China Prepares For Massive Bailout!

China spent around $586 to shield itself from the global meltdown in 2008. The aftermath has been to engender bubble conditions as evidenced by the ballooning balance sheets of their banking system and the local government. Recognizing the risk of a bust, China mulls a massive bailout.

The following report from Reuters, (bold emphasis mine)

China's regulators plan to shift 2-3 trillion yuan ($308-463 billion) of debt off local governments, sources said, reducing the risk of a wave of defaults that would threaten the stability of the world's second-biggest economy.

As part of Beijing's overhaul of the finances of heavily-indebted local governments, the central government will pay off some of their loans and state banks including some of the "Big Four" will be forced to take some losses on the bad debt, said the sources, both of whom have direct knowledge of the plans.

Part of the debt will also be shifted to newly created companies, while private investors would be welcomed in projects previously off-limits to them, sources said.

Beijing will also lift a ban on provincial and municipal governments selling bonds, a step aimed at bolstering their finances with more transparent sources of funding.

Many analysts see China's pile of local government bad debt as a major risk to the economy, especially as the economy slows, but few see widespread banking fallout as they believe cash-rich Beijing can step in to soak up losses.

The clean-up plan could boost investor confidence in Chinese banks, which have provided many of their loans as part of the massive economic stimulus program launched by Beijing in late 2008 to counter the global financial crisis.

The program resulted in unfettered lending to local government financing vehicles, hybrid government-company bodies that governments used to get around official borrowing restrictions.

After a months'-long investigation into local government liabilities, Beijing has determined that local governments have borrowed around 10 trillion yuan, said one of the sources.

Additional comments:

1. The previous bailout (stimulus spending) fostered a political economic environment of moral hazard whose consequence was to propagate massive misdirection of capital investments.

2 While lifting the ban on selling provincial and municipal governments seems good, as bond markets will supposedly reflect on the economic conditions, alternatively seen, this measure is meant to soak up private savings into government bailout programs. In short, this represents no more than China’s version of financial repression at work.

3. It is true that China has massive savings that perhaps may afford her to conduct another bailout, but as previously discussed, bailouts would only consume productive capital by diverting them into non-productive activities. Additionally part of the bailouts will surely be accommodated with inflationism.

4. The proposed bailout which accounts for as 20-30% of local government could be understated. Yet this seems like more evidence of the maturing phase of China’s bubble cycle.

5. If China applies the above bailouts before the bust then this could extend the boom but at the risk of that the next crisis will come with a greater intensity.