Welcome to China in 2016- the shadow banking system black hole
February 11, 2016
The letter, posted on the internet, warns that China has a problem- much bigger than the subprime crisis in 2008.
Kyle Bass was one of the hedge fund managers who correctly predicted and profited from the mortgage crisis in 2008.
The problem in China, according to Bass, is the banking system and its coming losses.
“We have been vigorously studying China over the last year, with the view that the rapid credit expansion in the Chinese banking system will result in significant credit losses that will require the recapitalization of Chinese banks and materially pressure the Chinese currency,” Bass wrote in a letter to investors dated February 10.
“This outcome will have many near-term and long-term effects on countries and markets around the world. In other words, what happens in China will not stay in China.”
In the investor letter, titled “The $34 Trillion Experiment: China’s Banking System and the World’s Largest Macro Imbalance,” Bass says China’s banking system has similarities to the US banking system before the most recent financial crisis — excessive leverage, regulatory arbitrage, and irresponsible risk-taking.
Bass said he had met with Wall Street firms, consultants, and China experts and they all had the view that China would get through the recent turbulence without an economic reset.
That’s not how Bass sees it. He wrote:
What we have come to realize through these discussions is that many have come to their conclusion without fully appreciating the size of the Chinese banking system and the composition of assets at individual banks. More importantly, banking system losses — which could exceed 400% of the US banking losses incurred during the subprime crisis — are starting to accelerate.
Put simply: China has an enormous debt problem and the rapidly decelerating economy means that the country’s banks will only be able to paper over the soaring NPLs for so long. If Beijing wants to eliminate the acute overcapacity problem that’s contributed mightily to the global deflationary supply glut, it will mean allowing the market to purge misallocated capital. And that means bankruptcies and a wave of defaults. “The unwavering faith that the Chinese will somehow be able to successfully avoid anything more severe than a moderate economic slowdown by continuing to rely on the perpetual expansion of credit reminds us of the belief in 2006 that US home prices would never decline,” Bass begins.
Bass is among a handful of hedge fund managers betting against China’s currency, the yuan. Much of Hayman Capital’s fund right now is devoted to the yuan short.