Kyle Bass: the US credit bubble peaked at 2%, China’s is currently at over 10%

Tightening credit conditions in China (FXI) (YINN) have turned borrowers to riskier loans due to lack of regular bank finance availability. This has led to the resurgence of shadow banking in China (YANG) (FXP) (CHAD). Shadow banking comprises opaque financial products with little regulation and oversight. In China, the system has doubled over the past 5 years. In fact, shadow banking amounted to about 82% of GDP last year, according to a Moody’s Investors Service report.

The severity of the situation has turned regulatory focus in China (YXI) towards a crackdown on its shadow banking system. As part of its effort, authorities in China are taking a closer look at the $4.4 trillion wealth management products (or WMP) market. The WMP market in China accounts for about 40% of the country’s GDP.  The WMP markets “are basically levered money market funds, some with dubious assets,” said Kyle Bass, CEO of Hayman Capital Management, during a Bloomberg interview recently.

Kyle Bass: this is the beginning of the Chinese credit crisis

The problem that Bass identified with China’s credit situation is that there’s an asset-liability mismatch. This is largely attributable to the prevalence of its expansive shadow banking system. “They’re buying long-term assets, with very short-term liabilities…..and that’s ballooned in the last 20 years,” said Bass.

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The key risk here is that some of these products aren’t doing very well. So, “as soon as the liabilities start having problems, all hell will break loose” exclaimed Bass. In the US (SPY), the asset liability mismatch bubble that led to the sub-prime crisis was at 2% of the total banking system. In China, the shadow banking system now governs over $4 trillion of the $34 trillion industry, so over 11% (see chart above).

Consequently, Bass is beginning to see the beginning of the China credit bubble burst. The big question is: Will President Xi be able to ‘make China great again.’

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