Peak Insanity: Chinese Brokers Now Selling Margin Loan-Backed Securities

One of the reasons why the Chinese dragon quite often appears to be chasing its own tail is that the country is trying to re-leverage and deleverage at the same time. 

Take China’s local government debt refi effort for instance. Years of off-balance sheet borrowing left China’s provincial governments to labor under a debt pile that amounts to around 35% of GDP and thanks to the fact that much of the borrowing was done via LGFVs, interest rates average between 7% and 8%, making the debt service payments especially burdensome. In an effort to solve the problem, Beijing decided to allow local governments to issue muni bonds and swap them for the LGFV debt, saving around 400 bps in interest expense in the process. Of course banks had no incentive to make the swap (especially considering NIM may come under increased pressure as it stands), and so, the PBoC decided to allow the banks to pledge the new muni bonds for central bank cash which could then be re-lent into the real economy. So, China is deleveraging (the local government refi effort) and re-leveraging (banks pledge the newly-issued munis for cash which they then use to make more loans) simultaneously. 

We can see similar contradictions elsewhere in China’s financial markets. For instance, Beijing has shown a willingness to tolerate defaults – even among state-affiliated companies. This is an effort (if a feeble one so far) to let the invisible hand of the market purge bad debt and flush out failed enterprises. Meanwhile, Beijing is enacting new policies designed to encourage risky lending. In April for instance, the PBoC indicated it was set to remove a bureaucratic hurdle from the ABS issuance process, which means that suddenly, trillions in loans which had previously sat idle on banks’ books, will now be sliced, packaged, and sold. Specifically, the PBoC said regulatory approval would no longer be required to issue ABS (hilariously, successive RRR cuts have served to reduce banks’ incentive to package loans, but we’ll leave that aside for now). Once again, deleveraging (tolerating defaults) and re-leveraging (making it easier for banks to get balance sheet relief via ABS issuance), all at once.