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Making the New Sub Prime – Part 1 – Backdoor to China

A little over a year ago in an article called “China’s New Revolutionaries”, I wrote,

I think the mistake everyone is making is to assume that because China is a ‘communist dictatorship’ this means the party must be in control. I think this is a dangerous assumption.

My point back then was that while the central bank was trying to reign in lending, the regional governments, banks and developers were largely ignoring the Central banks’ lending restrictions.  I looked at official versus academic estimates of the amount of debt that was swimming around in China’s economy and how little real control the Central bank appeared to have over it’s increase.

“… according to Shih and others the REAL level of Chinese debt could reach 96% of GDP by next year. The official IMF estimate is 22%. That 74% gap is the measure of how much the central government is NOT in control of who is taking on what debt.

My point is that we shouldn’t assume ‘China’ has a plan, or if it does, that anyone has any intention of following it. The era of absolute power of the party is over, but not because of students in Tieneman Square fighting for freedom of speech.

The new revolutionaries aren’t students and the revolution isn’t about a desire for democratic freedom. Those willing to challenge the party and ignore its decrees are the new aspirant middle class and they are driven by the desire to be rich.

Since then the evidence seems to me to have accumulated. Today I think we are seeing a major shift in power relations within China, a quiet revolution, in which the power to control China’s lending and debt is shifting away from Central government. What I think we are seeing is the opening of a financial backdoor to China. One that lies outside of Central Bank and Central Government control.

If I am correct then this will create massive changes within China – nothing short of the crowning of a new financial elite to contest control with the old political elite of Beijing – and for the rest of us it will create a new source of sub prime securities, this time made in China.

First we need to understand a little about power relations within China. The central government is concerned with national inflation and has been trying to reign in the lending and land speculation bubble that is, at least in part, driving that inflation. The Regional governments do not have this concern. At least not as their priority. Perhaps they should, but their actions say quite clearly that they don’t. Prudence is seen as a Central Government concern. Regionally, it is all about out-competing other regions to be the next new powerhouse of investment and development.

In all countries there are differences between regions/states and central government. In China, however, the regional governments have something regions in the West do not. They have huge untapped resources which they, not the central government ‘own’.  I put own in quotes because in theory everything is ‘owned’ by the communist party on behalf of the people. But on a practical level the regional government’s have control over and get the proceeds from selling off land in their region. If the central government elite tried to seize back control of or the revenue from regional land sales it would put the Beijing elite on a collision course with the regional elites throughout the rest of China.  Beijing would lose. So in practice the regions own the land.

The Regional elites are the party cadres, officials, bankers, developers and business people in each region.  Even developers who are nationally prominent have as much to gain from the regions as they do from Beijing, probably more.  In fact it is often the case  that economic prospects are seen as the gift of the regions while what comes from Beijing is mainly restraining laws.

The regions have land they want to privatize. The income from selling the land is the river of money from which each official, regional politician, developer, bureaucrat, banker and investor seeks to siphon their cup-full of wealth. What they all need in order to make it work is a developer who can buy the land, build on it and sell the properties on. For that the developer needs cash.  And that is where the central bank and government has been trying for over a year to exercise control by restricting the amount of lending Chinese banks can do. They have done this through raising interest rates and by raising the amount of capital the banks must hold against their loans. For 18 months it has just not worked. Now, however, the pressure may finally be working.

An article at Zerohedge recently reported that property prices in the Beijing area had plunged 27% and wondered if this was the first sign of the Chinese property bubble collapsing.  A further article reports that prices that had been rising even in February, suddenly dropped in March in a number of cities.  The article suggests this might be evidence that the tightening has finally had its effect on lending and debt.  And so it might.  In which case the Chinese regions will be looking all the harder for ways of getting  funding elsewhere and by unofficial means. If the flow of hot money from China slows it will also mean that Australia will soon be facing a property crisis.

Then, this last week we had the amazing spectacle of Wen Jiabao, the Chinese Premier, “asking” local governments to take responsibility to keep housing affordable and saying,

The central government’s aim to control the property market is “clear” and the determination is “firm,…”

Since when did Communist supreme leaders “ask”? And when did they feel it necessary to make their determination “clear” and “firm”?

The failure of the Central authorities to control the flow of loans, debt and money in to the Chinese economy for most of the last two years, is also attested to by how fast inflation is rising. A major part of inflation in China is the property bubble.

The question then, is what will now happen in the regions now that there may finally be a credit shortage from Chinese banks, and what does it have to do with Western banks and securitization?

Here is my suggestion.

On one side the regions have land to sell and developers who want to buy and develop it. What they both need is loans to finance the enterprise. The central government is doing its best to limit funding from those it has the power to regulate – Chinese banks and the few Western financial institutions that operate inside China. On the other side we have a Western Banking system which needs to find two things: a place or venture which will provide them with a higher return on their money than they can get at home, and a securitization system, essential to how the banks operate, which is in dire need of something to securitize.

Between the two is Hong Kong.  Western banks used to salivate over getting a licence to operate in China. But I think that dream has faded in to a background hope while dreams of China’s billions have gravitated to Hong Kong.

Why put up with all the interference from Central authorities inside China, when you can operate ‘outside’ of mainland Chinese regulations in Hong Kong? Hong Kong has always been the Asian portal in to the off-shore world of unregulated capital. When they took over, the Chinese did nothing to change that aspect of Hong Kong. Why shouldn’t China have its own off-shore conduit?  It’s like being a nuclear power – it gives a nation membership of a very exclusive club.

BUT, the offshore world is a franchise. Countries can have an outlet/inlet but that doesn’t mean they control it.  Hong Kong does not work primarily for China or the Chinese. Just as London does not work primarily for Britain or the British. Hong Kong works for the extra-territorial, supra-national interests of global capital, just like London, Jersey, The Cayman Islands and The Virgin Islands.  And there is the rub.

What is now, I believe, maturing fast in Hong Kong is a fully fledged off-shore, off-balance sheet portal into the world of shadow banking and unregulated, borderless finance.

Hong Kong now houses 148 international banks. The most recent to have been granted a licence is LGT Bank in Liechtenstein AG.  The nature of the bank and its arrival in Hong Kong are indicative.  The bank is the largest by Tier-1 capital in Liechtenstein and is one part of the LGT Group. The group is the largest private asset and wealth manager in Europe to be owned by one family. In this case the Royal Family of Liechtenstein whose head is the reigning monarch of Liechtenstein, Prince Johannes (Hans) Adam Ferdinand Alois Josef Maria Marko d’Aviano Pius von und zu Liechtenstein. Or just Hans-Adam II if you’re passing in the street and are in a hurry. The Prince is the main beneficiary of the bank and the entire trust. His personal fortune is estimated at £7.6 billion.

The bank has around 1900 employees in 20 locations which include all the major financial centres, plus Bahrain, Cayman Islands, Malaysia, Singapore, Uruguay and Hong Kong. The presence of the Cayman Islands in the list clearly indicates the bank has an interest in providing off-shore, no questions asked financing, tax evasion and full service banking secrecy.

Back in 2008 there was a furious row between Germany and the Liechtenstein royal family when Germany accused Liechtenstein of harbouring secret bank accounts for  up to 1000 of Germany’s wealthiest elite to help them evade up to €4 billion in German taxes.

It’s a wonderful little story. One of Germany’s intelligence services paid a former Liechtenstein banker for passing bank information about the accounts of German tax evaders to the German authorities.  Prince Alois, who was caretaker ruler of Liechtenstein at the time, and furious at his country’s and his bank’s secrecy laws being breached, was quoted as saying,

“Obviously Germany wants to be a big-time receiver of stolen goods,…”

Seemingly oblivious to the possibility that his bank was the receiver of ‘stolen’ German tax money. Anyway I digress. It would seem the bank thinks there might now be a call for its services in Hong Kong.

And I think they’re right. Chinese Banks want to lend even as they agree not to. Regional government officials want to sell land even as land already sold piles up. Developers want to develop more units even as millions stand empty. The answer to all these desires is the bond market in Hong Kong.

I’ll break here just to stop this getting too long.

In part two I will suggest that the People’s Bank of China, China’s central bank, has lost control and that the revolution has moved off-shore.

29 Responses to Making the New Sub Prime – Part 1 – Backdoor to China

  1. Pat Flannery April 16, 2011 at 11:10 pm #

    Golem: what you are describing underlines what is urgently needed: governments must start differentiating between traditional depository banks and non-depository shadow "banks". Nowhere is the need to establish this difference more urgent than in Ireland.

    Allowing national "banks" to operate as supra-national "banks", servicing supra-national global capital, defeats not only democratic governments but all forms of government. I look forward to your Part II if the Chinese experience.

    P.S. I was thinking of you yesterday as I got a two hour car tour of Tijuana by my Tijuana dentist. She is a third generation Tijuanian from an old and prominent Mexican family. She lives in the United States but practices in Mexico because she is a proud Mexican.

    I thought of you because she took me to places that the visitor never sees. She showed me the view from the other side of the border. It is chilling. She showed me shrines where locals have erected hundreds of white crosses on the border fence for those who died trying to cross into the U.S.

    I thought of you because I wished I had your film making talents. It would make a powerful BBC documentary film.

    I felt I was being shown a microcosm of the world economy, where the rich live in gated communities and the poor literally die to get over the fence.

    The U.S. and Western Europe are becoming two giant gated communities. The rich already live in gated communities here in Southern California. As a Realtor I am forced to do most of my business behind such "residential" gates.

    The economic gap is becoming more and more obvious every day. Hardly anybody owns their home in the neighborhoods any more. There is no home "owner-occupied" finance for the lower end of the residential sector but unlimited "investor" money for corporate landlords. All my clients are now corporate.

    The resultant fast-growing "Third World" reminds me of the tribes East of the Rhine and North of the Danube during the Roman Empire. We all know how that worked out.

    If we lose this "bank war" a repeat of Rome's collapse is inevitable. Just as with the Roman Empire it will be the "Third World" we are creating WITHIN our borders that will destroy us. We all know that Rome was destroyed from within.

    The double fence with its double layer of barbed wire on top, the swarm of armed border patrol vehicles the other side and the ominous helicopters overhead, will not keep the modern-day "barbarians" at bay – they are already inside our borders. That's why we have gated communities.

  2. nik April 17, 2011 at 2:46 am #

    Thanks for the interesting post – do you think the death sentence passed on Wu Ying has any relevance?


  3. StevieFinn April 17, 2011 at 10:50 am #

    Golem Great stuff, have been wondering about Chinas inner workings, would be one hell of a bang if they eventually crashed, a financial tsunami for the rest of us.

    Pat, I think you're right about the "gated communities" & I love the Roman Empire analogy.

    An interesting article concerning China & Gaddafi:-


  4. thrawn pop April 17, 2011 at 10:57 am #

    Interesting post – I've been wondering about China's relevance since reading those stories about ghost cities springing up and about how Chinese regional banks were all basically bankrupt as the result of all of this dodgy lending on real estate deals but were being constantly bailed out discretely by the Chinese authorities. Did I get that right?

    In passing, and off topic. Next time I hear Anne Atkins on Thought for the Day I'm going to break something. Just for everyone's memory: she was the Thought for the Day guest on 9 Nov 2010 and eloquently praised the "freedom" of the Chinese govt to provide stability without the bothersome business of elections. This was on the very day that Ai Weiwei was also being interviewed on the Today programme to explain that as an outspoken dissident artist he fully expected to get carted off sooner or later. Next time you hear Anne Atkins, please join me in flaming the BBC…

  5. richard in norway April 17, 2011 at 2:01 pm #


    I was getting worried by your absence, good to see you back, I hope all is well with you

    Now i'll read your post

  6. The MacPuddock. April 17, 2011 at 2:46 pm #

    i flamed the BBC some time ago. i.e. abandoned it as a source of information and fair comment. Today was the last refuge of someting like reasonable reporting but it was gutted after the Gilligan/david Kelly affair.
    I have also detected some developments in the guardian lately that undermine its credibility.

  7. Golem XIV - Thoughts April 17, 2011 at 2:56 pm #

    Hello Richard,

    Thanks for asking. And thanks for putting up with the long silences. Things are difficult. Just at the moment I can't concentrate as much as I would like to. But I am still here, still wanting to contribute.

  8. richard in norway April 17, 2011 at 9:43 pm #


    no worries

    i wonder if the Finnish election result is going to make the bond markets hyperventilate, they had a little panic on Friday. the Greeks are going to default before the summer without a doubt which will cause problems for Hungary which in turn will cause problems for our friends at uni-credit. it's going to be a long hot summer

  9. brucibaby April 18, 2011 at 9:17 am #

    10.000 protest Hungarian austerity. The protesters mainly from Fire/Police. There are eruptions taking place across Europe against savage cuts, rising unemployment and rocketing inflation. Very little reporting by MSM. Don't want to scare the horses.

  10. Whistleblower IRL April 18, 2011 at 10:55 am #


    I know this off-topic re the post above, but here is some breaking news from Ireland:

    Moody's cuts Irish banks to junk – Irish Times, this morning's breaking news

    "Rating agency Moody’s has downgraded long-term deposits at Irish banks by two notches to junk status. This follows last week’s cut to Ireland’s sovereign debt rating by the agency. Today’s move means Bank of Ireland is now rated Ba1 while AIB , EBS and Irish Life & Permanent are rated Ba2. The outlook on the long-term bank deposit and unguaranteed senior unsecured debt ratings of these institutions is negative, the agency said…"

    Accounting procedures flatter UniCredit Ireland’s performance – Kathleen Barrington in yesterday's Business Post

    "…UniCredit Bank Ireland has, by its own admission, endured a difficult period for liquidity, and was among the banks that availed of emergency amendments to accounting rules introduced in October 2008 at the height of the financial crisis…

    Writing in the annual report, chairman Ronan Molony said the significant turmoil experienced in 2008 and 2009 continued in 2010, culminating in Ireland accepting the bailout in November.

    This had a negative affect on UniCredit Bank Ireland’s funding costs.

    … the notes to the accounts reveal that the continued use of the emergency accounting treatment flattered the company’s reported profit figure by €63 million in 2010.

    … Elsewhere, the accounts show that there was a €344 million reduction in the value of certain assets which were available for sale during2 010.However, this reduction has been written off against shareholders’ equity rather than to the profit and loss account, a move which accountants say is entirely legitimate, but which also flatters headline performance.

    It is true that UniCredit’s performance at group level continues to appear stellar when compared with the performance of our own Irish banks…

    But there are concerns that the bank’s expansion into eastern Europe, and elsewhere, may lead to greater loan losses in future, which would require the bank to raise new capital. This has been reflected in a fall in UniCredit’s share price over the last few years…

    UniCredit then controversially accepted funding from the Libyan dictator Muammar Gaddafi’s Libyan Investment Authority.

    The decision to accept those funds contributed to the loss of shareholder confidence in UniCredit chief executive Alessandro Profumo, who was ousted last year. It has proven even more embarrassing now that Gaddafi’s own people are in open revolt against his rule.

    There have been repeated suggestions that UniCredit may be forced to raise new capital either through asset disposals or fundraising.

    Among the assets that might be disposed of is Pioneer Investments, its IFSC-based fund management division…

    UniCredit Ireland's EX Risk-Manager

  11. Hawkeye April 18, 2011 at 12:41 pm #


    Is this punishment for Ireland threatening to give the bond holders a haircut?

  12. Fungus FitzJuggler III April 18, 2011 at 1:05 pm #

    On China. Mao has foreseen this: "All power comes from the barrel of a gun!" The PLA controls China. Forget about anything inside, as you rightly point out, much capital is leaving, but that is not borrowed from Chinese sources, they are merely "feathering their nest". If an oligopoly is threatened, I expect them to be disappeared. China is a special place, by no means infallible.

    On Ireland. The facts are pushing reality into the markets. The hidden debts are revealed every few weeks and the consequences of interest rate rises are obvious.

    PIMCO has divested from certain fixed interest items …. Uni Texas pension fund is taking agency physical delivery of 1Bn in gold…… Things are speeding up!

  13. John April 18, 2011 at 5:30 pm #

    Golem, great post. I think your analysis of the situation in China is spot on. I have lived next door to China for 11 years, where the situation is very similar. The regions are fiefdoms and often ignore diktats from the centre. This is tolerated as long as "respect" (money) is passed up the line.

    Here is a nice piece on "Off-shore" by David Runciman in the LRB. http://www.lrb.co.uk/v33/n08/david-runciman/didnt-they-notice

    Looking forward to part II

    Your work is much appreciated.

  14. princesschipchops April 19, 2011 at 9:25 am #

    It seems like its all 'kicking off' these last few days. Increasing jitters about Greece. Hungary protests. The Finnish election results and now the US on a debt warning. First time since Pearl Harbor. That has got to cause some major market fluctuations.

    I don't think Greece can keep going much longer as it is. But who knows just how much pressure will be brought to bear to make sure they do?

    Golem it is good to see you still posting. I have checked in a few times but not been posting myself much recently. This is still one of the few places I always check for a view of what is really happening.

    @PatFlanner – wonderfully insightful comment Pat if you don't mind me saying. Especially this: ''If we lose this "bank war" a repeat of Rome's collapse is inevitable. Just as with the Roman Empire it will be the "Third World" we are creating WITHIN our borders that will destroy us. We all know that Rome was destroyed from within.''

  15. Pat Flannery April 19, 2011 at 6:10 pm #

    Princesschipchops: I love your name but you are too kind in your comments. The main thing is that Golem attracts thoughtful people like yourself to his blog which makes it a great forum.

    The Roman Empire analogy may be a little over the top but not entirely. I carefully watched Enda Kenny's speech to Bloomberg in London yesterday. It was obviously crafted by the Irish Government to assure the international capital markets of Ireland's continued fidelity.

    While Enda may not have much choice in the matter he is clearly relying on an "export-led" recovery. This means relying on the giant multi-nationals like Intel and Google who now seem to own Ireland.

    The Irish Government will publish its much anticipated jobs creation program next month. Will it continue to cater to the multi-nationals at the expense of indigenous enterprise?

    The political danger for Ireland is not loss of sovereignty to the EU but loss of sovereignty to the multi-nationals.

    To continue the Roman analogy the multi-nationals are equivalent to the great Roman families whose privileges destroyed its middle-class. Rome was great while it had a middle class but a culture of dependency on a few great families destroyed that core and eventually led to the Fall.

    An Irish "export-led" recovery will surely create an Irish culture of dependency on the multi-national corporations – if it hasn't already happened. This spreading culture of dependence on a few giant multi-national corporations like WalMart, Google, Intel etc. is too reminiscent of the concentrations of power that destroyed the self-reliant plebeians and precipitated the Dark Ages.

    The current Irish middle class, descendents of the tenant farmers who defeated English landlordism in the "Land War", may turn out to be the battleground of the "Bank War".

  16. dave from france April 19, 2011 at 7:06 pm #

    John's 18.30 link to David Runciman at the LRB is worth a look.

    " In that sense, Washington has gone offshore: its politics has been captured by the interests of a narrow group of very wealthy individuals, many of whom work in finance. For Hacker and Pierson this, more than anything else, explains why the rich have got so much richer over the last 30 years or so. And by the rich they don’t mean simply the generally wealthy; they mean the super-rich. The real beneficiaries of the explosion in income for top earners since the 1970s has been not the top 1 per cent but the top 0.1 per cent of the general population. Since 1974, the share of national income of the top 0.1 per cent of Americans has grown from 2.7 to 12.3 per cent of the total, a truly mind-boggling level of redistribution from the have-nots to the haves. Who are these people? As Hacker and Pierson note, they are ‘not, for the most part, superstars and celebrities in the arts, entertainment and sports. Nor are they rentiers, living off their accumulated wealth, as was true in the early part of the last century. A substantial majority are company executives and managers, and a growing share of these are financial company executives and managers.’"

    Very much on topic !

  17. RichGB April 20, 2011 at 8:02 pm #

    Hi Pat Flannery and Princess Chip Chops

    Continuing the theme '"What Did The Romans Do Like Us", I came across this chilling paragraph from Tactitus' historical record of the Roman Senate for the period A.D. 32 to 37:

    "Meanwhile a powerful host of accusers fell with sudden fury on the class which systematically increased its wealth by usury in defiance of a law passed by Caesar the Dictator defining the terms of lending money and of holding estates in Italy, a law long obsolete because the public good is sacrificed to private interest. … Subsequently, by a bill brought in by the tribunes, interest was reduced to half that amount (to 5 per cent), and finally compound interest was wholly forbidden. … In their dismay the senators, not one of whom was free from similar guilt, threw themselves on the emperor's indulgence. …
    Hence following a scarcity of money. a great shock being given to all credit, the current coin too, in consequence of the conviction of so many persons and the sale of their property, being locked up in the imperial treasury or the public exchequeur. To meet this, the Senate had directed that every creditor should have two-thirds of his capital secured on estates in Italy."

    Tacitus goes on to describe how property prices fell and many creditors were threatened with ruin, until Tiberius stepped in with – you guessed it – a bail-out, worth a hundred million sesterces.

    The Annals of Tacitus is a rather dry read, until you find parallels in history like this.

    Here is a link to feed 24K's craving: Tacitus

    Robolink is back and still angry.

  18. Golem XIV - Thoughts April 20, 2011 at 8:42 pm #


    WELCOME BACK! 24k and I have been worying about you behind your back.

  19. RichGB April 21, 2011 at 11:32 pm #

    Hi Golem

    Yes, I'd heard that 24K was suffering withdrawal symptoms, from images of brothers' faces smothered in chocolate. "No 24K. You shouldn't say that! Otherwise, hard working public sector workers will be offended."
    (My apologies are tendered to bemused newcomers to this forum for this 'David Lynch style' interlude.)

    The stark reality of this forum (et al) had a detrimental effect on my work-a-day job, forcing me to take a break for a while, and a lesson in time-keeping.
    The boss (me) says I can now kowtow with people possessing innate and unnerving common-sense of what is good for the future of humanity (Western, at least); which, according to Max Keiser and his minions, can only be Company Golem XIV. I'm proud to remain a camp follower, albeit recently subdued.

    It would be rude not to interject a link at this point in the diatribe – here is an example of a country re-discovering the basics of capitalism: Cuba.
    Hopefully, they'll learn by the mistakes of Wall Street and the Square Mile.

    Fair trade. Fair do. Bare face fronting openly, mutually beneficial exchange of goods, be it half a kilo of cassava root or tickets for a Lady Gaga concert. Let's hear it for the entrepreneur and small, private traders!

  20. Fungus FitzJuggler III April 24, 2011 at 2:17 am #

    Golem, thanks for your kind sympathy, but life goes on.



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