Red Capitalism
How the state banks, bond market and IPO machine are actually wired.
Summary
Carl Walter and Fraser Howie both worked in Chinese financial markets for many years, and they argue that China's financial system is not what its published statistics suggest. Their subject is the plumbing: how banks are capitalised, how bad debt is handled, how the bond market works, and who actually controls the flows.
The central claim concerns the bank bailouts. When China's four large state banks were technically insolvent at the end of the 1990s, the government created four asset management companies that bought non-performing loans at face value, funding the purchases with bonds issued to the same banks. The bad loans left the banks' balance sheets and were replaced by bonds whose repayment depended on recoveries that never materialised. The authors show these bonds being rolled over repeatedly, and argue that the losses were never recognised but merely relocated within the state sector. They apply the same analysis to subsequent recapitalisations using foreign exchange reserves.
They also argue that China's bond market is not a market, because the banks hold most of the issuance and the pricing is administered; that the equity markets were designed to fund state enterprises rather than to allocate capital; and that the National Development and Reform Commission and the party's personnel control over bank management matter more than any regulatory framework. Their conclusion is that the system is a closed circle in which the state owns the banks, the borrowers and the assets, so the accounting is a matter of political decision. The book was published in 2011 and its predictions of crisis have not been realised, which is itself an argument the authors partly anticipate: a closed system can defer recognition indefinitely.
Key takeaways 7
- China's bank bailouts moved non-performing loans into asset management companies funded by bonds issued back to the same banks, which relocated losses rather than recognising them.
- The bonds funding those transfers have been rolled over rather than repaid, which means the original losses remain unrecognised.
- China's bond market is dominated by banks holding each other's and the state's paper, so its prices are administered rather than discovered.
- Equity markets in China were designed to raise capital for state enterprises rather than to allocate capital to its best use.
- Party control of bank executive appointments matters more to lending decisions than any regulatory or governance framework.
- A closed financial system in which the state owns lenders, borrowers and assets can defer loss recognition for very long periods.
- Walter and Howie argue that published Chinese financial statistics describe an accounting construct rather than an economic position.
Who should read it
Investors in Chinese assets who want a structural account of how the financial system is actually capitalised and where losses have been placed.
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