China quietly suffering its own version of a subprime loan crisis

The National Audit Office said that local government debt now exceeds ¥3.85 trillion. But the real amount may be more than ¥12 trillion. In the face of a continued economic downturn, local governments, banks and trust companies are conspiring to unload this debt onto Chinese citizens by offering them wealth management products. China is staging its own  version of the subprime mortgage-loan crisis that the U.S. experienced.

How does this scheme work? The procedure is as follows:

1. The local government registers some investment companies, which they call “financing platforms.” The name can be some urban construction development company, urban construction asset management company, etc.

2. The local government sets up projects such as construction of highways, airports, government buildings etc.

3. The financing platform companies then go to the bank for money for these projects. Because these companies have government backgrounds and they are government projects, they always get their loans granted for as much as they ask.

4. Of course, banks know what local governments are doing. The loan, once given, will most likely never be paid back. So the risk is very high. Because of this, the bank resells the ownership of the debt to a trust company. For a loan of ¥1 billion, for example, the bank may keep 2 percent interest and let the trust company take over the rest. Because the interest rate in the agreement is 5 percent, whoever takes over still makes 3 percent profit.

Although the trust company also knows what the government is doing, they won’t let such lucrative business go. What they do is resell the debt again, thinking that it will be easy to sell if they increase the interest. As long as it can be sold, the trust company will face no risk or responsibility. Then the trust company turns these debts into different investments called “wealth management products.”

5. The trust company then takes these “wealth management products” to the bank, asking the banks to act as agents in selling them and the banks get kickbacks.

6. The bank prints some ads and opens a “wealth management office” equipped with a finance manager who will look at the amount of savings in clients’ accounts and call them to market the products. The rich are called “VIP customers.” But who is the creditor? Whoever bought the wealth management products is the creditor of the local government’s debt.

What if the debt is not honored? What’s to be done?
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You can go to the bank.
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The bank says: There is no bank stamp anywhere on the agreement. The bank only acted as an agent.
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When you look at the stamp on the agreement, you go to the trust company. Then the trust company tells you that it is a project of the urban construction company, we are only a trust company that does wealth management. It is like when you lose money in your stock of China Petroleum Corporation, can you blame the brokerage that helped you open the account?
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Then you go to the urban construction company. It will tell you that they signed an agreement with the bank for the loan. Who are you?
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Then you go back to the bank. The bank tells you that they financed the urban construction company and that the bank has no obligation to you.

You then go again to the urban construction company. It tells you to go to whoever sold you this product.
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You then return again to the bank. The bank tells you to go to whoever you signed the contract with. Where and who can you go to?

You  go back to the trust company. It tells you that there is always risk in investment. Didn’t you carefully read the terms in the agreement?

You tell the trust company that it says it guarantees your investment.
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The trust company tells you that it is a government project. Not only does the government guarantee the investment, it also says you will receive an additional return. If you don’t believe me, go ask the government!
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You ask the local government. It then tells you that they are only responsible for setting up and approving projects and that it is only an administrative institution. You don’t even know this?

You then say, forget it. I will not go anywhere. I will just file a lawsuit. I am a VIP customer and I have not been completely ripped off. I still have the money and resources to handle a lawsuit!

The first item in the complaint is: Who is the defendant? Who should you name?

By then you realize that when you file a lawsuit, it has to be filed in the court where the defendant is located. But the bank is in your city, the trust company is in Shanghai and the urban construction company is located in Beijing. You are not even able to fill out the item asking who is the defendant. There is no way you can even file a lawsuit.

The difference between the American crisis and that in China is that the U.S. companies sold their debt to the whole world. In China, the local government sold it to Chinese citizens. In Guangdong Province alone the amount outstanding is ¥700 billion.

(Author: Unkown, translated by Boxun from original Chinese)

(Copy editor’s note: In China, all documents bear inked stamps, usually in red, from whatever entity issues the document. This makes them official. Chinese visitors to the U.S. often are amazed that people here trust documents that bear no such stamps.)