JPMorgan Warns "Avoiding China Defaults Now Will Amplify The Future Problem"

Tyler Durden's picture

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it. The implicit guarantee that no investments will go sour is one of the key problems with China’s financial system as Orlik adds it encourages reckless lending often to borrowers whose only merit lies in backing from a deep-pocketed government. Crucially, as JPMorgan warns in a recent note, "avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future."

A default that encourages lenders to price in risk would be a positive development and the CEG#1 was an ideal product to 'fail' with its 11% yield and clear idiosyncratic company problems. However, regulators won't have to wait long for a second chance as JPM warns "There will be a default in China’s shadow banking industry this year as economic growth momentum slows."


Via Bloomberg's Tom Orlik,

Investors Should Embrace Defaults in China’s Fragile Financial System




In the years before the 2008 financial crisis, nominal growth outstripped the lending rate. Outstanding credit relative to GDP was low, keeping a lid on the burden of repayment. Against that backdrop, most borrowers were able to cover their costs and the chances of a default were low.



The situation today is different. Nominal growth has more than halved to 9 percent in 2013 from close to 23 percent in 2007.


Borrowers from trusts and other parts of the shadow financial system face interest rates in excess of 20 percent. An explosion in lending has increased the burden of repayment to more than 30 percent at the end of 2013 from about 19 percent of GDP at the end of 2008.


Lower growth, higher borrowing costs and mounting repayment costs mean defaults by borrowers and even bankruptcy at some small lenders are likely. After initial turmoil, that could actually be beneficial.



And JPMorgan adds:

  • China may narrowly escaped the first default in its shadow banking industry
  • Absence of default has become a major market distortion
  • The challenge is to contain the contagion risk if a default happens


...local media reported that the China Credit Trust has reached a last-minute agreement with investors, with all principal and most accrued interest to be repaid. That means China will again narrowly escaped the first default in its shadow banking. However, the worries remain.


The absence of default has become a major distortion in China’s shadow banking, and we believe that default will happen in 2014 amid economic slowing. The concern is that, if a default occurs, whether investors will walk away and put the whole shadow banking market into a liquidity-driven credit crisis.

But contagion is possible...

The concern about the contagion risk is not groundless. In the past several years, non-bank financing (or the so-called shadow banking) has grown rapidly.


We estimate that the gross amount (i.e. with possible overlapping among sub-components) of non-bank financing in China reached RMB 36 trillion by the end of 2012 (or nearly 70% of GDP), compared to RMB 18.3 trillion in 2010 (or 46% of GDP).


Non-bank financing continued to grow fast in 2013. An update of our estimate suggests that nonbank financing has further increased to RMB 46.7 trillion by September 2013 (or 84% of GDP). The increase was most dramatic for trust assets (an increase of RMB 2.66 trillion in the first nine months of 2013), wealth management products (an increase of RMB 2.82 trillion), entrust loans (an increase of RMB 1.8 trillion) and bank-security channel business (i.e. banks use security firms as a channel to extend loans, which more than doubled in the first three quarters in 2013 and reached RMB 2.79 trillion).



The rapid growth in non-bank financing activities, especially for trust loans, WMPs and banksecurity channel business, has been driven by the perception of implicit guarantee from product issuers and distributors. The absence of default confirmed such perception.




In addition, there is substantial overlap between interbank assets and other components, for instance WMPs investing on interbank assets or claims on trust assets being traded in interbank markets. Nonetheless, banks are closely connected to shadow banking activities, hence possible turbulence in shadow banking will also affect the banking system.

We believe that default will happen in 2014 as the growth momentum slows down, and it will help restore market discipline and mitigate the moral hazard problem in the long run. However, the challenge is how to contain the near-term negative impact, as there could be three possible outcomes (in the order of increasing severity) if a default occurs.

The first possibility is that it is perceived as an idiosyncratic event, i.e. no spillover at all. This is the least likely outcome.


The second possibility is that the contagion risk is contained within a manageable level, i.e. only to similar products or sectors. For instance, if "Credit equals Gold No 1" defaults, investors will move away from collectively trust products that are only sold to wealthy individuals (but not affecting WMPs that are sold to retails investors); investors will worry about the credit quality of similar loans (non-SOE borrowers in mining industry), but not spillover to other products (e.g. local government debt, real estate companies and SOEs); investors question about the safety of trust companies but not banks. We can call it "limited spillover".


The third possibility is a “systemic spillover”. In a mild scenario, it will affect the vulnerable components such as trust loans (48% of trust AUM), WMP investment on non-standard credit products (estimated to be 35-50% of total WMPs) and bank-security channel business. In a worse scenario, it will affect the whole trust industry, WMPs and channel business (with a total gross size of RMB 23 trillion). Rollover of trust products (we estimate 30-35% trust products will mature in 2014) and WMP (64% WMPs has maturity less than 3 months) becomes extremely difficult. The liquidity stress could evolve into a full-blown credit crisis.

What can the government do? In our view, avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future. Meantime, there are measures the government can take to contain the contagion risk.

First, let defaults happen but establish a transparent legal process (rather than under-table arrangements) to resolve the dispute between different parties.


Second, regulators should tighten supervisory and regulatory framework to contain regulatory arbitrage activities, and clarify the responsibilities in various shadow banking products. The uncertainty in regulatory and legal responsibility behind each product is an important caveat in the market, and could amplify the contagion risk.


Third, impose hard budget constraints on local governments and SOEs, so as to avoid crowding out of credit to other business borrowers and establish risk-based pricing practices.


Finally, avoid defaults that could be easily linked to systemic concerns, such as the default of banks (rather than non-bank financial institutions as the perception of government protection on banks is stronger) or local government financial vehicles or SOEs. Similarly, the default of a WMP could have a bigger impact than a trust product, as the latter does not have maturity mismatch problem and are sold to wealthy individuals rather than retail investors. In that sense, China may miss an "ideal” first default if “Credit Equals Gold No 1” gets bailed out.

Investors in China have been running scared of a default on a high risk trust product; but, as Bloomberg's Tom Orlik notes, they should embrace it.

And they are going to get a chance again soon as there are considerably more of these maturing in the next quarter...


Perhaps that is why 3mo SHIBOR has been rising 9 days in a row...

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ForWhomTheTollBuilds's picture
"Avoiding China Defaults Now Will Amplify The Future Problem"


Funny how we can see it in everyone but ourselves.   Now, those Japanese and their zombie banks and their ZIRP what are they thinking?   Am I right people?

nope-1004's picture

This is a rich piece of work.  A 100% wholly insolvent bank commenting on the debt problem of a country.  lol.


LetThemEatRand's picture

"That's why I'm richer than you."  -cufflinks

THX 1178's picture

JPM is starting to sound a lot like Peter Schiff. I'm not sure if that is a good thing or the scariest thing imagineable.

NoDebt's picture

A bit of both, but mostly the latter.

SafelyGraze's picture

"JPMorgan Warns "Avoiding China Defaults Now Will Amplify The Future Problem""

I will be using this as an example of "ironic" for the Common Core exam next month that will determine my future

Alanis Morissette

Tall Tom's picture

Jaime Dimon and the rest of you fuckers at JP Morgan...


TAKE A GOOD LOOK IN THE MIRROR. And bring your Barf Buckets as you will soil the carpets of your new Chinese Owners.


That statement by JP Morgue has got to be the epitome of Hypocrisy.


It is American Financial Institutions that are TBTF. God forbid that the Chinese have that option available.


They are some really blind jerks.

new game's picture

fucking illusion theater...

DoChenRollingBearing's picture

I do not know the motives of either, but I would lean more towards taking Schiff's advice.  Buy gold, before JPM takes it all and sends it to China...

disabledvet's picture

that's too much gold. not that it's better than zero but "China" is very quickly becoming the largest economy in the world...with "teething pain."

Sustaining a "skyscraper complex" is not easy. New York City defaulted many times prior to WWII.

It's now building out the largest Underground Railroad movement and terminal system in the world.
This will/does connect the subway systems of Boston and Washington DC.

I can't say I agree with any of it but the project has been underway now for over a decade. And it is MASSIVE.

What China...and East Asia in doing strikes me as far more complex: building an entire civilization "in the sky."

As Detroit and Chicago (et al?) have shown...this is not necessarily a "slam dunk." Los Angeles is interesting because they only built a downtown recently. very interesting the battle between the pedestrians and the cars ou there..."the cars were there first"'problem.

JLee2027's picture

Plausible deniability


JPM is starting to sound a lot like Peter Schiff.

Ignatius's picture

"That's why I'm richer than you." -cufflinks

I'm trying to remember.  Did he twirl his Presidential cufflinks when he testified before Congress?

NoDebt's picture

Read down the thread.  As of this writing, have you ever seen such unanimity of opinion?  A CHINA problem??  Just CHINA??  You gotta be kidding me.  It's far from just China.

DoChenRollingBearing's picture

Yes, almost every country I follow is having big bad problems.  And in the USA, just as an earlier thread mentioned, all you have to do is go to second tier cities to see the rot here.

Prepare, hard landing ahead.  I cannot say when...

yogibear's picture

It should be an export on being a insolvent bank.

KickIce's picture

Is there such a thing as a pot-kettle-black moment?

FreeMktFisherMN's picture

just what I was thinking. JPM BOA GS etc should all have gone bankrupt.

Confused's picture

Of course this is all just super ironice, but the really amusing part is this:


Investors in China have been running scared of a default on a high risk trust product


So by nature they knew what they were getting into. Fuck them.

Antifaschistische's picture

"A default that encourages lenders to price in risk would be a positive development"


LOL...maybe we should try that in the US!!! 

satoshi911's picture

Subsitute "Goldman Sachs" for "JPM", and then this story makes some sense.


Goldman wants to do a 'bear stearns' on JPM, by making this look like JPM problem, rather than GS problem.

Who owns ABC-MEDIA? Goldman Sachs or JPM?

Who was the original "TYLER" a GS or JPM employee?

Pickleton's picture

I heard he was a crew member aboard an Asiana flight that crashed, along with his buddy Sum Ting Wong.

I didn't know he survived.

Pickleton's picture

I heard he was a crew member aboard an Asiana flight that crashed, along with his buddy Sum Ting Wong.

I didn't know he survived.

The Vineyard's picture

Much ado about nothing.  The Chinese government will just print more paper like everyone else.  Bastards.  But it should be good for gold.

taketheredpill's picture



Japan didn't do it.


The US didn't / couldn't do it.


Maybe the Chinese will do it...



Loucleve's picture

Yes, OBVIOUSLY this applies to everyone in the world EXCEPT us.

And these morons can actually say this with a straight face.  Laughable.

Al Gorerhythm's picture

Wow. Sanctimonious polished turds.

KickIce's picture

And no matter how expensive the suit they still can't mask the stench.

LetThemEatRand's picture

Shut up and jump.  You fuckers.

NoDebt's picture

They are in London.  And it's BANKERS.  Yeah, can you believe it?  That's how you know something wicked this way comes when bankers are leaping to their deaths.  When you're used to winning ALWAYS, failure is NOT an emotion you're equipped to handle.

DoChenRollingBearing's picture

Hmm.  I'll try to be watching for "Bankers Falling" signs in our cities.

LMAOLORI's picture


"Shut up and jump."


LOL I posted that video on another article today - though I just think it's funny I really would prefer the corrupt bankers were prosecuted and made to serve lengthy prison sentences and abused by their fellow inmates.

BoNeSxxx's picture


Death By Cold Steel Report's picture

I was about to say; this is the definition of the POT calling the Kettle Black! 


PS for the Politcial Correct reading this you can see my face  by looking up the Death By Cold Steel Report via YouTube lol...

HulkHogan's picture

Thanks buddy. I fell for your PS BS. I won't get that image out of my mind for awhile.

fijisailor's picture
China Warns "Avoiding JPMorgan Defaults Now Will Amplify The Future Problem"

There.  Fixed it for ya

Maxter's picture

"avoiding defaults is not the right answer, as it will only delay or even amplify the problem in the future."

Same can be said about the united-states

Wahooo's picture

JPM of all squids calling for Chinese funds/institutions to fail for the good of the whole. Jaimie that swoosh you hear is the blade.

esum's picture

sidestepping the issue in the ussa at taxpayer expense = OK

sidestepping the issue in china = NOT OK


Eyedroppedthewater's picture

ForWhom you hit the nail on the head!

fijisailor's picture

China is buying the gold.  JPMorgan is losing the gold.  The Chinese will sacrifice the paper tiger at the altar of Keynes and then rule the world with gold.  They have many years of experience with paper money.

LetThemEatRand's picture

Translation -- JPM offloaded their China default derivatives to the Fed (meaning we taxpayers get the bill) and now JPM is on the short side of the China credit trade, so let it burn.

stant's picture

i should have bought the co that makes the nets for foxcon . and then cut cost on materials

Offthebeach's picture

"Mommy, where does pink slime come from?"

The_Ungrateful_Yid's picture

Sharpen the fucking guillotines already

NoDebt's picture

Somebody had to say it.  Might as well be you.

For future reference, the proper format to post that thought is as follows (according to the ZH code of conduct):

"Roll the fucking guillotines, already.  Until then, nothing changes."

RaceToTheBottom's picture

Nope, keep them dull.  I want to watch them have trouble cutting the scum's heads off

Wahooo's picture

Trade the guillotines for machetes. Bring the banksters eye to eye with the Rage.