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July 6, 2015

A Panicky Beijing Tries To Save Crashing Stocks

Stock-market rescue measures, concocted by the government, have been hailing down for days, including an interest rate cut by the People’s Bank of China a week ago. But the collapse proceeded with brutal relentlessness. So now, Premier Li Keqiang pulled out all stops and the State Council is calling the shots in the market, the craziest, most desperate shots.
From July 4 last year through June 12 this year, the Shanghai Stock Exchange (SSE) soared 150%. It was the era when stocks would create unlimited wealth out of nothing in no time, when all comers, from street vendors to farmers, would get their government-promoted chance to get rich quick.

“When our national economy is in its worst shape in more than a decade and many corporates have run into trouble, our stock market suddenly shot up to make everybody happy,” George Chen, Managing Editor for the International Edition of the South China Morning Post, wrote in mid-April. He described the phenomenon this way:

The bulls can always find reasons to defend why the market was up, but I rarely heard anyone explaining the disconnect between the weak real economy and the so-called bull run.
Even the state media probably got over-excited. One Chinese newspaper commentary tried to name the surprising market performance as the latest achievement of President Xi Jinping because the top leadership in the country wanted to “create a new opportunity for wealth redistribution for everyone” to narrow the income gap. Redistribute wealth through the stock market in a socialist country like China? Sounds an exciting new economic theory.
He must have caught some flak from the bulls at the time.

Then came June 13. In the three weeks since, the SSE plunged nearly 30%, including 5.8% on Friday, wiping out nearly $3 trillion in get-rich-quick riches, despite the efforts undertaken by the government and the PBOC to put a stop to it.

But the plunge only took the index back to where it had been on March 26. That’s how crazy this situation has gotten, and how desperate the Chinese government is. A three-month unwind shouldn’t worry anyone. But in China, the future appears to depend on an endless surge in stocks.
These farmers and street vendors have taken a nasty hit, according to an online survey: 26% of the respondents said they’ve been wiped out over the last three weeks.

Enormous leverage, not just through margin loans, but through the shadow banking system and all manner of other schemes, has helped drive up stock prices. But when the selling started, leverage became toxic and triggered forced selling, which drove down stocks further, triggering more forced selling…. At record pace, after a record binge.

And suddenly the Chinese government is scared. The SCMP:
Analysts said China would pay a high political, economic, and social price for the tumble. The stock market fall would delay the slow economic recovery, complicate macroeconomic management, damage the government’s credibility, trigger social discontent, and undermine the Communist Party’s leadership under Xi and Premier Li Keqiang. 
Economists said the government whipped up the stock frenzy to help it achieve its main policy goals by recapitalizing cash-strapped firms and injecting money into the real economy. 
The idea was also to promote consumer demand in an economy awash with overcapacity and grappling with a growth slowdown. 
Analysts said the slump had tarnished the government’s reputation because many believed the authorities were in large part responsible for the bubble. 
Indeed, the government has cheered on the rally via state media since the middle of last year, with officials talking daily about “an inevitable bull market.” 
Xinhua, the official China Securities Journal, and Securities Times all joined the chorus, singing along with slogans such as: “The A-share market is where to realize the ‘Chinese dream,'” and “The stock market is facing a 30-year golden time.”
In other words, the communist government converted a market place into a miraculous source of prodigious and endless funding. Which has now collapsed under its own leverage.

So how to stop the bleeding? Create even more leverage!

On Wednesday, the China Securities Regulatory Commission (CSRC) loosened collateral requirements for leveraged investors. When an investor’s portfolio has crashed to where it would trigger a margin call, brokerage firms may now accept all kinds of collateral to avoid liquidating the portfolio. Such collateral includes non-listed shares, “other assets” (old bicycles?), and even the investor’s home. So if prices crash further, the investor who pledged his home might lose it to a broker.

The best of both worlds: Tie the world’s most volatile and overpriced stock market to a swooning, overpriced real estate market where the collateral might take months to liquidate.

Brokerage firms can now give clients six-month extensions, instead of two days, before liquidating their positions. In addition, brokerages are now permitted to securitize margin loans – margin-loan backed securities? These rule changes allow brokerages to extend another $300 billion in new credit to already over-leveraged clients that they would otherwise have to hound with margin calls.
That was Wednesday. Whereupon stocks crashed for two days in a row.

So Friday night and Saturday, all heck broke loose. George Chen, at the SCMP, tweeted: “Premier Li is said to be keen to rescue market ‘aggressively’ not ‘gradually’; Chinese investors now highly praise Li.”

The tippy top of the government – the State Council and Premier Li – was taking charge of trying to rescue the market. And more than just the market. Things started happening.

“BREAKING: China’s propaganda ministry orders state media to publish positive opinions about stock market, NOT to criticize – media sources,” Chen tweeted.

Saturday morning, the CSRC called an emergency meeting for the top honchos of 25 big mutual funds. Later these funds jointly announced that they’d inject 27 billion yuan into the market to buy stock funds and hold them for at least one year to goose the market.

The CSRC also had an emergency meeting with 21 major brokerage firms. Afterward, it announced that the firms would contribute 120 billion yuan ($19.3 billion) to a new “balanced fund” that would buy ETFs of highly capitalized stocks. The group emphasized in the statement that the fundamentals that had justified the rally before it collapsed hadn’t changed, adding, “It is therefore our duty to unite in stabilizing this market.”

Chen put it this way:  According to Caijing, the “CSRC has ordered” these brokerages to get 120 billion yuan “ready by 11 a.m. Monday.”

“This 120 billion yuan won’t last for an hour in this market,” Hao Hong, a China strategist at Bocom International Holdings in Hong Kong, told Bloomberg. Hong had other doubts. “It might benefit blue-chip stocks, as investors may see them as value, but the bursting of the bubble in small-cap/tech stocks is likely to continue.” These stocks are of “most acute concern” as small investors levered up to buy them. These folks, lured by government assurances, make very unhappy campers. Yet, with valuations “in the stratosphere,” Hong said, “nobody is willing to step in and bolster these stocks.”

Chen saw another option: according to “sources,” if the 120-billion-yuan rescue fund “proves ‘not enough,’” the government can inject more into the market, including via pension funds and FX reserves.

The State Council also ordered the CSRC to suspend all new IPO approvals until the market stabilizes to prevent the diversion of funds from current listings. According to Bloomberg, based on filings as of Saturday evening, “10 companies will suspend IPOs on the Shanghai Stock Exchange and 18 will do the same at the Shenzhen Stock Exchange.”

And late Sunday (Chinese time), to round off the efforts, the CSRC announced that the PBOC would step into the melee and inject capital into a CSRC subsidiary, the China Securities Finance Corp, so that it would deploy these funds to allow brokerages to lend even more money to their clients so that they can buy even more stocks on margin.

Speculators, who may not have known what risks they were taking, were taking ludicrous risks, no questions asked, in a get-rich-quick scheme funded by dizzying leverage and promoted by the government. Now that the scheme is collapsing, the government encourages investors to take even greater risks and pile on even more leverage, secured by all kinds of collateral under loosey-goosey terms, underwritten by the government, major brokerage firms, and mutual funds, both funded and backstopped by the central bank. Nothing can go wrong in this scenario. Watch the fireworks when this moolah ignites.

Courtesy Wolf Richter at Wolf Street (Archive Here)

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