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On Friday, Chinese state media reported that China Credit Trust Co. warned investors that they may not be repaid when one of its wealth management products matures on January 31, the first day of the Year of the Horse.
The Industrial and Commercial Bank of China sold the China Credit Trust product to its customers in inland Shanxi province. This bank, the worlds largest by assets, on Thursday suggested it will not compensate investors, stating in a phone interview with Reuters that a situation completely does not exist in which ICBC will assume the main responsibility.
There should be no mystery why this investment, known as 2010 China Credit-Credit Equals Gold #1 Collective Trust Product, is on the verge of default. China Credit Trust loaned the proceeds from sales of the 3.03 billion-yuan ($496.2 million) product to unlisted Shanxi Zhenfu Energy Group, a coal miner. The coal company probably is paying something like 12% for the money because Credit Equals Gold promised a 10% annual return to investorsmore than three times current bank deposit ratesand China Credit Trust undoubtedly took a hefty cut of the interest.
Zhenfu was undoubtedly desperate for money. One of its vice chairmen was arrested in May 2012 for taking deposits without a banking license, undoubtedly trying to raise funds through unconventional channels. In any event, the company was permitted to borrow long after it should have been stoppedreports indicate that it had accumulated 5.9 billion yuan in obligations. Zhenfu, according to one Chinese newspaper account, has already been declared bankrupt with assets of less than 500 million yuan.
Mega Default In China Scheduled For January 31 - Forbes
On Friday, Chinese state media reported that China Credit Trust Co. warned investors that they may not be repaid when one of its wealth management products matures on January 31, the first day of the Year of the Horse.
The Industrial and Commercial Bank of China sold the China Credit Trust product to its customers in inland Shanxi province. This bank, the world’s largest by assets, on Thursday suggested it will not compensate investors, stating in a phone interview with Reuters that “a situation completely does not exist in which ICBC will assume the main responsibility.”
There should be no mystery why this investment, known as “2010 China Credit-Credit Equals Gold #1 Collective Trust Product,” is on the verge of default. China Credit Trust loaned the proceeds from sales of the 3.03 billion-yuan ($496.2 million) product to unlisted Shanxi Zhenfu Energy Group, a coal miner. The coal company probably is paying something like 12% for the money because Credit Equals Gold promised a 10% annual return to investors—more than three times current bank deposit rates—and China Credit Trust undoubtedly took a hefty cut of the interest.
Zhenfu was undoubtedly desperate for money. One of its vice chairmen was arrested in May 2012 for taking deposits without a banking license, undoubtedly trying to raise funds through unconventional channels. In any event, the company was permitted to borrow long after it should have been stopped—reports indicate that it had accumulated 5.9 billion yuan in obligations. Zhenfu, according to one Chinese newspaper account, has already been declared bankrupt with assets of less than 500 million yuan.
Wow, worlds largest bank to declare default? Can bankruptcy be far behind?
There has never been a default—other than one of timing—of a WMP, so the Credit Equals Gold product could be the first. If it is, it will edge out the WMP that invested in loans to Liansheng Resources Group, another Shanxi coal miner. Jilin Trust packaged Liansheng’s loans into a wealth management product sold by China Construction Bank , the country’s second-largest lender by assets, to its customers. Liansheng is in bankruptcy, and it looks like the WMP holders will not be repaid in full.
A WMP default, whether relating to Liansheng or Zhenfu, could devastate the Chinese banking system and the larger economy as well. In short, China’s growth since the end of 2008 has been dependent on ultra-loose credit first channeled through state banks, like ICBC and Construction Bank, and then through the WMPs, which permitted the state banks to avoid credit risk. Any disruption in the flow of cash from investors to dodgy borrowers through WMPs would rock China with sky-high interest rates or a precipitous plunge in credit, probably both. The result? The best outcome would be decades of misery, what we saw in Japan after its bubble burst in the early 1990s.
Most analysts don’t worry about a WMP default. Their argument is that the People’s Bank of China, the central bank, is encouraging a failure of the Zhenfu product to teach investors to appreciate risk and such lesson will improve the allocation of credit nationwide. Furthermore, they reason the central authorities would never allow a default to threaten the system.
Observers make the logical argument that “to have a market meltdown, you have to have a market” and China does not have one. Instead, Beijing technocrats dictate outcomes.
That’s correct, but that is also why China is now heading to catastrophic failure. Because Chinese leaders have the power to prevent corrections, they do so. Because they do so, the underlying imbalances become larger. Because the underlying imbalances become larger, the inevitable corrections are severe. Downturns, which Beijing hates, are essential, allowing adjustments to be made while they are still relatively minor. The last year-on-year contraction in China’s gross domestic product, according to the official National Bureau of Statistics, occurred in 1976, the year Mao Zedong died.
Why will China’s next correction be historic in its severity? Because Chinese leaders will prevent adjustments until they no longer have the ability to do so. When they no longer have that ability, their system will simply fail. Then, there will be nothing they can do to prevent the freefall.
We are almost at that critical point, as events last June and December demonstrate. The PBOC did not try to tighten credit as analysts said in June and December; it simply did not add liquidity. The failure to add liquidity caused interbank rates to soar and banks to default on their interbank obligations. In the face of the resulting crises, the central bank backed down both times, injecting more money into state banks and the economy. So Chinese leaders showed us twice last year that they now have no ability—or no will—to deal with the most important issue they face, the out-of-control creation of debt.
A few minutes before 8pm on Aug. 8, 2012, two Chinese living in Spain — a banker and her client — held a blunt telephone conversation. Wang Jing was a senior officer at the Madrid branch of the state-controlled Industrial and Commercial Bank of China (ICBC). The client, Xu Kai, was an alleged top figure in an international money laundering group that was suspected of using the bank to transfer illegal income to China. The network was allegedly using multiple accounts in the name of Chinese residents of Spain, in some cases without their permission, to make the transfers, but there had been a hitch. Earlier that day, Wang said a woman had come to the branch to complain that transfers were being made from her account without her knowledge.
Wang chided Xu, telling her to make sure that account holders used in the scheme were on board. “You have to look out for yourself and make sure these people are obedient,” Wang said. More complaints would lead to “problems” for the bank, Wang added. The bank already had problems. Big problems. Spanish police were listening. Wang’s warning to Xu is documented in confidential court filings that include wiretap transcripts from a series of police investigations starting in 2009 into Chinese organized crime in Spain. The Spanish authorities have said publicly they suspect these groups siphoned up to 1.2 billion euros (US$1.4 billion at the current exchange rate) out of Spain to China between 2009 and the end of 2012.
The wiretaps and findings from police investigations ultimately led Spanish investigators to the front door of ICBC — the world’s biggest bank by assets. On the morning of Feb. 17 last year, dozens of police officers burst into the bank’s Madrid branch and arrested Wang and four other senior managers. Two more executives were arrested after the raid. In a statement released in May last year, Spanish prosecutors said the giant Chinese state-run lender was a conduit for laundering tens of millions of euros in illegal funds from tax fraud and smuggling by “Chinese criminal organizations.”
The sums laundered were so large, the prosecutors said, that “the damage to the socio-economic order and the national economy is clear.” However, beyond news of the arrests and a summary of allegations in the statement, little information has been revealed about the case. Now, thousands of pages of confidential case submissions reviewed by reporters, and interviews with investigators and former ICBC employees, provide the first detailed account of the alleged racket and show that the probe reaches high into the state-run bank’s European operation. The investigation has so alarmed Beijing that China’s top official in Madrid has publicly pressured Spanish officials to conclude the inquiry, warning that failure to do so would harm economic relations.
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