Aubible.com just released a new show on Bernie Madoff (Ponzi Supernova: Bernie
Madoff Speaks, available for free to subscribers) that explains how the
world's biggest financial scam was enabled by banks and hedge funds who were
making so much money that they chose to ignore obvious red flags.
Which sounds a lot like today's China, Inc. Here, for instance, is a
sequence of events involving China Huishan Dairy Holdings, an apparently
too-big-to-fail chain of dairy farms:
March 21. Huishan Dairy misses payments on some of its loans. The
wife of the chairman and largest shareholder (herself an executive in charge
of relationships with the company's bankers) goes missing.
March 23. The local provincial government holds a meeting with the
company and its creditor banks to propose a plan to inject liquidity into the
company. None of this is announced publicly.
March 24. Huishan's shares plunge 85% in an hour, wiping out more
than $4 billion of market value and leading to an indefinite trading halt.
March 28. Huishan admits to missing loan payments and misplacing
the Chairman's wife, but denies reports of faked invoices and
misappropriation of funds. The local government, it promises, will buy some
of the company's excess land to bolster its balance sheet and the Chairman
will sell some of his shares and invest the proceeds in the company.
Somewhere along the way, the government "ordered financial institutions
involved not to downgrade the company's credit rating or file lawsuits
against it."
As Quartz.com
noted at the time:
The Chinese government can't afford to let Huishan fail. Credit markets
already deeply distrust the rust-belt Liaoning province. Authorities there
were revealed to be faking economic numbers, including the province's GDP
growth, from 2011 to 2014. The province was the only province that fell into
recession last year. Meanwhile local firms Dongbei Special Steel and Dalian
Machine Tool went into default last year.
If Huishan does go bust, the fallout could also be disastrous for some Chinese
banks. At least one of them has already felt the chill: Jiutai Bank, which is
the dairy maker's second-biggest creditor, saw the biggest one-day drop in
its shares this week. According to Caixin, the small bank's loan to Huishan
currently stands at around $266 million, bigger than its estimate of
impairment losses on bad loans for the whole of 2016.
The situation is not much easier for the midsize Ping An Bank, which lent
nearly $300 million to Yang's offshore entity Champ Harvest, with a 25% stake
in Huishan as collateral.
And now this, from today's Wall Street Journal:
Chinese
Aluminum Giant Faces Credit Crunch
The world's biggest aluminum producer is in trouble, locked in a feud with
its accountant over fraud allegations that have forced it to suspend trading
of its shares and seek help from the central government in Beijing.
China Hongqiao Group Ltd., has drawn the attention of the global aluminum
market and U.S. trade officials as it soared to the pinnacle of the industry
in the past few years, leapfrogging the production of giant competitors like
Alcoa in the U.S. and United Co. Rusal in Russia.
Its rise coincided with American allegations that Chinese companies—helped
by government subsidies—flooded the world with cheap aluminum, coal and
steel, depressed prices and decimated U.S. industries. U.S.-Chinese trade
issues were a focus of a two-day summit last week between President Donald
Trump and President Xi Jinping of China.
Now China Hongqiao, a Hong Kong-listed company that employs nearly 60,000
people, is facing fraud allegations from two short sellers that the firm says
threaten its financial stability.
In a March 4 letter reviewed by The Wall Street Journal, China Hongqiao
sought assistance from a trade group, the Chinese Non-Ferrous Metals Industry
Association, or CNIA, saying the short sellers' claims of inflated profits
were forcing the company's accountant, Ernst & Young, "to adopt an
extremely conservative and careful attitude."
Then, on March 6, Ernst & Young notified the company it had suspended
its audit of its 2016 financial results, according to a March 31 statement by
China Hongqiao. Ernst & Young asked the company to commission an
independent investigation into the short sellers' claims, delaying the
release of the company's annual financial results, China Hongqiao said.
Without audited results, China Hongqiao said in its letter to CNIA, the
company risks an investigation from Hong Kong securities regulators and a
credit crunch. The company has about $10 billion in debt, according to
securities filings. It could be in default on a $700 million loan unless it
gets waivers from creditors, says Standard & Poor's Global Ratings.
S&P, citing the move by Ernst & Young, has downgraded China
Hongqiao's bonds a notch deeper into junk territory to B-plus.
China Hongqiao asked the CNIA and the Chinese government to come to its
aid, warning in its March 4 letter of "serious effects" if nothing
is done, including "regional systemic financial risks" and
"dramatic social unrest."
The U.S. government in January launched a formal complaint against the
Chinese government with the World Trade Organization, accusing China of
funneling artificially cheap loans from state-run banks to aluminum producers
including China Hongqiao. China provides China Hongqiao with access to cheap
coal, aluminum and electricity, according to the WTO complaint.
There's a pattern here that isn't confined to just these two companies:
Cheap financing either subsidized or provided directly by government enables
Chinese companies to expand beyond the limits of the global marketplace,
producing a glut which makes the previously-mentioned loans unmanageable.
The companies hide their failure for a while but eventually are exposed,
leading local governments to step in with new money and the central
government to change the rules to prevent market participants from warning
others and/or moving their capital out of the way.
As with Madoff's Ponzi scheme, the game goes on as long as new money
continues to flow in and the major players continue to pretend (or are forced
to pretend) that things are okay. It ends when either of those conditions
changes.
Such scams don't tend to peter out over time. Usually -- like the above
dairy and aluminum companies -- they seem fine until one day they're not.
