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How “Ghost Collateral” And “Yin-Yang” Property Deals Will Collapse China’s Credit Bubble

December 5, 2017

How “Ghost Collateral” And “Yin-Yang” Property Deals Will Collapse China’s Credit Bubble

One lesson from the 2007-08 crisis was that the vast majority of financial market participants, never mind the general public, were unfamiliar with subprime mortgages until the crisis was underway. Even now, we doubt many have much understanding of repo, the divergence between LIBOR and Fed Funds from 9 August 2007 and Eurodollar liquidity. In a similar way, when China’s bubble bursts, we doubt the majority will be that familiar with “ghost collateral” and “yin-yang” property contracts either.

A second lesson from the 2007-08 crisis was that as the value of the collateral underpinning the vast amount of leverage declined, the surge in margin calls led to cascading waves of selling in a downward spiral.

A third lesson was that the practice of re-hypothecating the same subprime mortgage bonds more than once, meant collateral supporting the most vulnerable part of the credit bubble was non-existent. It only became apparent with the falling prices and margin calls. Few people realised the bull market was built on such flimsy foundations, as long as prices kept rising.

A fourth lesson was that in order for the bubble to reach truly epic proportions, key financial institutions, especially banks, needed to conduct themselves in a negligent fashion and totally ignore increasing risks.

Each of these warning signs from the 2007-08 crisis exists in China’s property market now – and other parts of its financial system – bar one…falling prices leading to cascading waves of selling. However, as we’ll explain, we think it’s only a matter of months away now.

We should note that our thesis that China’s bubble would eventually be undermined by a “black hole” of insufficient collateral is one that we have been developing for several years. What we came to realise is that insufficient collateral is nothing more than normal business practice in the Chinese economy.

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