Reuters Goes To China, Discovers "Ghost Collateral"

Tyler Durden's picture

Back in 2014, a scandal erupted when media reports confirmed what many had previously speculated about China's banking system: namely that much of China's staggering loan issuance had been built (literally) upon air and that billions (or trillions) in loan collateral had been "rehypothecated" between two, three or many more debtors - or never even existed - forcing banks to accept that they would never recover much if any of the pledged collateral - in most cases various commodities - if the economy were to suffer a hard-landing resulting in mass defaults. The most famous example involved collateral fraud at China's 3rd largest port, Qingdao, where numerous borrowers were found to have "pledged" the same collateral of steel and copper to obtain funding from various banks.

For those unfamiliar there is an extensive selection of stories covering the topic, which peaked three years ago, and then quietly faded away as China did everything in its power to deflect attention from what some have said is the biggest threat facing its economy: a giant hole . Below we link to some of our more comprehensive articles on the topic:

To be sure, the story briefly resurfaced last month, when we reported that "Some Chinese Banks Suspend "Interbank Business" As Regulator Demands That Collateral "Actually Exists", however it then quickly  fizzled again, for two reasons: i) China watchers assumed that Beijing no longer had a "collateral problem" which had been somehow fixed after all the noise rehypothecation stories from in 2014, and ii) China now seemingly has even bigger problems on its hands, such as finding the right balance between maintaining the latest housing bubble, keeping capital outflows in check and its currency stable at a time when China's debt (all 300% of GDP) was downgraded by Moody's for the first time in 28 years, while its gargantuan shadow debt powder keg is one big red headline away from a $9 trillion shadow bank run.

And while the latter is certainly accurate, the former couldn't possibly be further from the truth.

That's what a fantastic expose by Reuters discovered, when its reporters went to China to determine the current status of China's long-standing collateral problem. What it found was that "ghost collateral" continues to haunt countless loans across China's debt-laden banking system, which is a problem because as we explained in 2014, and as Reuters notes "lax lending practices and overvalued collateral spurred the U.S. financial crisis in 2008. Now, banks in China face risks of their own as fraudulent borrowers and corrupt bankers burden the financial system with loans lacking genuine collateral."

The story, while familiar to regular readers, may be a surprise to some, so here are some key excerpts.

The banker at the other end of the phone line was furious, recalled Shanghai lawyer Wang Chaoyu. A pile of steel pledged as collateral for a loan of almost $3 million from his bank, China CITIC, had vanished from a warehouse on the outskirts of the city. Just several months earlier, in mid-2013, Wang and the banker had visited the warehouse and verified that the steel was there. “The first time I went, I saw the steel,” recalled Wang, an attorney at Beijing DHH Law Firm, which represents the Shanghai branch of CITIC.

 

“Afterwards, the banker got in contact with me and said, The pledged assets are no longer there.’”

As Jon Corzine might say, "it vaporized." 

The trouble had begun in 2012, after CITIC loaned the money to Shanghai Hanning Iron and Steel Co Ltd, a privately held steel trader. Hanning failed to meet payments, according to a mediation agreement reviewed by Reuters, and CITIC took ownership of the steel. It was when CITIC moved to retrieve the collateral that the banker visited the warehouse and discovered that the 291-tonne pile of steel was no longer there, Wang said. The bank is still in court trying to recoup its losses.

 

The missing collateral is a setback for CITIC. But it is indicative of a much wider problem that could endanger the health of China’s financial system – fraudulent or “ghost” collateral. When bank auditors in China go looking, they too often find that collateral recorded on the books simply isn’t there.

At risk of spoiling the surprise, what has been going on in China, either in conventional asset-backed lending, as well as among the more esoteric, complex commodity-funded deals, which we discussed extensively in the early part of 2013...

 

... is nothing less than pure fraud: in some cases, collateral that has been pledged simply doesn’t exist. In others, it disappears as borrowers in financial distress sell the assets. There are also instances in which the same collateral has been pledged to multiple lenders, i.e. rehypothecated. "One lawyer said he discovered that the same pile of steel was used to secure loans from 10 different lenders" Reuters reports.

And while China was able to brush off its "ghost collateral" problems three years ago when it still had substantial debt incurrence capacity, and debt/GDP was about 100% lower, now that it is becoming increasingly difficult to keep the Ponzi scheme - by definition - running, especially with the recent crackdown on shadow banking, the pervasive collateral problems are about to become a huge headache for Beijing again: with the mainland facing its slowest growth in over a quarter of a century, defaults are mounting as borrowers struggle to repay their loans.

The danger of fraudulent collateral in this situation, say economists, is that it exacerbates the problem of bad debt for China’s banks, increasing the risk of financial turmoil.

 

As growth slows, lenders can expect more nasty surprises, said Xin Qingquan, professor of accounting at Chongqing University. More instances of fake collateral will arise, he said.

Things were going fine until May 24, when out of the blue Moody’s downgraded China’s credit ratings for the first time in almost three decades, saying it expects the financial strength of the economy will erode in the coming years as economic growth slows and debt continues to rise.  Naturally, the last thing China needed was the unexpected spotlight on its breathtaking debt load, and the excess scrutiny outside on what is for all intents and purposes, the world's biggest debt bubble.

Ironically, the US already learned its lesson almost a decade ago that any financial system is only as strong as its weakest collateral: the 2008 global financial crisis showed how the combination of lax lending standards and overvalued collateral can lead to disaster. The catalyst for that meltdown was the collapse in the value of housing in the United States that served as security for a mountain of highly leveraged lending, the so-called subprime mortgages. Now, banks in the world’s second-biggest economy face their own collateral risks. Fraudulent borrowers, corrupt bankers, poor risk assessment and a weak legal system are conspiring to load China’s financial system with loans lacking genuine collateral.

* * *

But back to Reuters, whose reporter Engen Tham writes that his review of dozens of court cases involving collateralized loans and interviews with lawyers, regulators and 30 bankers in China "reveal that fraudulent collateral – in the form of buildings, private apartments, copper and steel – is haunting loans across a wide swath of business and industry."

The bankers interviewed by Reuters said they had encountered multiple methods by which loans were fraudulently secured, including the use of fake land certificates and bogus warehouse receipts. Most of the bankers said that kickbacks were prevalent, with loan officers turning a blind eye to the quality of collateral and knowingly accepting dubious and even fraudulent documents. Two of the bankers said they themselves had taken bribes to smooth the approval of loans.

Overall, 23 of the 30 bankers described the existence of ghost collateral as a serious problem and expected more instances to emerge as the Chinese economy slows. The bankers interviewed come from 13 banks in China, including some of the nation’s biggest lenders.

"HUGE ISSUE"

There are no official statistics or estimates of the problem. But fraudulent collateral is “a huge issue,” said Violet Ho, senior managing director and co-head of Greater China Investigations and Disputes Practice at Kroll, which conducts corporate investigations on the mainland. “Often you also see that the paperwork around collateral may be dodgy, and the bank loan officer knows, the intermediary knows, and the goods owner knows – so it’s essentially a Ponzi scheme.”

Making matters worse for China is that its financial system is only fractionally less corrupt than its legal system.

Even when banks resort to the courts, there’s no guarantee they’ll get their money back. Inadequate legal protections for collateral and the complexity of some borrowers’ business dealings can make it difficult for lenders to foreclose. That’s what happened to CITIC after it made the $2.71 million loan to Hanning Steel. When Hanning defaulted, CITIC won a court order freezing the collateral, after which the parties entered into mediation, lawyer Wang Chaoyu said. But the collateral is still missing.

In response to questions from Reuters, CITIC said that the case was still being enforced in the courts and that it had since strengthened its risk management procedures. Representatives of Hanning did not respond to questions. When Reuters visited Hanning’s registered Shanghai address, there was no sign of a company office there.

Meanwhile, total debt in China rose to 277% of GDP at the end of 2016, according to UBS, and 300% according to the IFF. That’s twice the figure eight years ago.

Additionally, bad loans are mounting fast: while officially, just 1.74% of commercial bank loans were classified as non-performing at the end of March most analysts admit the true figure is much higher. Recently Fitch Ratings estimated non-performing loans in China’s financial system could be as high as 15 percent to 21%, or trillions of dollars. This in a banking sector that has undergone a massive credit expansion. The value of outstanding bank loans ballooned to $17.2 trillion at the end of April from $5.8 trillion at the end of 2009. The total size of China's financial system is roughly $35 trillion, more than double the size of the US. In September last year, the Bank for International Settlements warned that excessive credit growth in China meant there was a growing risk of a banking crisis in the next three years.

In a report last September, Fitch Ratings estimated that it would cost as much as $2.1 trillion to clean up China’s bad debt – almost a fifth of annual Chinese economic output. According to our estimates, the number was substantially higher: nearly $8 trillion. By comparison, during the global financial crisis, the direct cost of rescuing U.S. banks was about eight percent of gross domestic product.

Adding to the problems is the implied assumption of virtually infinite moral hazard within China's financial system: the fact that China’s banking system has been shielded by the expectation of government bailouts means lenders haven’t developed the risk assessment tools needed to judge loan exposure as banks elsewhere have. It is this challenge of assessing the creditworthiness of borrowers that explains why physical collateral is so important for banks in China.

QINGDAO

As we reported first three years ago, big foreign (or domestic) banks have not been immune to the risks of fraudulent collateral. In a high-profile case that came to light in June 2014, banking giants including HSBC, Standard Chartered and others were exposed to potential losses totaling several billion dollars on loans to Decheng Mining, a private metals trading company in Qingdao. The company faked warehouse receipts for the same batch of metal, using it as security for multiple loans. 

To be sure, it’s not hard to dupe bankers and lawyers in a physical inspection of collateral. Warehouses often contain hundreds of piles of steel or copper, making it difficult for an untrained observer to identify the specific pile that is serving as security for a loan their bank has issued. “One pile of iron ore looks exactly like every other pile of iron ore, so I may say it’s mine, but it could be anyone’s,” says Kroll’s Violet Ho.

The value and quality of security in China’s real estate sector is a concern for bankers in China. Fitch Ratings has mentioned "wildly misleading" property valuations as one reason why high collateral coverage may not protect banks. Another is a sudden fall in property prices. According to Fitch's Grace Wu, over 60 percent of financing in China uses property as collateral in some way. 

 

The lack of a consistent and open nationwide property registration system also increases the prevalence of fraudulent collateral.

“There is a complete lack of transparency of information,” says Ho. The United States, she notes, has open property records that buyers can search to ascertain the true owner of a building. “You can’t do that in China. There is no easy way to verify the information, so you have to take people’s word for it.”

"DEAD PIGS AREN'T AFRAID OF BOILING WATER"

Bankers say borrowers often provide them with fake cash-flow statements, so property buyers can be more leveraged than they appear. The falsification of mortgage certificates is also a problem, they say.   That’s how the International Finance Corporation (IFC), the World Bank’s investment arm, got taken for tens of millions of dollars by one of China’s richest men.

As Reuters describes this fascinating story, the deception began in 2007, after the IFC lent the money to Hong Kong-listed Zhejiang Glass Co Ltd, then owned by Chinese tycoon Feng Guangcheng. Two years later, the IFC made an unpleasant discovery: In discussions with other banks it found that the collateral for the IFC loan had also been pledged to other lenders, according to a person with direct knowledge of the case. Anxious IFC officials hurriedly dispatched lawyers to the land and company registration authorities in Zhejiang Province, where they made another startling discovery: The stamps on the mortgage certificates for the land, properties and industrial machinery used to secure the loan were fake, people familiar with the case said.

Concluding they’d been swindled, IFC officials traveled to the eastern city of Hangzhou in late 2009 to confront Zhejiang Glass’s chairman. Feng, who sat at the head of the table with a junior by his side, didn’t want to dwell on the loan, recalled one person who attended the meeting. He admitted right away that the documents were fake and quickly tried to move the discussion along.

“His attitude was, ‘Dead pigs aren’t afraid of boiling water’,” the person said, using a Chinese proverb to describe Feng’s attitude: Any attempt to punish him was futile because the loan was already lost.

In 2010, a court ruled that Zhejiang Glass should repay the loan to the IFC. That never happened. In 2012, local media reported that Feng was convicted in a separate fraud case and was sentenced to eight-and-a-half years in prison. The company was declared bankrupt the next year and delisted in Hong Kong. Ultimately, the IFC recovered only 2 percent of its loan, according to a person familiar with the case. In response to questions from Reuters, the IFC called the case an isolated incident related to the larger fraud perpetrated by Zhejiang Glass.

One thing is 100% certain: there are hundreds if not thousands Feng Guangcheng in China, pledging the same collateral multiple times, ultimately putting banks on the hook for billions in losses.

INSIDE JOBS

Sometimes it is the banks themselves who are facilitators of collateral fraud. In 2015 the former vice president of Agricultural Bank of China Ltd, Yang Kun, was sentenced to life imprisonment for accepting bribes of more than 30 million yuan ($4.4 million) in connection with loans, among other things, according to local media reports.

In another case from 2015, a 37-year-old man named Lou Zhenshen, who controlled a trading company, was convicted of bribing the president of a branch of CITIC Bank with 50,000 yuan (about $7,250) in cash and supermarket vouchers worth 10,000 yuan. According to court records, the judge said Lou had used fake warehouse receipts to apply for loans and had repeatedly used the same metal as collateral. Lou was also convicted of paying a 200,000 yuan bribe to a credit officer at China Minsheng Bank.

While “kickbacks for loan approvals is routine,” said Gary Tian, a professor at Macquarie University in Sydney who has researched corruption and bank lending in China, "near-infinite rehypothecation" of the same collateral - as Goldman explained it several years ago - however is not.

So are China's collateral problems fixed...

CITIC Bank said that in the past two years it has focused on managing employee behavior, strengthening accountability and raising the cost for employees who violate rules. Still, more than three years since lawyer Wang Chaoyu took the phone call from the incensed CITIC banker about the missing collateral from Hanning Iron and Steel, the lender is still trying to get back some of its money. CITIC is now trying to sell several apartments that were put up as part of the security for the ill-fated loan.

... or is it just getting started?

Four years ago we called China's collateral fraud "a Bronze Swan." As Reuters has discovered, contrary to conventional opinion, nothing has been fixed and the problem remains however it has been deftly swept under the rug of trillions in new debt as China's ponzi scheme continues to grow. And yet, if and when the day comes that the Chinese debt creation machinery grinds to a halt, or - worse - goes into reverse, that's when all the abovementioned problem, which we contend are the weakest link in China's financial system, will re-emerge, prompting the world's most furious scramble to recover collateral first. It will also be the catalyst that finally tips China's financial system, which for years now has been in the ponzi finance phase, over into the inevitable, and terminal, "Minsky moment."

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Killtruck's picture

It's probably nothing...

JRobby's picture

Collateral is so passe in this new fast moving world of finance

Jim Sampson's picture

Collateral is like having a high P/E, no one gives a fuck.

nuubee's picture

What's the chinese phrase for counter-party risk? CCP?

BaBaBouy's picture

Speaking Of "Ghost Collateral"

What Do you think the CB's Do With Phys GOLD ???
It's here, its there, Then its NOwhere ...

Gonzo ...

nope-1004's picture

This is the natural evolution of a debt system fully saturated and done.

When a credit system is failing and requires more debt and credit just to stay afloat, possession and colateral become secondary and theft is rampant.

Witness all commods.  Hang'em all.

Ghost of Porky's picture

Corraterar? What corraterar?

new game's picture

chinese counter party risk defined as: a ghost of the ghost in a ghost city.

and i thought elvis had left the building.

hmmm.

doz sneaky china man.

house of fiat bout to blow away.

lol, lmao

fed smed, moar lmao.

lol in distance as "not give two shits dude" walks away....

Beam Me Up Scotty's picture

Sounds like the gold market.  Sell over 100 paper ounces of gold for each physical ounce of gold in existence.  Hell, if they only are at 10 loans per pile of steel, they are way ahead of gold.  They can take out loans on that pile another 90+ times before anyone should get too nervous......

gladih8r's picture

Come on guys.  Maybe it just rusted into the dirt.  Dig it up again, refine it, turn it into rebar and let it sit on a skid behind a fence again.....then something, something..... and bingo: profit.  I don't know if I'm being sarcastic here or wtf.  It's friday.

froze25's picture

So what people are finally realizing that Chinese companies have been playing musical chairs with their collateral? I guess the music is stopping.

mdr attitude's picture

Chinks are the kikes of the East.

Always trying to swindle when doing business.

Must be the penial inferiority complex.

Jews, Multiculturalism, and the War on Free Speech


beemasters's picture

“Afterwards, the banker got in contact with me and said, ‘The pledged assets are no longer there.’”

A banker got swindled. What a sad story.

ShorTed's picture

...aaaaaaaaannnnndddd it's GONE!!

tmosley's picture

Slanteyes trading soon to be gone Yuan for Bitcoin and Co.

Roundeye can rearn resson.

Kotzbomber747's picture

Really? The Chinese cheat? You don't say...

So much for all these ZH fanboys who are hoping that China will somehow introduce a gold-backed Yuan... Better count every single ounce, kilo, ton of that supposed 'backing' should it ever occur.

By the way, I'm wondering: are these 'China gold fans' the same people that are fans of Trump?

jeff montanye's picture

another consideration is that, in a pinch, should some of the lenders get their hands on some of the collateral, they would likely sell it to increase their own liquidity.  this in turn is likely to drive down commodity prices, perhaps making other loans default, etc. . . . .

NotApplicable's picture

Well, it's not like they were lending real money, anyway.

toady's picture

This reminds me of a story from back in the day. I was working at T as a contractor and the guy running the contracting company just disappeared with all the money. No paycheck for over a month.

The guy was supposed to be a big shot in India, had a state of the art data center and call center in Mumbai or something... very outstanding reputation.... so they finally got someone on the ground in India and there was a giant hole in the ground where the data center/call center was supposed to be.

That's when T finally gave up and issued all the back pay and moved everyone to new contracting companies.

The last time the dude was seen was in the canary islands headed east. It's estimated he Madoff with between 10-15 million. 

TuPhat's picture

There are no China gold fans on ZH.  There are gold fans but what is a 'China gold fan', please?  You just make up a fake category and then criticize it or what?

Creative_Destruct's picture

(Viva Southpark!!!)

"This is the natural evolution of a debt system fully saturated and done." (nope-1004)

Yep, BUT remember, now that Trump has "abdicated US leadership" in the magical GHOST world of the "alternative energy economy" China will take the mantle of economic leadership using its GHOST collateral to finance moar & moar wonderous unscalable GHOST alt energy prods to pimp to the world.

chunga's picture

Heads up, ^^^ this mdr attitude turd is a bald-headed Michael Moore, tittilated by fake web page visits to dailywestern malware site.

It has ~ 50 fake ZH accounts but it likely just one guy, smudged with dried mustard, jelly.

dailywestern site reportedly loaded with malware

Kotzbomber747's picture

It could very well be that dailywestern has malware, but he still has a point though about the Chinese being gigantic swindlers.

Most people here never been to China, so to them it's something exotic and they believe all the bullshit about them being the all-knowing Zenmasters. They ain't...

I've said it lots of times before, but all the Chinese can do is copy (i.e. fake) the west; copy DVD, fake bags, copy software, sell fake iPhones, Imitate western cars, copy the housing bubble, copy the debt bubble etc.

shovelhead's picture

"You make loan 10 million Yaun. I give you paper say I own Montana USA.

Big, very big, no pwoblem. You loan, yeah?"

Lonesome Crow's picture

"Sounds like the gold market. Sell over 100 paper ounces of gold for each physical ounce of gold in existence."

Is this different than any other futures contracts? Stocks, bonds, oil, sugar?

land_of_the_few's picture

Also, isn't 290 tonnes of steel pretty paltry amount as collateral for 3M dollar loan? Because:-

1 It is not worth more than 200,000 USD whatever way you look at it. Possibly half that or less.

2 I've seen mobile roadgoing cranes that weigh nearly that much and no-one is paying 3M for those as scrap steel, not really a huge pile.

Yes, a car only weighs 1.something tonnes so it seems like a lot of cars in 290 tonnes but they are nearly paper-thin (ok heavy card 0.8mm) and contain mostly designer air.

CNONC's picture

I had the same thought.  Article suggests some other property was pledged as well, but the steel could not have covered more than 10% of the loan.  At current prices, maybe 4%.

Just Another Vietnam Vet's picture

Corraterar ...   Oh, it ovar dare !!     No ?    den ovar dare, mabe.

peopledontwanttruth's picture

China learned well from the West and especially the bankrupt USA. I don't see China as a economic threat. Iran and Russia will be emerging as economic strongholds. Low debt and tons of resources. They've done very well being in the storm with sanctions all these years.

man from glad's picture

I'm looking forward to the "Big Short II" movie starring Jackie Chan and Jet Li.

ThirteenthFloor's picture

Aw what the hell is a little collateral damage here and there
Nothing the US hasn't done a few times around the globe

Arnold's picture

Mortgage Backed Securities.
Good as gold.

Lost in translation's picture

All of my collateral is at the bottom of Lake Powell.

Oops.

TuPhat's picture

You shouldn't tell anyone where it is. 

Giant Meteor's picture

Meh, the China miracle, behold ......

divingengineer's picture

Collateral, and by extension, deficits, don't matter.

order66's picture

Just like the Santander fraud in Subprime Car Loans, they only verified income on 8% of borrowers they packed into those bonds. Holy shit.

https://www.bloomberg.com/news/audio/2017-05-22/bloomberg-s-scully-on-sa...

W....T.....F?

Lumberjack's picture

And who runs Santander sub prime loans???

https://www.wsj.com/articles/santander-taps-former-j-p-morgan-official-b...

Former J.P. Morgan Chase & Co. executive Blythe Masters has been appointed nonexecutive chairwoman of Santander Consumer USA Holdings, the subprime auto lending unit of the Spanish banking company.

---yup, the queen bee of the carbon tax---

new game's picture

requirement met: a pleb to sign and drive. lol.

Arnold's picture

She gets around, jack.

GunnerySgtHartman's picture

Nothing to see here, no different than notional gold.  Eat, drink, and be merry!

xrxs's picture

 That's what I thought.  They rehypothecated the collateral? How innovative.

onewayticket2's picture

agree....this is the same as those "INTANGIBLE ASSETS" the fed was using years ago....

Arnold's picture

Monetizing good will where ever we go.

Apocalicious's picture

What do you call it when your collateral value is zero? No asset covfefe.