More On Hebei Credit Guarantee Collapse; 3 "Invisible" Trusts Also Involved

A couple days ago I posted The Credit Dominoes Are Falling Again; Northeast Faces Deflationary Collapse Without Bailout. Reuters covers the topic today in Chinese province's debt crisis exposes economic fault line
Hebei Financing Investment Guarantee Group has sold too many guarantees, too cheaply, on loans that have now gone sour.

"The domestic financing guarantee model is a very bad one," said Hebei Financing general manager Ma Guobin.
"The profit model is an important reason for the large-scale collapse of credit guarantee firms, a 2% profit is not sufficient for taking on 100% of the risk."
"This is unbelievable," said an executive of a trust company that was one of the signatories to the petition. She declined to be identified because of the sensitivity of the matter.

"Who would dare to believe in the guarantee industry in the future? What's the point of having this industry?" she added.
Putting aside a real business model of providing credit guarantees based on the real underlying risk involved, the point of having this industry is to convince banks and investors to make loans they would never make otherwise, to keep a credit fueled inflationary expansion from going bust.

This is not a problem isolated to Hebei. Other guarantee firms have been going bust for the past couple of years. What makes Hebei special is the credit guarantee firm is a major state owned firm and there are a lot of industrial businesses such as steel mills which cannot repay their debts. The acute nature of the crisis has the government going to work. In September, Hebei will begin investigating credit guarantee firms. People's Daily: 9月起河北开展融资性担保机构经营检查
From the provincial Department of Industry was informed that since September, Hebei Province will be financing guarantee institutions business conduct random checks focus on checking whether these institutions have illegal fund-raising, illegal deposits from the public or for the illegal fund-raising, illegal deposits from the public to be secured, etc.
That's a good idea since the Chinese media today reported 3 "invisible" trusts are also involved in the Hebei mess: 河北融投风险波及3只“隐形”信托“通道”类业务

It's a bit late though, considering what happened in Handan less than a year ago. Another Credit Guarantee Gone Bust, One Month After Backing A Trust.
Handan Golden Century, a developer based in the central province of Hebei, is struggling to repay 2.9 billion yuan ($506 million) in debts and its major shareholder Shi Yubao may have skipped town, according to reports in Money Week and Handan News.

Handan Golden Century was the guarantor for a trust product launched last month by the Sino Australian ­International Trust Company (SATC), which is just under 20 per cent owned by Macquarie.
Only now is Hebei going to do investigations. I'm sure there are cases of illegal fundraising and regulatory violations, but the real problem is the Chinese financial system. When bad credit is labeled good credit, less capital is needed to back the loans. The credit guarantee model uses the AIG model of small profits on huge sums of money. One loss on one big loan can be enough to wipe a firm out. Losses aren't expected because the credit is labeled good because it has a guarantee! It is also assumed the government will bail people out and Chinese economists think a 6.5% GDP growth forecast is pessimistic, so how many losses will there be anyway? All it takes is a bit more losses than expected and the whole thing blows up, as it has in the steel trading industry, Sichuan, Handan, Wenzhou, Xi'an and so on. It's not always banks involved either, sometimes it is trust companies, aka shadow bankers, who lack explicit government backing.

And then there's the Sichuan case.
A manager of a credit guarantee firm explains that the trust companies became vehicles for excessive risk taking and leveraging. Credit guarantee firms became the lead actors: they issued the loans to the small borrowers who should not have had access to credit obtain trust loans, while the trust company handled fund raising. He also said that this is seldom seen with government credit guarantee firms, but often seen with private firms. The loans have costs of 16-18% (interest plus fees), with 12% going to the trust company and about 4% to the credit guarantee firm.
This is not unlike what was happening during the U.S. housing bubble, when mortgage brokers were driving lending activity and Wall Street was raising the funds to invest in their junk paper.

I leave you with a few appropriate quotes from Mises.
Inflation is the true opium of the people and it is administered to them by anticapitalist governments and parties. The Theory of Money and Credit, p. 485
The government does not care, at first, that some people will be losers, it does not care that prices will go up. The legislators say, "This is a wonderful system!" But this wonderful system has one fundamental weakness: it cannot last. If inflation could go on forever, there would be no point in telling governments they should not inflate. But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last.
And most imporant:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

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