The Right Way To Stabilize China Stock Markets

Latest stories

And the Oscar goes to...Myanmar military psyops

China needs bold, open-door policies for economic resurgence

How US airstrikes will and won't hurt Iran-backed militias

Chinese stocks are gyrating wildly, the property crisis is deepening, deflationary risks are entrenching and opaque regulatory crackdowns on tech, finance and even due diligence firms all have investors on edge.

A delegation led by Jay Schambaugh, US Treasury undersecretary for international affairs,
will be keen to learn about China's plan to stabilize Asia's biggest economy.

One immediate temptation might be to pick the minds of Treasury officials concerning Washington's more recent 2008-09 global financial crisis.

Many investors couldn't help but
wonder if news last week that a Hong Kong court forced the liquidation of property giant China Evergrande Group might be a“Lehman moment .”

As analysts at Commerzbank put it:“Even if a court in mainland China recognizes the Hong Kong court order, Beijing's more aggressive stance to contain risk as well as potential political considerations mean the fallout will probably be relatively contained.”

Residential buildings developed by Evergrande in Yuanyang, January 2022. Image: Twitter

Shehzad Qazi, an analyst at advisory China Beige Book, adds that Xi's team essentially controls all the moving parts in the financial system, making it almost impossible for lending, borrowing or supply dynamics to seize up, Lehman-style.

That's why the S&L comparison is likely more apt. In 1989, US lawmakers passed the
Financial Institutions Reform, Recovery and Enforcement Act to cleanse an industry beset with bad assets.

The legislation created the Office of Thrift Supervision while placing thrifts' insurance under the Federal Deposit Insurance Corporation (FDIC).

Most important of all, arguably, was the creation of the Resolution Trust Corporation (RTC) to bring the remaining troubled S&Ls to heel. The RTC closed 747 S&Ls with assets of over the then-equivalent of $407 billion.

By 1995, the RTC was closed, having succeeded in repairing the financial system. Not that the US learned its lesson. Congress would err a few years later when lawmakers
dismantled the
Glass–Steagall
Act of 1933, which erected firewalls between banks' commercial, investment and savings businesses.

If that Depression-era law hadn't been repealed, the“Lehman shock” of 2008 likely wouldn't have happened. The same with last year's Silicon Valley Bank blowup, which reminded many how troubles in a couple of mid-tier banks about which few investors were even aware could quickly morph into a systemic risk.

The reason these comparisons matter, circa 2024, is how America's S&L crisis began and festered under the surface until it was too late.

As Adrian Blundell-Wignall, a former Organization for Economic Cooperation and Development economist and current Australian Financial Review columnist, notes, the
laws of economics“always work.” And yet history is replete with the follies of governments trying to escape them.

“It's not just authoritarian regimes that misallocate resources via state investment and funding, capital controls, subsidies and the corruption that always travels with these elements,”
Blundell-Wignall notes.

“Anywhere where funds are raised with an explicit or implicit guarantee, problems will follow. The Evergrande crisis
in China reminds me of the S&L crisis, with the difference that Evergrande is both intermediary and property developer. Double risky.”

Imagine,
Blundell-Wignall argues,
a cross between a hedge fund, a private equity firm and a developer.“China,” he argues,“has all the authoritarian regime issues and, where it allows strategic well-connected – private – individuals to raise funds with an implicit guarantee to develop property, it ties onto this risk the S&L-like problems, squared.”

In the 1990s, many US Treasury officials tried to sell Tokyo on the RTC playbook. The institution had, after all, managed to arrange for the auction of bad loans as a means of luring opportunistic investors into the market and, in turn, buttressing broader trust in the system.

Might Xi's team be more receptive than Japanese officials calling the shots in the mid-to-late 1990s? Only time will tell. But Xi and Premier Li Qiang would be wise to remember that time isn't on their side.

Time ticking down on Chinese President Xi Jinping (L) and Premier Li Qiang (R) in a file photo. Image: NTV / Screengrab

The biggest lesson from Japan is that acting glacially to dispose of bad assets creates the very deflationary mindset with which Japan is still grappling 25 years later.

In China's case, notes IMF economist
Hoyle,“many developers have become non-viable but have avoided bankruptcy thanks in part to rules that allow lenders to delay recognizing their bad loans, which has helped mute spillovers to real estate prices and bank balance sheets. Home prices have also decreased only modestly in part because some cities have sought to limit price declines through rules and guidance on listing prices.”

In other words, China, like Japan in the past, is still treating the symptoms of its crisis, not the underlying causes.

“China's housing market faces additional pressures in coming years from structural factors, in particular demographic change,” Hoyle notes.