BofAML: China financial crisis risk rising

From BofAML via Zero Hedge:

The A-share correction: The damage could spread far beyond the stock market

A dent to market’s faith in government role

We believe that the biggest damage caused by the A-share market’s roller-coaster ride since the middle of last year has been to investors’ faith in the government’s ability to manage asset prices (stock, RMB, debt and even property) reasonably smoothly. The difficulty the government has faced to stabilize the stock market has demonstrated the downside of that faith. As a result, we expect many of these assets to be re-priced lower going forward. Also,the ripple effect from the market correction has yet to show up – we expect slower growth, poorer corporate earnings, and a higher risk of a financial crisis.

Many assets in China may get re-priced lower

We question the implementation of government policy in urging people to buy stocks. Regarding the deleveraging process in the market, in our view the government started too late & without adequate preparation for the potential downside (we suspect because it didn’t know the true extent of shadow margin financing activities) and it resorted to administrative control when the market turned down. So far, government measures have appeared to us to be behind the curve. As a result, we expect investors to assign less value to various perceived government “puts” going forward. The fall in the stock market could also make the government even more cautious towards QE and potentially using the property market or debt market to hold up growth, in our view – a burst of any of these bubbles, if fully developed, will be far more difficult to deal with than what’s happening in the stock market.

Real economy & corporate earnings will suffer

The net result of this volatile market is a transfer of wealth from the people on the street to the wealthy, including many major shareholders, who cashed out. We expect this will likely hurt consumption down the road. More critical is a potential distortion to credit flows due to the impairment to financial institutions’ balance sheets – as experience with Japanese banks shows, even if they don’t have to mark to market and book losses, their lending attitude may turn more cautious. Of course, the impact of a full-blown financial crisis in China, if it materializes, on the economy would likely be severe. On corporate earnings, other than the drag from slower growth, many companies may have to book stock-market related losses over the next few quarters by our assessment.

A possible trigger for a financial crisis in China

If the market continues to fall sharply, stock lending related losses could run into Rmb trillions, of which, banks and brokers may have to bear a meaningful share. These potential losses can be especially dangerous to brokers whose capital base is less than Rmb1tr. Even more important, the opaqueness of China’s financial system and the lack of clear definition of risk responsibility mean that contagion risk is high, similar to the subprime crisis. We had always considered the risk of a financial crisis in China as high. What has happened in the stock market has likely increased the risks considerably and also brought forward the timeline by our assessment – the leverage is much higher now and economic growth rate, potentially lower.

We’ve seen these kinds of falls in China before without financial crises so I’m skeptical on the last point. Having said that, the swiftness of the rise this time around does stink of margin so this one may be different. It must also be remembered that China still owns its banks so it can simply order them to lend even when they’re insolvent.

I agree with everything else.

David Llewellyn-Smith
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Comments

  1. all the chinese people I have talked to over the years about investing, mainly in RE, believe the Govt will never let prices fall, lol, a bit like here in straya

    • Even worse than shattering the notion that the CCP won’t ‘let’ prices fall is the possibility that people discover that they aren’t demigods after all, and their power over markets may be very limited.

      Here is AFP today:

      “SHANGHAI: China’s benchmark Shanghai stock index was down 8 percent on Wednesday morning as additional government moves failed to shore up the tumbling market, dealers said ”

      How damaging to confidence if the CCP appear to do everything in their power with absolutely no effect?

  2. CAL in CALAMITY. And calamity is not what anyone wants. So although my gut feel on this is negative, and with Grexit still in the ballpark, I’ll go for hopium that all round good sense prevails. Or at least a carnival of can kicking.

    • BoomToBustMEMBER

      What is the stronger emotion, fear or greed ??

      This leads me to believe that Chinese investors will continue to cash out or have margin calls. Then again I could be wrong as I didnt think the Greeks would vote No as people dont like change, of course change for those with nothing to loose is a different story, hence the no vote winning.

      • ref. B2B “What is the stronger emotion, fear or greed ??”

        Shame that people aren’t fearful of greed. Never heard of or seen anyone greedy for fear.
        Fear can be a good thing, cannot think of a good or purposeful place for greed though.
        As for high anxiety activities causing themselves and everyone else around them dangerous ‘adrenal highs’ – best ask our command personnel: Cap’n Abbott and Bosun: Joe HOCKit….. or Ensign: Glenn S CheCk oFF – Helmsman, Weapons Officer……

        Watching all this unfold beats any of the Star Trek episodes Lol

  3. The big risk in my view is political, rents in tier one cities are rising sharply based on locals I visited last month. Some rises of 30% makes me think landlords./ladies need cash for other non performing investments. Of course this is just a hunch, but one thing is sure its not market driven as wage growth is nil and stock increases are at the high to very high end at this point.

    So when I visited business I saw signs of soft but bumpy landing however where the ordinary folk live it seems like a hard landing with cost shocks descending they will bounce back up the price chain as greatly reduced living standards.

    The equality gap that is already a sore point will have greatly increased by the time this shakeout is over, that is the real risk, and Chinese watching Greece must eventually know a little more about ‘people power’..