When The Credit Cycle Ends, It's Over: Banks Refuse to Buy Local Govt Debt

Originally posted 4/24/15, update below.

FTAlphaville: The trouble with market-based financing… in China
The thing about market-based financing is that market-based financing isn’t always available the way you want it.

Which is why it’s big news in China on Friday, as the FT reports, that several Chinese provincial governments have been forced to postpone bond auctions as banks balk at the low yields on offer. The news comes by way of state media.

Now, the reason this is interesting is because last month when China’s finance ministry revealed its plan for provincial governments to refinance RMB1tn in debt, analysts were super cheery about its chances of lowering debt-servicing costs and extending maturities for provincial authorities.
When credit is tightening, people don't line up to overpay for bad debts.

FT: China banks balk at local debt-swap plan
Local governments are not legally responsible for repaying LGFV debt, but investors largely viewed such debt as carrying an implicit government guarantee — an ambiguity that elevated yields. Converting the implicit guarantee into an explicit one is intended to lower yields.

...“Banks aren’t very enthusiastic about this plan,” said Sun Binbin, a bond analyst at China Merchants Securities in Shanghai.

“Maybe the bank president has a positive attitude because he wants to establish good relations with the local government and open up other business opportunities in the region. But for the treasury department, they’re under pressure. Other business lines aren’t part of their KPI [key performance indicator]. They’ll take losses on these bonds — rates are low, and liquidity is poor.”
This follows the lack of enthusiasm for low down payment mortgages and discounted mortgages. To the government's credit, they're no longer forcing banks to make loans based on politics instead of profits. The next step is crucial though. If the government leaves it up to the market, interest rates are likely to rise as investors demand greater compensation in a tight credit market. Another option is for the government to buy the assets itself, a Chinese quantitative easing program by another name.

UPDATE: China Local Government Debt Surge Boosts Focus on PBOC Help
The PBOC is discussing adopting unconventional policies including making direct purchases of local government bonds from the market, Market News International reported Monday, citing unidentified people. Previous reports from the Wall Street Journal and Bloomberg News indicated officials were considering letting banks use the notes as collateral for loans from the central bank.

The PBOC and Ministry of Finance didn’t immediately reply to faxes seeking comment on plans to support the municipal bond market or upcoming sales.

Purchases of securities would expand the PBOC’s balance sheet, similar to how the U.S. Federal Reserve grew its assets in recent years as it took on mortgage securities in an effort to shore up the American housing market. While the PBOC isn’t allowed to buy government bonds at Ministry of Finance auctions, it can do so in the open market.
If China joins the QE party, there will be no one left. This is the final stage of the post-2008 rally.

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