Sunday, May 17, 2009

Chinese Banks Are Not Good Students

Peter Goodman, whose columns are always concise and well informed, wrote yet another stinging critique of American banks entitled “Lessons the Teacher Forgot.” The basic argument of the piece is that US banks increasingly behaved like Chinese banks, which were supposed to learn market discipline from their teachers. His observations of Chinese banks were also quite on-point:

In effect, American banks operated not unlike the Chinese banks they were supposed to modernize. They extracted profits by following a variation of the principle long pursued by their Chinese counterparts: lend without hesitation while extracting your cut, confident that the government is on the hook for the losses.

In China, ventures may be spectacularly unprofitable, yet enrich everyone lucky enough to get a piece. Developers, for example, construct vacant office buildings as an excuse to borrow from state banks. They rake off a cut for themselves, pay bribes to the party officials who deliver the land and reward bank functionaries with sumptuous banquets and trips to Macao. Soon enough, the trophy skyscraper descends into financial disaster, but the developers, bankers and party officials have already extracted their riches, and for long afterward they will still enjoy them.

As an illustration, there was an interesting exchange between Baogang executive and CBRC official at the Lujiazui Conference recently. Basically, Xu Lejiang argued that the government is doing too much to keeping steel firms alive (Baogang was forced to buy up many firms, for example) and that some steel firms should be allowed to go bankrupt. Banks then should be prepared to “foot the bill.” There is a wonderful sense of irony here because Baogang has benefited from billions upon billions in preferential loans from banks. Anyway, a CBRC official in audience responded by saying that “as a banking regulator, I most fear the phrase ‘banks footing the bill’.”

As Goodman points out, the reality is that thousands of Chinese firms are being kept alive by the banks and government policies now. The difference between the US and China is that the US government could not have ordered the Feds to intervene to save these financial institutions before the crisis, whereas the main job of the PBOC and CBRC is to prevent a major financial crisis. Of course, they do some monitoring, but when financial institutions become insolvent, they have shown perfect willingness to print money to bail them out to preempt a system-wide crisis. So, this signals to all financial firms and state-related conglomerates that the center is there to bail them out, setting off a frenzy of borrowing and bond issuance. Over time, massive debt is issued on the basis of empty office buildings, under-utilized infrastructure, stock market speculations….etc. I am not sure how this all will end…..

Quote: "...enrich everyone lucky enough to get a piece. Developers, for example, construct vacant office buildings as an excuse to borrow from state banks."

But how do the developers profit from this? Don't they need to find somebody who's willing to invest his money to buy the buildings, i.e. someone who doesn't recognize that he's getting a bad deal?
Dear Professor Shih,

I just wonder how you could think of the new published book regarding Zhao Ziyang's age in China's 1980s. I feel the title of its Chinese version “改革历程” is more appropriate than its English version's title, even though the "prisoner" word can attract more readers.

As a researcher in political science, will the truth told by Zhao make some impact in your previous research outcome? How will the facts contribute to your future work on China's politcs and economy?
Thank you.

Kind regards,

In 1997, at a time of several runs on small branches in rural areas, I informally surveyed businessmen I'd met in Shanghai about whether they had any concern. They had none, because, as they said, 中央绝对不会让它倒。 What if, I followed, central government was unable to staunch the bleeding? No businessman was even willing to consider this as a possibility. (嘻嘻哈哈地)不可能,讲什么话呀!

Nothing has changed since then, especially given the purported stimulus program.

Rich Kuslan
I find it difficult to believe talking to a few Shanghai businessman you somehow know what everyone thinks...
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