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