China steers toward a subprime economy

By William Pesek*, Bloomberg

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China steers toward a subprime economy

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Everyone knows the Chinese government is desperate to keep stocks from crashing. But this desperate?
The regulatory tweaks aimed at supporting equities included this shocker: Homes are now acceptable collateral for borrowing to buy more stocks. Perhaps the least of the too-many-to-list problems with this idea is that property is difficult to liquidate when assets crash. The biggest is that China is sowing the seeds of a third financial time bomb to match its debt and stock bubbles.
Ginning up shares with central bank liquidity and regulatory inducements, as China has already done, is a slippery slope. Tying the future of the nation's housing sector to today's stock mania is lunacy. Why bother letting banks churn out subprime debt instruments, as Wall Street did in the 2000s, when you can turn your whole economy into one?
Memo to President Xi Jinping: Suppose some of the $4 trillion worth of debt amassed by local governments in recent years were to go sour (many already have, but you don't do transparency). And suppose that volatility in interest rates spills over into Shanghai and Shenzhen shares (hardly a reach). That would smack one bubble into another, bursting both and triggering a third shakeout in the one Chinese asset market -- home ownership -- that's not supposed to be a giant casino.
The good news is that many securities companies may resist betting the house on the market, or at least as much as they can in top-down Communist China. Why welcome such a risk-management nightmare in a nation that already has too many ghost cities? The wording of China's new rules -- and its list of "other assets" that can be used as collateral -- will force brokers to become experts in valuing everything from property, to antiques, to art.
The bad news is that the authorities in Beijing clearly are betting everything on a stock rally that's hasn't come: Stocks just sustained their biggest three-week loss in more than two decades. That's despite moves last week to loosen margin lending, cut interest rates, reduce reserve requirements, direct the state-run media to churn out don't-panic articles, you name it. Over the weekend, the government even suspended initial public offerings and set up a market stabilization fund.
Margin traders, who increased their leveraged investments nine-fold in the last two years, to about $322 billion from $35.7 billion, have been rushing to close those positions for a record nine consecutive days. And the Shanghai Composite Index's plunge below the symbolic 4,000 level signals even more selling. Further, a slide in iron-ore prices last week suggests that Chinese demand is slowing more sharply than the government is letting on.
All of this indicates that the government's recent stimulus efforts aren't working. At a time when Xi's team should be strengthening China's financial system, they're just making it more fragile. What's needed are decisive steps to shore up domestic demand, not more market froth.
* William Pesek is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region. His journalism awards include the 2010 Society of American Business Editors and Writers prize for commentary.
The opinion expressed is his.

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