By Matt O’Brien at The Washington Post
It would be like finding out Warren Buffett’s financial empire may have been, quite possibly, a sham.
That’s what happened last year when China’s richest man — at least on paper — lost half of his wealth in less than half an hour. It turned out that his company Hanergy may well just be Enron with Chinese characteristics: Its stock could only go up as long as it was borrowing money, and it could only borrow money as long as its stock was going up. Those kind of things work until they don’t.
The question now, though, is how much the rest of China’s economy has come down with Hanergy syndrome, papering over problems with debt until they can’t be anymore. And the answer might be a lot more than anyone wants to admit. Although we should be careful not to get too carried away here. Hanergy is now a nothing that used debt to look like a very big something, while China’s economy actually is a very big something that is using debt to look even bigger. In other words, one looks like a boondoggle and the other a bubble. But in both cases, excessive borrowing — especially from unregulated “shadow banks,” such as trading firms — has made things look better today at the expense of a worse tomorrow.
In Hanergy’s case, there will, of course, be no tomorrow. To step back, the first thing to know about Hanergy is that it’s really two companies. There’s the privately owned parent corporation Hanergy Group, and the publicly traded subsidiary Hanergy Thin Film Power (HTF). The latter, believe it or not, started out as a toymaker, somehow switched over to manufacturing solar panel parts, and was then bought by Hanergy Chairman Li Hejun. And that’s when things really got strange. The majority of HTF’s sales, you see, were to its now-parent company Hanergy — and supposedly at a 50 percent net profit margin! — but it wasn’t actually getting paid, you know, money for them. It was just racking up receivables. Why? Well, the question answers itself. Hanergy must not have had the cash to pay HTF. Its factories were supposed to be putting solar panels together out of the parts it was getting from HTF, but they were barely running — if at all. Hedge-fund manager John Hempton didn’t see anything going on at the one he paid a surprise visit to last year. It’s hard to make money if you’re not making things to sell.
But it’s a lot easier to borrow money and pretend that you’re making it. At least as long as you have the collateral to do so — which Hanergy did when HTF’s stock was shooting up. Indeed, it increased 20-fold from the start of 2013 to the middle of 2015. But it was how more than how much it went up that raised eyebrows. It all happened in the last 10 minutes of trading every day. Suppose you’d bought $1,o00 of HTF stock every morning at 9 a.m. and sold it every afternoon at 3:30 p.m. from the beginning of 2013 to 2015. How much would you have made? Well, according to the Financial Times, the answer is nothing. You would have lost $365. If you’d waited until 3:50 p.m. to sell, though, that would have turned into a $285 gain. And if you’d been a little more patient and held on to the stock till the 4 p.m. close, you would have come out $7,430 ahead. (Those numbers don’t include the stock’s overnight changes).
That’s some pattern. And there’s almost no way it could have been the result of chance. The most reasonable explanation is that someone was deliberately moving the stock up and up so that he could borrow more and more against it. Nobody knows who was behind it — at least not yet, but it’s clear who benefited from high share prices the most: Hanergy Chairman Li Hejun, who was posting his HTF shares as collateral for loans from Chinese state-owned lenders and shadow banks, according to Bloomberg News and the Financial Times. He did some of it through offshore subsidiaries, the FT found, but there was no hiding it when, according to anonymous sources who talked to the Chinese business magazine Caixin, he defaulted on some of this high-interest-rate debt. Lenders sold the HTF shares that had been pledged, and the stock then sold off 47 percent in a matter of minutes and was subsequently suspended. It still is. After all, there isn’t much of a company left. HTF has lost four times as much money as it’s taken in over the past year, it can’t even pay the rent for all of its offices, let alone its bonds, and Li just unloaded some of his shares on the private market for 97 percent less than they were worth at their peak.
(Li, of course, has rejected these accusations of financial mismanagement and blamed short-sellers instead. Neither Li nor his companies have faced any formal accusations, although Hong Kong’s securities regulator has taken the unusual step of publicly confirming it is investigating).
Debt can be a dangerous thing, and it’s not just Hanergy but also China itself that has a lot of it. According to the Economist magazine, China’s total debt has gone from 155 percent the size of its economy in 2008 to 260 percent by the end of 2015. And that, in turn, has created three big problems. The first is that most of this money has poured into just a few sectors of the economy — in particular, steel, cement and housing. The result has been a glut that has pushed down prices so much that companies can’t afford to sell at them. But they can’t afford not to either, because they need some money coming in to at least pay the interest on what they owe.
In a normal economy, the word for this kind of situation would be “bankruptcy.” But China is far from being a normal economy. The government still controls a lot of banks and companies, so it can tell them when to lend, when to borrow, and when to restructure or roll over debt all in the name of social stability rather than making money. It can also subsidize electricity or just give companies cash outright to keep them in business. That turns them into zombies — not so dead that they need to fire people, but not so alive that they can hire more — just kind of stumbling along.
That brings us to problem No. 2. It’s hard to lend out so much money so fast without a lot of it going to people who won’t be able to pay you back. In China’s case, the consultancy Oxford Economics thinks this could add up to nonperforming loans equal to 14 percent of gross domestic product. Now, it’s true that China was able to grow out of an even bigger debt problem 15 years ago, but its economy has slowed too much to pull off that again. Beijing is trying to get lenders to instead swap their bad debts forownership stakes or sell them to investors — good luck with that — but it sure seems as though it’s going to need to put some money in as well. That, at least, is what shadow banks are counting on. They “guaranteed” big returns by taking big risks they pretended were not, so now that a lot of those bets are going bad, they’re clamoring for bailouts.
The biggest problem, though, is that Beijing hasn’t done anything about this. Well, other than make it worse. Why do I say that? Because every time the economy slows down, like it did last year, the government just opens the lending spigots up again —which you can tell by the fact that its housing market is looking bubbly again. But while this adds more debt than before, it doesn’t add as much growth. Think about it like this. China already has so much debt that a lot of new loans are just going to pay for old ones instead of for new projects. So that means it’s getting less bang for the borrowed buck — about a quarter of what it did in 2008. Now, if this sounds too close to being a Ponzi scheme for comfort, that’s because it is. But it’s been Beijing’s policy for the past five or six years even though it knows better. Indeed, the government’s official mouthpiece the People’s Daily just warned that too much debt could lead to “systemic financial risks.”
Hanergy isn’t China, but Hanergy is what’s wrong with China. That’s an over-reliance on borrowed money, the belief that there’s no problem another loan can’t put off, and that you can always play another song after the music stops.
Whether you’re talking about a company or an economy, that works until it doesn’t.