Chinese Banks Using Goldman-Greece / Lehman Tricks ?

Posted on Jul 22, 2010 in Blog, Newsletters

Chinese Banks Using Goldman-Greece / Lehman-Repo 105

Tricks ???

Consistent readers of Economy Watch are aware we have been more than hard on the shenanigans of US investment banks,

notably Goldman’s rampant tricks with Greece – which played a significant role in both that country’s somewhat deceptive entry into

the Eurozone.  AND the eventual revelation of its fiscal problems, leading, as we all know, into the current and enduring crisis of the

Euro – as well as the chicanery regularly practiced by Lehman Bros for years, hiding its debts using the now-infamous Repo 105

before its whole house of cards collapsed during Black September 2008.

Now, a report released last week by Fitch, one of the US credit ratings agencies whose own credibility has been severely

damaged by all these revelations,

We hope it’s not true – but we fear it could well be.

Fitch says that Chinese banks have been increasingly engaging in the sort of complex deals -following the example

of prominent American and Western investment banks with derivatives – that hide the size and nature of their

lending, obscuring hundreds of billions of dollars in loans and possibly even masking a coming wave of bad real

estate and infrastructure loans.

The report also said that Chinese regulators understated loan growth in the first half of the year, by 28 percent, or

about $190 billion, and that many banks continued to secretly shift loans off the books, creating a “pervasive

understatement of credit growth and credit exposure.”

This coziness between regulators and banks is ALSO – if it turns out to be true – equally disturbing, as it replicates

the deeply problematic relationship that now makes the AIG “bailout” look like nothing so much as a sleazy deal

to help a few select powerful banks avoid potential losses.

“The growing amount of credit moving out of the banking system through these channels is one of the most

disconcerting trends we’ve seen in China in recent years,”

Charlene Chu, a Beijing-based banking analyst at Fitch, said of the practice of repackaging loans and moving them off bank

balance sheets.

While China’s economy remains robust, the report is troubling because the country’s recovery has been fueled by

aggressive lending and soaring property prices.

Lending by state-run banks was one of China’s most aggressive forms of stimulus last year, but analysts constantly

warned that banks could face the risk from overbuilding and nonperforming loans.

Beijing is trying to tame housing prices, rein in overly aggressive lending and stop banks from shifting loans off

their books.

China’s biggest banks, like Bank of China and China Construction Bank, are relatively healthy, analysts say.

But many banks could face sizable risks if borrowers failed to repay loans.

Analysts say that trying to rein in growth is a delicate and precarious balancing act and that even regulators are struggling to

keep up with the rapid innovation in the banking system.

Chinese banks reported a sharp drop in lending in the first half of the year after record amounts in 2009,

suggesting that the economy was growing at a strong clip with more normalized lending.

But Fitch maintains that lending has continued to be aggressive — powering the economy, but raising the risk of

nonperforming loans.

Much of the lending through off-balance-sheet channels is fueled by trust companies, mostly privately owned,

that are partnering with banks and engaging in complex deals that involve repackaging loans into investment

products — akin to an informal type of securitization.

The deals are essentially disguised loans, analysts say.

Beijing has tried repeatedly to stop the practice, but analysts say that banks and trust companies have come up

with innovative ways around the rules.

Two weeks ago, the China Banking Regulatory Commission ordered banks to stop working with trust companies

to securitize or repackage loans, according to industry analysts. But the regulator made no official

announcement. A spokesman in Beijing for the commission declined to comment, insisting senior officials

needed to be alerted to the request for an interview.

Indeed – now isn’t THAT a surprise !!!

Stephen Green, a Shanghai-based analyst at Standard Chartered Bank, said trust companies in China were acting as

intermediaries and partnering with banks to raise and then lend money to a variety of projects.

According to his estimate, trust companies raised hundreds of billions of dollars in 2009 and the first five months of

2010, partly because depositors were frustrated by low interest rates at banks, and trust companies were willing

to offer double that amount – with principal guaranteed. Mr. Green called the practice troublesome.

“There’s limited transparency, so obviously that’s a red flag,” he said in a telephone interview reported in this story from

the New York Times.

Worries about a potential wave of bad loans have led regulators to pressure Chinese banks to raise more capital and strengthen their

balance sheets.

Banks have also been pressed to lower their exposure to local government debt — money often raised for huge

infrastructure projects.

But analysts now say they believe that banks are lowering their exposure to local debt and hiding the size of their

lending by working even more aggressively with trust companies.

Analysts say that last year the process worked something like this:

a bank would hand over a big loan, say $50 million, to a private trust company in exchange for $50 million in

cash. Then the trust company would create a wealth management product out of the loan, and give it to the bank

to sell to investors and depositors. The money raised would be given back to the trust company. Investors would

receive as much as double the regular saving rate AND their principal when the loan was repaid. That $50

million would then be given to the trust company as if it were an investment; in fact, it was a short-term,

high-interest loan to finance a real estate project.

Now, analysts say, to get around new regulations, the transactions are much more complex, but have the same aim

to pretend that a loan is an investment.

If the developer or trust company fails and cannot repay the loan, analysts say the banks could face huge,

unrecognized risks.

We sincerely hope this practice is being over-stated by Fitch, because it sounds to us almost EXACTLY like what

Goldman did with Greece, and Lehman Bros did with their infamous Repo 105s.  And if that indeed turns out to be

the case, then it could turn out the “China bust” people have been right all along, and we “soft landing” folks have

been kidding ourselves, which would be mildly embarrassing for us, but disastrous for the Chinese financial

sector, and, of course, its people – not to mention the rest of the world economy.