This Is The $3.5 Trillion "Neutron Bomb" That Keeps Kyle Bass Up At Night
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.”
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No, they are not. That is a lazy, loser, template driven answer.
They are driven by governments who are convinced that they can control things they cannot. Most all the corruption has to tie in directly to government.
Ouch. Very socially intelligent. Naw dude its a banking cartel.
How about government controlled billionaire banksters? That works.
While you are being humorous it is more accurate. Sachs et al. are generally the largest campaign donors. It is like paying mafia protection money with an occassional favor. However, the mafia is the government.
"Let us just demonstrate why you should borrow from our group of banks"
Who do you think the governments work for? Those who finance their campaigns.
Banksters clearly pick the government, not the other way around. Anyone claiming the governments control the banks is speaking the NetanYahoo party line.
Bullshit. That is typical lazy conspiracy-theory pablum. There is no way you can prove that and there is no way to explain it. Are they in bed together? Of, course. The government is a drunk and the banks are bar tenders. The drunk has one key thing, though. He has a gun. The banks do not have guns, NSA, TSA, DEA, FBI, DHS, a navy and so on.
Power is the ultimate aphrodesiac and governments ultimately have it. That is why guys like Castro, Kim and Chavez picked relative poverty but absolute power.
While many here at ZH say they favor liberty or that direction you end up being dupes for the leftist-statist-collectivists. They will let you hate bankers all day as they accrue more power and yes protect the bankers. But it is a sort of Mafia protection racket and every once in awhile they make an example of someone.
As Mao said, "All power comes out of the barrel of a gun." It is an supremely simple and accurate statement.
Put it another way, you cannot disempower your banker (or any other) conspiracy without disempowering the government.
I should add that the government has a fat wallet with tax payer money in it, as well. You can run up a hell of a tab with that and be good for more when you run out. It is called "the national debt".
Agree, FG. The laws of the land that govern all of us are ultimately determined and authorized by the government. To say the bankers control the government is akin to saying a bottle of booze controls an alcoholic.
By the way, no matter how bad people may despise banks and other corporations -- only government can take away your freedom at the point of a gun.
Not enough people get that, Name. This keeps the opposition chasing snipes instead of aiming at the real target. Take away government power and not one single conspiracy works, e.g., bankers, Jews, Rothschilds, Bildebergers, Illuminati, etc.
very true MarkD....right now it's a race by our collective governments to see who can be the stupidist. The least stupid may win. However, put our parasite army up against their working class and they win hands down every day of the week.
God is always on the side with more lawyers.
I'm thinking global war is inevitable
Imminent.
fify.
Right. Was FDR a banker?(yes)
I've said before but I'll say again: Once you understand fractional reserve banking you immediately come to the conclusion that global war is inevitable. There is no way around it. It is the greatest reset known to mankind, and the horrors of war hide the money shifts found throughout the globe during great wars.
Follow the gold, and try to stay alive.
The worst part is the nobody will have any clue why they are murdering eachother. The economy broken so....somebody has to die!
He worries about China banking and here I sit - stupid me - worrying about American banking.
How do you claw back digital currency? Sanctions? Mandates (not the steamy Thursday evening kind Obama prefers)? I'm sure the ChiCom government will surely execute some traders, but that 3.5 Trillion just went "POOF!"...ermmm...was "Corzined"
China, china, china...these HF maniacs only have one word in their mouth.
They forget that they ARE the icons of this capitalism gone mad : the shadow banking leaches and cockroaches who got fat on bankster derivative frenzy. One side won when his TWIN brother lost; both sat on the Titanic!
Both two faces of the SAME Greenback hegemonial and debt supercycled coin, running out of margin.
And now they have to find a bogey man and its China; when it was Greece two years ago or whoever is the next domino to fall in this crazy free for all concocted out of WS since 1971.
When the Gods drive these Oligarchs crazy you know their dreams will be in the image of Banco's ghost.
+1 this litany of Wall Street commentary on China's problems is absolutely illifying. FU Bass, you wouldn't know real value (and values) if it hit you in the face.
Zoro, lets try to be nice to our friends like KB, OK? Just give it a try.
I'll try, but it's awfully hard to when guys like him smugly serve up crowded trades as something brilliant and show absolutely no perspective regarding their own role in this mes.
When the Gods drive these Oligarchs crazy...
Whom the gods destroy, they first make mad. Debt-drunk Keynesian bankers, and their vassal politicians, for starters.
Bass: Correct on subprime, wrong on Japan, but his plain-english, startling summation of the magnitude of China's NPL disaster - is worth another 1000 Dow points down, starting any day.
Nothing wrong with the KB analysis. What's missing from the piece is that you could shine the light in any direction and find some version of the same thing.
Why would anyone want to be so arrogantly public about "profiting from the collapse" when all those people with very tradable skills (many who may have been snipers from any one of America's wars) lose their jobs and are desparate to feed their families?
Never understood the arrogance of useless fucking paper-pushers in this regard.
Time to WORK for a living again!
Now jump you fuckers!!!
I never understood people who would go on CNBC (but your point is taken)
Any monetary system that is NOT tethered to reality through real collateral requirements of some sort is doomed to fail.
Greedy fucking bankers and financiers will buy the political class and write new laws to make their grift/fraud "legal".
This will eventually turn productive, skilled labor against the wealthy who got rich in the first place via their alliance with skilled labor.
Fine.
Skilled labor is the only capital/asset that matters.
Skilled labor will build the guillotines and the new "wealthy" and politcal class will DIE.
the blood pudding we make will feed some.
While I am one of those constantly crowing about productivity as the true source of wealth, We must also acknowledge that those with skills to manipulate...and we know such skills exist, have great value to those plying them. If they can talk themselves out of the hangman's noose, I just don't know. We do know that they have been very proficient at pitting groups against each other, and if they can keep that up, there is no telling how long they can last.
The idea is, people will have a collapsed induced epiphany and the selfserving bs won't work anymore.
He was asked... The blowhorn is /has been so addicted to Fed. funny money, they don't know what selling, or normalization means.
You said before that you were once a medic in the Army right? Thanks for that!
I once was an anti-tank assaultman for a few years, and I agree with your assessment. Its not like grunts don't know how to hunt people down and end them. I think that what it boils down to is that this thin veneer of civilization (and the, for now, resulting punishment for killing them) keeps us from carrying through in doing the world a favor. I know quite a few vets just sort of waiting, and quietly preparing.
In all honesty. Considering the way my brothers and now sisters in arms have been treated, what has been asked, what has been sacrificed, and how I see many being treated by the V.A. I am genuinely amazed that we have not seen a military coup in this country.
Likewise on those waiting and preparing. IMO, if ALL people were required (even the politician's and banker's children) to serve for two years. They would not be so liberal with war. Stuffing the guts of a high school friend back into what remains of his torso will change a person. I thought I wanted to be a doctor at some point. Went the engineering route took a company public in 2001 (this first time I learn first hand how these useless ivy league paper-pushers FUCK us over) and back to farming for personal reasons. Learned a lot along the way, as we all should.
I sort of agree. But, there is now way in hell I'd ever want a conscript in a tactical stack with a loaded weapon behind me. It might be OK if conscripts were on a two year shit duty detail, but I wouldn't trust them with anything that could be readily sold on EBAY.
However, with the collectivist cock-sucker Ray Mabus in charge right now, I expect the USMC standards to lower significantly so that no female Marines feelings will be hurt in spite of unit readiness.
Yes. However, nothing of real value comes without sacrifice.
Be vigilent, productive, and a good person. Surround yourself with the same and prepare or "hedge".
It's all you can do anyway. Local politicians will start looking after local interests that can feed and protect them soon enough. The idiocracy in Oregon is just the begining.
Everything comes from sacrifice. Never submit
We will gain nothing from a military coup, and they won't do it because they are making $ from the current system.
CIA, military and NATO are THE SOURCE OF HEROIN for all of Europe, Russia and the US. They use $50-100B per year revenue to finance black ops and their bank accounts.
No, military coup will produce no improvement in the honesty of our government.
Sibel Edmons, Boiling Frog Post is a first source for Gladio, Gladio B, etc.
Most valuable things I learnt in the military was adaptation, innovation, repair, fix-it, stuff like that.
Because a simple look at recent economic collapses disproves your position.
The last economic collapse was in the 1929 for the U.S., earlier for the europeans.
We had two world wars to "sort it out".
We were a global producer/creditor after that and up until the late 60's. BUT have been papering over shit in the U.S. since 1971.
How is my position "disproved" exactly?
Some would rather make a profit and live in a house than lose their jobs and live in the car while the wife finds a new man.
Work where? Getting paid what? The blue collar jobs were exported and even the jobs left pay less than before. Many of the blue collar jobs are filled with latins.
It is not the traders who created the corrupt economic situation in the US.
I respect a good laborer of any type, but most see the lack of reward, how blue collar no longer provides job security and how many of the jobs break you down.
The white collar crew who thought it would stay a blue collar problem have started to find out otherwise.
I paid a plumber in silver (when it was $48 an ounce) to run some sewer lines. Profit that is HONEST is the result of something of REAL VALUE being created, anything else DESTROYS your seed corn (real capital).
People will do WHATEVER they need to survive. Period.
I am well positioned to defend and run a planatation regardless of useless paper-pushers on wall street and their political puppets in D.C.
Many others are as well. Local politicians who want to live will in fact return to looking after local interests that can FEED them. Look at the idiocracy in Oregon right now. The whole thing is stupid, but none of those armed squatters have been removed, when the Feds can do that EASILY.
YES, you are correct, moral hazard is a real motherfucker.
Scooby loves to work. Just last week Shaggy and I got hired to solve a caper. We solved it in 4 days!
A rhoo-rhoo-rhoo Scobby Doo!
Speaking of working for a living - I think rural, semi-rural, and former military guys will have an edge - not in work, which will dry up, but in their vast knowledge of how to fix stuff, making things happen, find solutions. At their core they have the original American impulse for self-reliance and independence. They can hunt for food, be reliant on their own form of heat (logs), fix any damn thing (toilet, truck, furnace), and they know how to protect their family and property. They can grow food on their land. They have retained the proactive mindset. That alone, coupled with their desire to plan in advance, will put them in a much better position that the dependent masses.
That said, the blue collar guy and the rural guy who knows how to fix stuff will be in far more demand than the intellectual or office worker, when it call comes down. People who have critical stuff that gets broken will have to get it fixed (toilet backed up, car won't start, brakes don't work, etc.) This happened in Austria during hyperinflation - reading Pearl Buck's "How it Happens."
http://www.amazon.com/HAPPENS-Talk-About-German-People/dp/B000FYZH68/ref...
Big data services and the like will become even more important as companies and small business strive to find out where their best chances are in the market.
Sometimes you dont have to be faster than the bear. . .just faster than one poor SOB. In your hypothetical, you dont have to be a Green Beret. You can just prey on the REALLY stupids . . . until they perish, anyway.
the ability to protect what you have, or just get out of the way,will be quite valuable
Amen. Create value or go away. Financial engineers fuck off!
Who's going to save the world this time? We're allout of "Bernake Puts" Perhaps we'll get a "Yellen Yelp!"
Everyone will have to Tribalize and help out each other.
The only thing's gonna save US is US, We The People.