Insolvency Stalks China's Banks

By ALAN ABELSON | MORE ARTICLES BY AUTHOR

Are China's banks threatened with insolvency? Yes, warns a seasoned global-market watcher.

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Kicking the can down the road. That graphic phrase has captured the fancy of legions of Street sages as a euphemism for deliberately delaying until tomorrow (or many tomorrows on end) what desperately needs to be done today. It's almost exclusively used to describe the proclivity of our civil servants, the president and Congress particularly, to postpone some painful action as far into the future as they, well, can.

Catchy on first hearing, promiscuous use of the phrase has worn it down into a cliché and badly dulled its vividness. Which has not deterred in the slightest those aforementioned sages from uttering it with just as much relish as if they had invented it, which many no doubt think they have.

Of late, the accusation of kicking the can down the road has been expanded to include Ben Bernanke and his troupe, chastising them for continuing their quantitative easing and all the evils it supposedly is inflicting on the economy from debasement of the dollar to providing tinder for an inflationary flare-up. We don't think what the Fed's chairman has been doing is actually kicking the can down the road and so we don't think it's cricket to kick his can for doing it.

Instead, he and his predecessor can unarguably be blamed for their contribution to the catastrophe of the recent past rather than what Mr. Bernanke is purportedly wreaking on the future. Apparently both suffer from a visual impairment, poor chaps, that prevent them from recognizing a bubble when it's expanding right in front of their noses. To make matters worse, after it bursts, they witlessly seek to repair the damage by creating an even bigger bubble, which, of course, they're similarly blind to.

What seems to further enrage their already enraged critics is the aplomb with which Mr. Greenspan and Mr. Bernanke respond to the wretched aftermath of their unfortunate inability to take preemptive action. For example, Albert Edwards of Société Générale in his latest commentary confesses: "Very little surprises me anymore in this business. But even I was surprised by Ben Bernanke's comment on CBS's 60 minutes that he has '100% confidence' that he can act quickly to stop inflation getting out of control."

If there's one thing Ben Bernanke should be 100% confident of, Albert snarls, "it is his own fallibility. Remember, this is the man who was not only adamant that U.S. house prices would not decline, but refuted the very notion there was even a house-price bubble in the first place!"

Albert sighs that he realizes "these guys have to pretend that they know what they are doing, but you would have thought that, having been at the epicenter of the biggest economic and financial crash since the 1930s, he would show a little humility and uncertainty. Apparently not."

Come on, Albert, self-doubt and humility have never been prominent in the lexicon of Washington or Wall Street. And Mr. Bernanke is merely being faithful to that venerable tradition.

THE STOCK MARKET IS CERTAINLY UNPERTURBED by the Fed's determined efforts to keep rates prone. Nor is it bothered by Bernanke & Co's remorseless exertions to pump liquidity into the financial system, hoping, we suppose, some of it spills over into the economy. The same, alas, can't be said for the bond market, which has been taking its lumps of late, as equity fever prompts investors to shave their fixed-income holdings and scramble into stocks.

As we've observed perhaps ad nauseam, the bullish ranks of investors, big, small and in-between, are swelling mightily. Bloomberg reports that a tally of 11 leading strategists who rubbed their crystal balls shows all are bullish for 2011, expecting a gain in the S&P 500 ranging up to 25%-plus (Deutsche Bank) and averaging just shy of 11%. The roster includes some of the same stalwarts as this week's cover story, whose average guesstimate for next year is 10%.

This kind of unanimity is not unique, especially in an investment climate like the present one, which is decidedly hot and seemingly growing more so with every passing session. But to repeat last week's headline on these scribblings, when everyone's bullish -- that's bearish.

HARALD MALMGREN is a savvy gent who runs the Malmgren Global fund, which renders advice to financial institutions, those huge bundles of capital known as sovereign-wealth funds, a number of central banks and governments the world over. Back on Aug. 30, we ran a piece in this space discussing an article by him and a colleague on high-frequency trading, titled "The Marginalizing of the Individual Investor," that was spot on as a critical analysis of the baleful effects of that sordid practice.

So we were delighted a few days ago to find in our electronic mailbox an epistle from Harald updating his views on the global economic and financial scene (more than a little bleak, not to keep you in suspense). For the U.S., he avers, the unrelenting deleveraging of household debt, the rise in the cost of fuel and food, the stagnation of income and the negative wealth effect of a continued decline in home values strongly suggest discretionary spending, which so many economic seers are counting on to spark a quickening of this slowpoke recovery, is more than likely to "disappoint" in 2011.

Nor is he particularly sanguine about the Old World. He points out governments in the euro zone face the rather daunting necessity next year of borrowing close to a trillion euros, including refinancing sovereign obligations and issuing new debt to cover deficits. The European Central Bank itself has been weighing a request for more capital to cover possible weakness in its holdings of euro sovereign debt, and he calculates that the bank is already leveraged by more than 300 times the size of its underlying capital of slightly less than � billion. That makes our Fed, which is leveraged something like eight times, look like the epitome of prudence.

We found especially interesting Harald's take on China. He notes that while investors everywhere have been uneasily eyeing the rise of the inflation dragon in that nation and have anticipated that Beijing would hike interest rates to contain the beast, it hasn't. And the reason why it hasn't, he posits, is that profit margins for many Sino businesses are razor thin, and an abrupt rate boost would mean appreciably higher debt-service costs, really putting the kibosh on profits.

Despite all the global focus on inflation, Harald contends, the big challenge confronting China can be found in the nonperforming loan portfolios of its banks and kindred financial institutions. That enormous pile of deadbeat loans is the legacy of late 2008-2009, when exports dried up and the spooked rulers of the command economy ordered the banks to seriously step up their lending -- no ifs, ands or buts. The banks dutifully complied with an awesome $1 trillion in fresh lending.

Much of that huge mountain of loans has fallen into the nonperforming category, which translates from the polite banking parlance into delinquency, big time. To avoid a financial meltdown, Harald expects, Beijing will raise capital-adequacy requirements substantially during the first few months of 2011, conceivably in incremental steps to cushion the pain. Since he anticipates Chinese banks will have trouble raising capital, he expects a large-scale shrinkage in lending.

Chinese banks, he emphasizes, aren't suffering from insufficient liquidity. Rather, he warns, the danger to the country's banking system is insolvency. In the current lineup of problem banks around the world, he would rank Chinese banks as the most troubled, with European banks next, followed by U.S. banks and Japanese banks probably holding down fourth place.

That's one list on which we are more than happy to find this blessed land of ours isn't No. 1.

THE ECONOMY INCONTESTABLY has been showing more signs of life, and that, of course, has helped juice the market. On this score, last week even brought ostensibly good news on housing starts. To wit: Single-family housing starts in November posted a seasonally adjusted gain 7% over the revised October total.

But, as Mark Hanson, who knows just about everything there is to know about housing, points out, on a seasonally unadjusted basis -- which frequently is much closer to the way things really are -- November starts were actually down 6.1% from October, 4.3% from November 2009 and some 35.4% from April.

Far from signaling a sustainable turnaround, he envisages building permits and single-family housing starts double dipping, as the industry simply can't get hold of any stability in pricing power.

He grants that starts obviously are closer to the bottom than ever before because "the number can't go to zero." But, he insists, there's nothing to suggest starts have to increase much, either, even were lagging household formation to suddenly shoot up. It's an open question, Mark believes, whether home builders will be able to construct houses cheaper than they can sell them, given the formidable overhang in supply and pressure on prices from foreclosures and short sales

And he concludes, somewhat grimly, after five years of declines and bottom calling, the home-builder stocks remain suitable strictly for an occasional trade.