China's debt dragon

Copying America's Resolution Trust Company (RTC) model after the Savings and Loan crisis, the Ministry of Finance (MOF) approved the formation of five asset management companies (AMCs) to acquire "selected" NPLs for warehousing, and auction to the highest foreign bidders.

Beijing ignored the RTC's success criteria of independent professional management, liquidating weakest entities, debt discounting, and market pricing, and took control, refusing discounting and liquidation of any state owned enterprise.

The MOF authorised the AMCs to purchase about US$204 billion of NPLs from the banks at book value, partly in cash loaned by the Central Bank, and partly in 10-year bonds, both guaranteed by the Central Bank.

The logic was simple. Since the State "owns" the AMCs and the banks, the state incurs no net loss by providing backing. Solvency problem solved. The debt goes around in circles. Some cash and central bank guaranteed bonds with substantial interest revenue replaced the NPLs on the banks' balance sheets.

NPLs again surged in 2002, and in 2003, the AMCs acquired an additional US$120 billion in NPLs, issuing more bonds, at undisclosed discounted values.

In 2002 and 2003, state media reported multi-billion dollar NPL sales to foreign investors.

In 2009, state media reported the AMCs as profitable.

The report defied economic logic, implying likely creative accounting, concealment, collusion, and questionable management standards by the AMCs.

Due to extremely poor asset quality, questionable security, and China's vague laws, among other things, auctions realised just 1.5 per cent to 9 per cent of the NPLs face value. By the end of 2005, only US$20.63 billion of the US$324 billion of saleable NPLs had sold.

Foreign interest evaporated leaving an estimated US$304 billion in unsaleable NPLs on the AMCs balance sheets accruing operating expenses and interest on bonds and cash loans.

Profitability implies that the remaining "dud" NPLs had sold well beyond face value, producing windfall profits clearing the estimated US$325 billion NPL residual, accrued operating expense debt, and interest.

Early 2009 the four state banks were reportedly discussing strategies to bail out their insolvent AMCs.