China’s Coming Financial Meltdown
Anbang Insurance Group is one of China’s largest and most aggressive financial institutions. It is known for its huge customer base, high leverage, and fast-paced deal making.
At least it was until the Friday before last.
That’s when Anbang was taken over by the Communist Chinese government. You can call that takeover, “a bailout with Chinese characteristics.”
Today, Anbang is a financially distressed ward of the Chinese state. In a classic too-big-to-fail moment, the Chinese Insurance Regulatory Commission, a government financial regulator, took control of Anbang, installed new management, and said they would manage Anbang for at least a year, “to protect the legitimate rights and interests of consumers and safeguard public interests,” according to the commission’s press release.
Anbang is not some medium-sized regional insurance company. It’s gigantic. Anbang has over $310 billion in assets, over 35 million customers, and has operations in Asia, Europe and North America.
China’s Anbang Insurance went on a global acquisition spree using policyholder funds. Among Anbang’s most high-profile acquisitions was New York City’s iconic Waldorf-Astoria Hotel, pictured here. Anbang paid almost $2 billion for the landmark property. After the takeover of Anbang, such assets are effectively owned by the Chinese government.
Anbang thrived by selling customers a kind of life insurance called “universal life,” which is more like a structured high-yield note than true insurance. Anbang sold these policies through a network of bank branches throughout China.
The sale proceeds were used to finance high-profile overseas acquisitions including the Starwood Hotels chain, and New York City’s historic Waldorf-Astoria Hotel on Park Avenue.
The problem with Anbang’s business model was that many of the universal life insurance policies had required payments in three-to-five years, while its investments were illiquid long-term investments. The only way Anbang could meet its obligations was with bank loans or sales of new policies in a kind of Ponzi scheme where new customers’ funds were used to pay off the old promises.
As Anbang’s business became more highly leveraged and its asset-liability maturity mismatch grew, policyholders became more nervous and started demanding their money back instead of extending the maturities on their policies. An insurance version of a run-on-the-bank was beginning. The Chinese authorities moved in to bailout the policyholders and prevent an out-of-control financial panic.
Anbang a good example of what might be called a “managed meltdown.”
You’ll be reading and hearing a lot more about the Anbang disaster in the weeks ahead. More importantly, investors need to take a step back from the headlines and consider the bigger picture of financial distress and the coming credit collapse in China more broadly.
Let’s consider how this will play out:
On the one hand, the Chinese financial sector (banks, insurance, asset management, shadow banking, etc.) is totally insolvent. Consumers’ savings have been used to finance ghost cities, white elephants, capital flight, Ponzi schemes, bribes and kickbacks.
There are some real assets to show (their trains are the best in the world) and some growth, but not nearly enough to cover the liabilities that have been created in the form of bank deposits, corporate bonds, wealth management products, intercompany loans, etc.
On the other hand, China has enough in hard currency reserves to clean up the mess. China will need hard currency in addition to yuan money printing to handle the external dollar-denominated debt.
The policy issue for China, therefore, is when and how they go about the clean-up. If China moves too quickly, they risk slowing the economy, slowing job creation and delegitimizing the Communist Party.
If China waits too long, they risk an uncontrolled panic and a liquidity crisis, which can grow far worse than the initial problem through contagion. Chinese contagion also has the potential to go global.
Given this dilemma, China is trying a Goldilocks approach of not too fast and not too slow. This Goldilocks plan has three parts:
1. Keep the problem from getting worse than it already is.
2. Shut down the worst institutions in a relatively transparent “no drama” manner.
3. Play for time with regard to the rest of the financial system and try to grow out of the problem.
This all comes at a critical time in China. The Communist Party Politburo is in the process of selecting a new head of the central bank. Financial regulators and party officials don’t want to rock the boat while this delicate transition is taking place.
Also, the Communist Party Politburo has just announced they are repealing term limits on the President of China. Currently that office is limited to two five-year terms, but those are being eliminated. The incumbent, President Xi Jinping, will remain in office indefinitely.
This puts Xi on a par with Russia’s President Vladimir Putin. Xi is now “Big Xi,” the most powerful ruler in China since the death of Mao Zedong.
If China encounters a financial crisis, Xi could quickly lose what the Chinese call, “The Mandate of Heaven.” That’s a term that describes the intangible goodwill and popular support needed by emperors to rule China for the past 3,000 years. The term applies equally to the new “peasant dynasty” of Communist rulers as it has in the past to Ming, Tang and Qing Dynasty emperors.
If The Mandate of Heaven is lost, a ruler can fall quickly.
Will China be able to pull this off this Goldilocks approach to a potential credit crisis? Of course not, nobody’s that good or that lucky. Still, the Communists will try and may be able to keep the greatest Ponzi scheme in history afloat in China for another year or so.
The endgame is still a financial crisis that the Chinese won’t see coming. In that case, China’s only solutions are to close the capital account, devalue the currency, nationalize the financial sector, and put the malefactors in jail.
This story is getting worse because U.S. President Donald Trump has now launched an all-out trade war on China with tariffs on certain appliances and solar panels and new tariffs on steel and aluminum.
In addition, Trump is considering other punishments aimed at China for its theft of U.S. intellectual property. Trump is also banning Chinese acquisitions of U.S. companies using national security powers through the Committee on Foreign Investment in the United States, CFIUS.
The Chinese financial sector is caught in a vise between internal constraints imposed by President Xi, and external constraints imposed by President Trump. The result will be a financial meltdown of unprecedented magnitude in China with the potential to go global and cause a market collapse in Europe and the U.S. as well.
In one version of the old Goldilocks fairy tale, she is almost eaten by the three bears, but manages to escape the cottage and run into the woods.
The Communist Chinese will not be so lucky.
Regards,
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