gold

Worries about China’s shadow banking system rattled global stock markets this winter, after a wealth management product called “Credit Equals Gold” was reported to be on the verge of default. It was quickly restructured, only to be followed by concerns about a similar product known as “Opulent Blessing”.

Noting how large the sector has grown, many in China warn that the country could face its own “Lehman moment” if it were to see a serious run on shadow banks.

“The [traditional] banks have been very strategic about pushing their weakest assets into these channels,” says Charlene Chu, the former Fitch analyst who was one of the first to raise serious questions about the rise of China’s shadow banking sector and who now works for Autonomous, the research group. “The weakest institutions and creditors are the ones engaged in shadow banking, where bad decisions and bad risk management are the norm.”

Credit Expansion Comparison

Misplaced Concern

The Financial Times states “The concern is that financing could disappear for the most leveraged and riskiest parts of the economy, from real estate developers to steel mills. China’s investment-reliant growth could come to an abrupt end.

That’s ridiculous. The concern ought to be that absurd lending to unprofitable, poorly-managed companies and State-Owned-Enterprises (SOEs), continues, not that it ends.

The longer malinvestment foolishness continues, the bigger the ultimate crash.

Mike “Mish” Shedlock