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China Embraces Ponzi-Bonds


China is preparing to launch a program that will create the same complex debt-instruments that triggered the global financial crisis in 2008. The pilot program will allow banks to convert pools of loans into securities via off-balance sheet securities firms called Special Purpose Vehicles (SPV) or Structured Investment Vehicles (SIV). The process, which is called securitization, helps banks to circumvent capital requirements by hiding debt on off their books, thus, allowing them to increase leverage by many orders of magnitude. Securitization turbo-charges credit expansion while concealing the risks from shareholders, investors and depositors.

Chinese authorities claim that securitization will help to kick-start the economy by “freeing up funds for lending at a time when Beijing is seeking ways to bolster growth”. But according to an article in the Wall Street Journal, increasing “lending” does not appear to be the real goal at all. Here’s an excerpt from the WSJ article titled “China Looks for Loan Boost”:

“Despite the cautious approach adopted by Chinese regulators, securitization boasts risks that could leave China’s banking system with less of a buffer for loans that default. That is because any buyers of such repackaged products sold in China’s still-underdeveloped capital markets are likely to be banks themselves.

“In China, risk transferring through securitization will be limited because the buyers of the securities will be mostly banks, and, therefore, most of the risks remain in the banking system,” said Yvonne Zhang, a Beijing-based senior banking analyst at Moody’s Investors Service.

In addition, Ms. Zhang said, “If banks, with the capital relief, go on to take on more risks in their new lending, it could also increase the risks for the banking system.”

See? The purpose of securitization is not to boost lending to consumers or businesses, but to recycle securities and cash between the banks themselves in a way that masks the buildup of leverage. (“the buyers of the securities will be mostly banks.”) And the buildup of leverage is done in a way that puts the entire financial system at risk. (“securitization …could leave China’s banking system with less of a buffer for loans that default.”) In other words, the banks may not have enough capital to meet their liabilities. This is precisely what happened in the so called shadow banking system prior to the Lehman Brothers default. China is now taking the first step on that same path.

Securitization enhances credit expansion through a process called “rehypothecation” which allows banks to reuse collateral that has been posted against repurchase agreements to back new trades and loans.  This sounds more complicated than it really is. What’s really going on, is the banks are using the same securitized bonds
many times over to borrow more and more money.  (Imagine if you took your prize stamp collection to many different pawn brokers and borrowed money from each one without posting the collection itself. This is the same thing.) Here’s a short rundown from Repowatch: “In a repurchase agreement, companies use securities as collateral to get a loan from another shadow banker, often just for overnight. Now, at this step in shadow banking something interesting happens. In a securities lending transaction or in a repurchase transaction, somebody gives cash and gets back securities. Whoever gets the securities can re-use them as collateral to get their own repo loan. Then the second repo lender can re-use the same securities as collateral to get a repo loan for themselves. And so on. 

This is a daisy chain where the same securities become collateral for several loans. It’s another reason that shadow banking is so interconnected.”

The banks are taking their securitized bonds to big pension funds and institutional investors and exchanging them overnight for a small fee. (short-term loans) But it doesn’t stop there, in fact, the securities are posted over and over again, creating extraordinary amounts of leverage on insignificant bits of capital. This is the very definition of risk.

As you can see, none of this has anything to do with increasing demand or “bolstering growth”. This is pure bubblemaking, the purpose of which is to enrich the lucky few at the top of the system who are in a position to skim the profits before the bubble bursts and the economy goes into a nosedive.

If China really wanted to end the slowdown, they’d increase fiscal stimulus to generate more activity through personal consumption. There’s nearly universal
agreement that China’s investment-dependent economic model will not work long-term, and that personal consumption needs to increase to strike a balance. Securitization does not achieve this, in fact, it hampers long-term growth by transfering more of the national wealth upwards. Working people are actually worse off because they have to deal with the fallout from the burst credit bubble which typically results in high unemployment and belt tightening. Securitization makes periodic meltdowns unavoidable since bank leverage is not regulated and since the underlying collateral used in the bonds is not supervised. It’s “anything goes”, which means disaster is never far off.

To make this point clearer, consider this report in Friday’s Wall Street Journal titled “ECB takes further measures to increase collateral availability for counterparties”:

“On 20 June 2012 the Governing Council of the European Central Bank (ECB) … reduced the rating threshold and amended the eligibility requirements for certain asset-backed securities (ABSs). It has thus broadened the scope of the measures to increase collateral availability which were introduced on 8 December 2011 and which remain applicable.”

The ECB assures us that the EU banking system is “solvent” and has assets worth many trillions of dollars. But that can’t be true, can it? After all, the banks borrowed one trillion euros in 3 year, low interest loans just 6 months ago, and already they need more money. So, they are broke, right? And, on top of that, they only have securitized garbage  to exchange for the new loans.  Now take a look at this from the Financial Times blogsite:

“The ECB’s Governing Council has … broadened the scope of the measures to increase collateral availability …. the Eurosystem will consider the following ABSs as eligible:

Auto loan, leasing and consumer finance ABSs and ABSs backed by commercial mortgages (CMBSs) which have a second-best rating of at least “single A” ….

Residential mortgage-backed securities (RMBSs), securities backed by loans to small- and medium-sized enterprises (SMEs), auto loan, leasing and consumer finance ABSs and CMBSs which have a second-best rating of at least “triple B”….RMBSs, securities backed by loans to SMEs, and auto loan, leasing and consumer finance ABSs would be subject to a valuation haircut of 26%, while CMBSs would be subject to a valuation haircut of 32%.”

Garbage, garbage, and more garbage. “Sure, bring us your old toasters, your lumpy mattresses, and your three-legged coffee table. We’ll give you cash for whatever you got. Cha-ching!”

Now, tell me, who in their right mind would give money to an indigent banker whose sole possessions are dodgy “B-rated” securitized auto loans, commercial real estate loans, or garbage mortgages?

This is a joke. The banks have no capital, and because of securitization and rehypothecation, they don’t even have any decent collateral left. All they have is a massively leveraged stinkpile of securitized ponzi-bonds that aren’t worth the paper they’re printed on.

And this is the system that China wants to duplicate.


So, the 1 percent can scoop the cream off the top (like they did in the US and EU) before the whole thing blows up in their faces. That’s why.

Just so you have a better idea of how ridiculous the  situation really is consider this: According to the Wall Street Journal, “Spanish banks took more than 230 billion euros of ECB’s three year loans”….from the 1 trillion euro allotment. Also from the WSJ: “Outstanding Spanish bank borrowing from the ECB totaled 325 billion euros in May, and banks there were heavy users of the ECB’s 3-year lending operations in December and February”.

So, Spain is getting money via the Emergency Liquidity Assistance (ELA) program, the Target2 program, the LTRO program and now it needs a straightforward bailout. When does it end? When do the eurocrats in Frankfurt and Brussels admit that the banks are busted and need to be restructured? Instead, all the red ink is being heaped on the state, which is widening the deficits and forcing a breakdown in all the social programs that assist workers, the sick, the elderly, and vulnerable…..And it’s all being done to protect the interests of  a corrupt oligarchy of racketeers.

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at

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