BofA Notices Something Troubling: China's Debt Bubble Has Burst

It was just a few days ago when we covered most recently that China has created a subprime debt bubble of monstrous proportions. We explained that the exposure isn’t just within the conventional, state-backed banking system, but also within their "wild west" shadow banking system, which has introduced "investors" to a significant amount of risk. 

We know that it’s not a question of if, but when will the bubble finally pop (and as we show below, it already has) and introduce a new subprime (and debt in general) financial crisis for the world to deal with.

While it is sometimes difficult to get the data around just how significant a problem NPL defaults have become for China, and more specifically how the shadow banking lenders are faring, Bank of America has done some work to help give clarity around just that.

As BofAML shows below, defaults in the shadow banking sector have accelerated sharply, growing in both size and volume since late 2011.

And just like that, the relaxed credit policies in China, in their desperate desire to reinflate housing prices and stimulate the economy, have created a significant issue for the central planners to contend with , one which seems to be a recurring theme... Needless to say, the government is now scrambling to both suppress the number of defaults, and companies are even taking drastic measures to not have to report that they’re insolvent, but it may be too late.

Because as the chart above clearly shows, China's debt bubble has officially burst. It's all downhill from here.

BofA's David Cui explains:

We have noticed a sharp jump since mid-2015 in the total value of reported defaults of shadow banking products, defined here as non-bank-loan debt instruments that include bonds, trusts, and credit products offered by peer-to-peer (P2P) and various offline wealth management companies (WMCs). While the government and some involved parties are busily trying to suppress defaults, risk exists that at certain point the scale and scope of the task may overwhelm their efforts; which may trigger a credit crunch, in our view. Although the exact timing is difficult to forecast, as defaults pile up, the risk of the debt market reaching a psychological turning point should keep on rising by our assessment.


Chart 1 (above) shows the trend of defaulted value in the shadow banking sector, based on data we gathered on noticeable default cases since late 2011 as reported by the media. As of June 2015, the accumulated amount was Rmb53bn; by now, it’s reached Rmb214bn.


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The government is clearly concerned about the risks in shadow banking. Just today, it’s reported that 1) NDRC had called upon issuers and underwriters of enterprise bonds to assess default risks; 2) the Shanghai municipal government had stopped registration of new WMCs, and will review certain existing ones; 3) the Asset Management Association of China (AMAC) will announce rules by the end of Apr to help investors identify illegal fund raising activities by privately raised funds; and 4) CSRC may require brokers to include their off-balance sheet businesses, including derivatives, in their risk assessment, including leverage. The question is whether the government is closing the stable door after the horse has bolted. We suspect that the answer is yes.

One couldn't make it any more convoluted, opaque and sadly, entertaining (for when it all unravels) if one tried.

It sounds like an enormous storm is brewing, and once again it’s a direct result of central planners convinced they know best not only how to run an economy, but that they will be able to fix everything once what is China's most historic debt bubble ever, burst. 

Or maybe, what we are told by overeager 17 year old hedge funds is true, and this time it’s different.