This Is The $3.5 Trillion "Neutron Bomb" That Keeps Kyle Bass Up At Night

Tyler Durden's picture

Earlier today, CNBC invited Kyle Bass, the man who correctly predicted and profited from the subprime collapse, to discuss what he thought was the biggest threat to the global financial system.

Here is the highlight of what he said:

What I think the narrative will swing to by the end of this year if not sooner, is the real issue in China is not simply that profits have peaked. The real issue is the size of their banking system. Do you remember the reason the European countries ended up falling like dominoes during the European crisis was their banking systems became many multiples of their GDP and therefore many, many multiples of their central government revenue. In China, in dollar terms their banking system is almost $35 trillion against a GDP of $10 and their banking system has grown 400% in 8 years with non-performing loans being nonexistent. So what we are going to see next is a credit cycle, and in a credit cycle you see some losses, but if China's banking system loses 10%, you are going to see them lose $3.5 trillion. 

He then puts this number in the context of China's "massive" foreign reserves:

What's the magic number in their FX reserve pile today? When you look at banking system assets divided by their foreign exchange reserves, China is 7x, it's one of the worst in the world. I think people are mypoically focused on a giant number of reserves, of $3 trillion or thereabouts, and no one is really paying attention to the size of the system and what's about to happen.

Actually that's not true: we first pointed this out more than 2 years ago, when we showed "How China's Stunning $15 Trillion In New Liquidity Blew Bernanke's QE Out Of The Water."


A few weeks later we followed up with another stunning chart showing "How In Five Short Years, China Humiliated The World's Central Banks." However, we do agree fully with Bass that virtually nobody else is paying attention to this epic question of scale, especially as it relates to another topic we have been covering for the past two years: China's soaring, and dramatically underreported non-performing loans.

More on that in a second, but first a quick reminder that as we also reported over the weekend, for Kyle Bass, "The Greatest Investment Opportunity Right Now" is to short the Chinese currency: a trade which just in the past week has generated tremendous returns (using the embedded FX leverage), and which we are confident will continue to be very profitable, especially since as we first said in August, days before China's devaluation, the only thing that could save China's economy from an even harder landing, is to rapidly devalue their currency. China did just that, and has been doing that ever since.

Earlier today, even Goldman - with a huge delay - finally came to see things correctly, when it said that:

"We are adjusting our USDCNY forecast weaker, to 7.00 on a 12-month horizon (our twelve-month forecast was 6.60 previously) and 7.30 by end-2017 (from 6.80 previously). Though markets have been moving quickly, and today's lower USDCNY fixing suggests the possibility that policymakers may want to stabilize expectations for the CNY, this puts us back on the weak side of market pricing over a twelve-month horizon, consistent with our view that 2016 will be a year of continued “bumpy deceleration” and significant policy easing in the Chinese economy, and that the potential for greater CNY depreciation remains a large source of uncertainty."

So going back to Kyle Bass' thesis, it a relatively simple one: China has been avoiding a credit, or non-performing loan cycle, and fabricating the data, but the time has run out.

"China many years ago attached its currency to the dollar: they hitched their wagon to our star very smartly because back then our goal was to depreciate our dollar through inflation. So we issued debt to the rest of the world to depreciate the dollar. And so now the real problem is China has hitched their wagon to our star, and their currency has effectively appreciated about 60% versus the rest of the world since 2005 and it's killing them... China's effective exchange rate moving up versus the rest of the world made their goods and services a little bit more expensive each year and now that labor arbitrage is gone. And if that labor arbitrage is gone, and the banking system has expanded 400% in 7 years without a nonperforming loan cycle, my view is we are going to see a non-performing loan cycle."

So what exactly is this non-performing loan cycle that Kyle Bass is referring to, and where does he get a $3 trillion potential loan loss - a quantum step in admission of economic failure which we first dubbed China's neutron bomb" in October 2015 - number?

Luckily, we explained all of this two months ago when we showed how "China's Banking Sector Is Sitting On A $3 Trillion Neutron Bomb." For those who missed it, here is the explanation behind what could be the best trade of the next 12-18 months (the best trade of 2015 incidentally was to be long Glencore CDS, as we suggested in 2014) according to Kyle Bass:

* * *

We’ve long contended that official data on bad loans at Chinese banks is even less reliable than NBS GDP prints. Indeed, the lengths Beijing goes to in order to obscure the extent to which banks’ balance sheets are in peril is truly something to behold and much like the deficient deflator math which may be causing the country to habitually overstate GDP growth, it’s not even clear that China could report the real numbers if it wanted to. 

We took an in-depth look at the problem in “How China's Banks Hide Trillions In Credit Risk: Full Frontal”, and we’ve revisited the issue on a number of occasions noting in August that according to a transcript of an internal meeting of the China Banking Regulatory Commission, bad loans jumped CNY322.2 billion in H1 to CNY1.8 trillion, a 36% increase. Of course that’s just the tip of the iceberg. In other words, that comes from a government agency and although the scope of the increase sounds serious, it still translates into an NPL ratio of just 1.82%. Here’s a look at the “official” numbers (note that when one includes doubtful accounts, the ratio jumps to somewhere in the neighborhood of 3-4%):

Source: Fitch

There are any number of reasons why those figures don’t even come close to approximating reality. For instance, there’s Beijing’s habit of compelling banks to roll over bad loans, and then there’s China’s massive (and by “massive” we mean CNY17 trillion) wealth management product industry which, when coupled with some creative accounting, allows Chinese banks to hold some 40% of credit risk off balance sheet.

Well as time goes on, and as market participants scrutinize the data coming out of the world’s second most important economy, quite a few analysts are beginning to take a closer look at the NPL data for Chinese banks. Indeed, if Beijing continues to move toward “allowing” defaults to occur (even at SOEs) and if China’s transition from smokestack economy to a consumption and services-driven model continues to put pressure on borrowers from the manufacturing sector, the situation is likely to deteriorate quickly. If you needed evidence of just how precarious things truly are, look no further than a recent report from Macquarie which showed that a quarter of Chinese firms with debt are currently unable to cover their annual interest expense (as you might imagine, it's even worse for commodities firms). 

Just two weeks after we highighted the Macquarie report, we took a look at research conducted by Hong-Kong based CLSA. Unsurprisingly, it turns out that Chinese banks' bad debts ratio could be as high 8.1%, a whopping 6 times higher than the official 1.5% NPL level reported by China's banking regulator. 

We called that revelation China's "neutron bomb" but it turns out we may have jumped the gun. According to Hong Kong-based "Autonomous Research", the real figure may be closer to 21% when one takes into account the aforementioned shadow banking sector. Here's more from Bloomberg:

Corporate investigator Violet Ho never put a lot of faith in the bad loan numbers reported by China’s banks.

Crisscrossing provinces from Shandong to Xinjiang, she’s seen too much -- from the shell game of moving assets between affiliated companies to disguise the true state of their finances to cover-ups by bankers loath to admit that loans they made won’t be recovered.


The amount of bad debt piling up in China is at the center of a debate about whether the country will continue as a locomotive of global growth or sink into decades of stagnation like Japan after its credit bubble burst. Bank of China Ltd. reported on Thursday its biggest quarterly bad-loan provisions since going public in 2006.


Charlene Chu, who made her name at Fitch Ratings making bearish assessments of the risks from China’s credit explosion since 2008, is among those crunching the numbers.


While corporate investigator Ho relies on her observations from hitting the road, Chu and her colleagues at

Autonomous Research in Hong Kong take a top-down approach. They estimate how much money is being wasted after the nation began getting smaller and smaller economic returns on its credit from 2008. Their assessment is informed by data from economies such as Japan that have gone though similar debt explosions.


While traditional bank loans are not Chu’s prime focus -- she looks at the wider picture, including shadow banking -- she says her work suggests that nonperforming loans may be at 20 percent to 21 percent, or even higher.



“A financial crisis is by no means preordained, but if losses don’t manifest in financial sector losses, they will do so via slowing growth and deflation, as they did in Japan,” said Chu. “China is confronting a massive debt problem, the scale of which the world has never seen.”

As a reminder, here's a look at the scope of the "problem" Chu is describing:


And here's a bit more on special mention loans and the ubiquitous practice of "evergreening":

Slicing and dicing the official loan numbers, Christine Kuo, a senior vice president of Moody’s Investors Service in Hong Kong, focuses on trends in debts overdue for 90 days, rather than those classified as “nonperforming.” Another tactic some analysts use is to add nonperforming debt to “special mention” loans, those that are overdue but not yet classified as impaired, yielding a rate of 5.1 percent.


Banks’ bad-loan numbers are capped by “evergreening,” the practise of rolling over debt that isn’t repaid on time, according to experts including Keith Pogson, a Hong Kong-based senior partner at Ernst & Young LLP. Pogson was involved in restructuring debt at Chinese banks in 1998, when their NPL ratios were as high as 25 percent.

So let's just be clear: if 8% is a "neutron bomb", a 21% NPL ratio in China is the asteroid that killed the dinosaurs. Here's why: 


If one very conservatively assumes that loans are about half of the total asset base (realistically 60-70%), and applies an 20% NPL to this number instead of the official 1.5% NPL estimate, the capital shortfall is a staggering $3 trillion. 

That, as we suggested three weeks ago, may help to explain why round after round of liquidity injections (via RRR cuts, LTROs, and various short- and medium-term financing ops) haven't done much to boost the credit impulse. In short, banks may be quietly soaking up the funds not to lend them out, but to plug a giant, $3 trillion, solvency shortfall. 

In the end, we would actually venture to suggest that the real figure is probably far higher than 20%. There's no way to get a read on how the country's vast shadow banking complex plays into this but when you look at the numbers, it's almost inconceivable to imagine that banks aren't staring down sour loans at least on the order of a couple of trillion. 

To the PBoC we say, "good luck plugging that gap" and to the rest of the world we say "beware, the engine of global growth and trade may be facing a pile of bad loans the size of Germany's GDP."

We close with the following from Kroll's senior managing director in Hong Kong Violet Ho (quoted above):

"A credit report for a Chinese company is not worth the paper it’s written on.”

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Francis Marx's picture

I though some of my sleepless trading nights were bad  lol, got me beat..

Jlasoon's picture

Have no fear, the Canadian Prime Minister/President Rafael-De-Calgary is here - by way of Goldman Sachs of course!

nuubee's picture

It's kind of the opposite of a Neutron Bomb, isn't it? This bomb would kill all of the goods/services/toys that people use, but leave the people. In that situation, I don't think everyone stops what they normally do and become experts singing KumBaYah.

remain calm's picture

kyle thinks the decline is way more than 20%, but is afraid to stick his neck oiut any further since his Japan call has not worked out and in fact he no longer holds the position. He rather just get it right and tell us later how much he made.

Scooby Dooby Doo's picture

Hey Gang it Scooby Time! Yeah.

I just want to remind everyone that Kyle does his homework very thoroughly. Kyle is the man when it comes to complex economies. Let's give three cheers for Kyle! Ready Gang?


Stainless Steel Rat's picture
Stainless Steel Rat (not verified) Scooby Dooby Doo Jan 8, 2016 7:39 PM

The asian bomb currently keeping me up at night is the one the US sniffer planes can't smell and that can somehow trigger fusion in the trigger sized range.  We should at least smell the trigger, and we don't.  So, an alternate trigger?  This would be the same mechanism required by heavy water enrichment.  So, an alternate method of producing heavy water?  I imagine such a bomb is vastly cheaper than any built by current nuclear powers and way easier to get past borders.  If/when we can smell it, I will be relieved.

Government needs you to pay taxes's picture

The 20% NPL assumption smells of wild ass guess.  I understand the 'accounting' makes it difficult to determine with confidence, but it's not like the Chinese are simply going to say, "Yeah, you got us, we've got 3 trillion in NPLs, time to take a bath".  They will fudge, fudge, fudge, and at its most dramatic, there will be an incremental trickle/stream of bankruptcies.  Just like when Meredith Whitney was predicting 1000s of muni defaults.  Fundamentally, she may have been right-ish, but when the Fedcoats look the other way, the folks fudging the numbers play the 'pretend and extend' game.

old naughty's picture

"If one very conservatively assumes that loans are about half of the total asset base (realistically 60-70%), and applies an 20% NPL to... "

The new normal, isn't it. It takes two to play. 

So "willing" (or "enticed") loaners get actions...

Who (or perhaps, what) will "fix" this?

Four chan's picture

china is a stacking error with bureaucrats lying all the way up to the top to keep their positions. the system of slaves is not to be trusted on any level.

SafelyGraze's picture

here is the highlight of what he said:

"it's not the end of the world"

we kinda got lost in all the other words and stuff, but he definitely said it's not the end of the world. 

so that is reassuring to our viewer-investors.

the media-vestment-archy


SilverDOG's picture

@ Government need...

Hey ya never know. US dropped a couple towers and a few ground offices to make 2.1 trillion disappear. Coulda been 1.2 but... accounting.

Escrava Isaura's picture



Kyle, China will never run out of money because China is a SOVEREIGN NATION.

The Neutron Bomb is not money, it’s not debt, but OIL.


Those, who do not understand the differences between MONETARY SOVEREIGNTY and MONETARY NON-SOVEREIGNTY, do not understand economics. 

Any monetarily NON-sovereign government — be it city, county, state or nation — that runs an ongoing trade deficit, eventually will run out of money. Rodger Malcolm Mitchell

Oliver Jones's picture

Weimar Germany and Zimbabwe both debunked that argument some time ago. Both were sovereign nations with their own currencies - and they both had governments that thought exactly as you do.

JRobby's picture

Come on guys! What? Do you need a refresher course? It's all credit cycle now!

Whenever the contribution to GDP from "Finance" is growing much faster than other sectors, there will be a correction.


(requires looking through the accounting tricks (fraud))

back to basics's picture

Vintage ZH article. Well done Tylers, the "as we predicted" narrative is fully deserved this time.


Scooby Dooby Doo's picture

Yeah but lets not start sounding like Reggie Middleton boombustblogger. Yuch!

warpigs's picture

He cut that Japan trade?

remain calm's picture

Yes. In a nutshell, He could no longer get the terms he wanted.

sam i am's picture
Saker’s Technology Sitrep Threatens NATO’s Precious Bodily Fluids!

RiverRoad's picture

So are their big banks leveraged 44 to 1 like ours were?  Any half-way reliable figures on that subject? 

Thank you Nixon for your and your globalist buddies' "achievements" re gold and China.  Way, way, way more historically relevant than Watergate.  Gonna be some new chapters in those history books now.

geno-econ's picture

Don't forget Henry Kissinger who wanted to screw the Soviets by warming up to Communist China.   Result is Russia and China are now friends and China in a position of destroying global banking and trading system and at the same time stripping US of any manufacturing leadership.  So much for Realpolitic.

RiverRoad's picture

The blowback from our foreign policy failures is getting overwhelming.  Making "capitalists" out of some of these folks has not done all that much for mankind considering the present state of the world.  The globalist banksters who promulgated this will have their private islands to retreat to when things get hot. 

Wild Theories's picture

don't blame Kissinger for that one, blame his successors for screwing up the plan by pushing Russia and China together again

JRobby's picture

Lesson: No one ever trusted Kissinger. Why would you?

bIlluminati's picture

Infinite leverage. NPLs are greater than equity. So China can't/won't let the banks fail, so expect the yuan to go over 10 som time in 2017. However, things could move faster than that, as in 1923 Germany. I so do not want 1.3 billion resentful Chinese, with 120 million military-age Chinese under/unemployed. I have been calling WW3 for a while now, but from the European/U.S. front. At this point, I am studying fallout patterns. The Easern U.S. does not look promising, and the PLA is too close to the rest of Asia. Sitting on an ammo dump and giving off sparks ...

RiverRoad's picture

So far it's basically been Financial WW3 with a lot of paper flying around; eventually the bullets fly.  I find fallout patterns interesting too re prevailing winds.  Made Japan a much better target than Germany.  If anything escalates, I assume there will be several fronts in order to task the "enemy" as heavily as possible, especially as most interactions affect the global scene now. No doubt lame duck (in every sense) Obama is the catalyst for much of the insanity and surreality taking place.  Hoping and praying we all muddle through this.

Mr Pink's picture

The fact that I have believed Kyle Bass in the past is what keeps me up at night

buzzsaw99's picture

They float. They all float. [/Pennywise]

He thrusts his fists against the posts and still insists he sees the ghosts.

KesselRunin12Parsecs's picture
KesselRunin12Parsecs (not verified) Jan 8, 2016 6:07 PM

a trillion here, a trillion there... Next thing you know you're sleeping on a bed of nickles.

NotApplicable's picture

It's okay. After all, they owe it to themselves.

t0mmyBerg's picture

That is an interesting question actually.  The key phrase in this piece is:

“China is confronting a massive debt problem, the scale of which the world has never seen."

30 trillion dollars woth of debt, like 25 of which is in the last 8 years.  At least 10% will be unserviceable, potentially half.  So lets say back of napkin 2-10 trillion dollars.  In a 10 trillion dollar eceonomy. 

So that is 2-3 times the size of the Subprime crisis that killed the west.  But that is because the banks of the West were killed and they are at the center of the world trading and financial system.  Most of the debt in asia stays in asia.  Only 2-3 Trillion based on what I have read is from Europe and US.  Syill very big even if only 10% of that outward facing amount goes bad (whats a few a few hundred billion among crony friends).

Still, the scale of the debt is absolutely epic, biggest ever in the history of the world type stuff.  When the writeoffs come, they will leave marks all over the place.

The problem with the short Yuan as the greatest trade of the year is that you have to be a big player to do the trade.  I have been looking into it since early last year after seeing an interview with Mark something something on Realvision who made a great case for it in summer of 2014 I think.  The only way to do the trade is through a big bank so you need to be able to do hundreds of millions at least.  In other words you have to be a big fund or very wealthy individual.  Anyone see a way to do the trade?

JLee2027's picture

Revelation 18, predicts a total collapse of wealth in one hour. The word HOUR appears 3 times. Question is this port city Shanghai or New York?


In one hour this great wealth has been ruined." Every captain of a ship, every traveler at sea, sailors, and seafaring merchants stood at a distance


and cried out when they saw the smoke of her pyre, "What city could compare with the great city?"


They threw dust on their heads and cried out, weeping and mourning: "Alas, alas, great city, in which all who had ships at sea grew rich from her wealth. In one hour she has been ruined.

Seek_Truth's picture

Revelation 18 is talking about Babylon the Great.

Ancient Babylon is the originator if the modern banking/financial system.

Babylon the Great is the worldwide banking/financial system.

That is why all the merchants, and all those who make a living in the transportation industry weep and mourn when she collapses.

Revelation 18:23 is the clincher- the "magic spell", the "sorcery" is the power of fractional reserve banking, fiat currency, derivatives, etc.

"By your magic spell all the nations were led astray..."

What greater magic has ever been concieved?


The global financial system will die a speedy end- soon.

sschu's picture

Your interpretation of Rev 18 and Babylon is interesting.  Mostly I have heard that it is a nuke that destroys Babylon "in one hour".  We see the city "burning",  

It does make sense and it could be.


Government needs you to pay taxes's picture

Rumor has it North Korea's got a shiny new bomb, just waiting to be exploded!

SoilMyselfRotten's picture

Rev 17 and 18 both make reference to a burning up with fire, which agreed, sounds like a nuke. This happening to the great city /harlot who sits on many waters. Most of the references sure make it sound like the US to me, which frankly is scary. 

ATM's picture

Babylon to me sounds much more like the Islamic states of the Mideast. 

piceridu's picture

How the fuck on this forum of ZH of tin foil hatters can someone quote the bible? What kind of moron wakes up and lives their life according to a fairy tale?

Are you guys kidding? Jesus fucking christ...

Rabbi Chaim Cohen's picture

Brother, the real fairy tale is told every night on MSNBC, NY Times, and by most professors at our universities.

sober_kiwi's picture

I've got a long USD/CHN CFD position open. As peg slowly moves upwards towards 7...winning

Im sure there are many ways of doing this, but I found the above the eaisiest.

But what would I know, im a trading noob.

Antifaschistische's picture

I once tried to have a rationale discussion with my associates in China.  That got me NOWHERE!!  I tried to warn them about their stock market....note to self.  NEVER go against Chinese sentiment...with a Chinese citizen.   Just go with the flow.

However, after the bulk of them lose a large percentage of their savings in "the market" I wonder how they are going to feel about soaking up millions of "homes" still unsold and unoccupied.

I asked around this week and the sentiment in China is STILL that you can't lose buying property in Beijing or Shanghai...only goes one way.  However, they believe that prices MAY come down in smaller cities.  (small being under 10 million people)  But they say this very reluctantly...because optimism bias still dominates the mind of all home owners.

Once the Chinese bandwaggon sentiment goes pessimist...THEN you better watch out.  As of today...I think optimism is still leading the pack. 

FreedomGuy's picture

Part of it, I believe is that they are still new to both capitalism and the Western style management of it. In the 1920's, early 80's and other periods you would have heard of unbridled enthusiams for stocks, tech or housing. That is when you are at the mania phase and all rationality has evaporated.

After a really good bust most will wise-up, a bit and remember the rules of gravity.

Apart from that, I have rarely found that you can advise Chinese on much of anything if it goes against their firmly preset beliefs, whether it's finance or medicine.

JLee2027's picture

It's the Asian hive mentality. China has had numerous boom bust cycles, starting with the first recorded hyperinflation documented by Marco Polo.

MarkD's picture

All those charts don't change the fact that we have a shitload of lazy "I deserve everything" folks...... while China has a shitload of "I will work for anything" folks