The Real Signal from Anbang's Takeover

By Roy C. Smith

Last week the Chinese government seized control of Anbang Insurance Group, a hyperactive financial conglomerate with assets of about $300 billion, to avoid its collapse. Anbang’s free-wheeling, billionaire chief executive, Wu Xiaohui, who founded auto dealerships in 1996 that grew into car insurance, banking and overseas real estate, was detained by Chinese official last June and has been held in custody since for “economic crimes.”

Anbang, is one of China’s so-called “Gray Rhino” companies founded by China’s first wave of successful entrepreneurs. Others include fast-growing conglomerates such as Fosun International, HNA Group and Dalian Wanda Group that have feasted on cheap debt provided by state banks while spending lavishly to build their empires. (Gray Rhinos are so named after a 2016 book by Michele Wucker about facing obvious but ignored dangers). The companies relied on important connections with government officials for their access to business opportunities and finance, but they may now be an endangered species.

A dramatic failure of any high-flying company is big news. In China, however, big news also contains signals from the government for the people to absorb. What might the signals be in this case?

First, Mr. Wu, 51, in pursuit of Anbang’s interests, seems to have ignored some recent government policy guidance. Anbang was among the first Chinese companies to make major acquisitions abroad, including a $2 billion purchase of the Waldorf Astoria in New York in 2014. This was OK with the government when it happened, demonstrating that Chinese companies could be important players in the global investing world. But things changed after the Chinese stock market crash of 2015, and the government wanted to restrain such acquisitions to conserve foreign exchange and support the yuan. Wu wasn’t listening, however, and proceeded in 2016 to offer over $14 billion for the Starwood Hotel Group, and, in 2017 to discuss the purchase of 666 Fifth Ave., a troubled New York office building owned by Trump son-in-law, Jared Kushner’s family. Both deals were abruptly halted in mid discussion without explanation, presumably under Chinese government pressure.

Second, Anbang’s means of securing finance for its various acquisitions is not fully known but is thought to come from the sale of “wealth management” products, a lightly regulated, non-bank “shadow banking” activity that has grown substantially despite government efforts to more closely manage the country’s credit system. Wealth management products began as higher-risk bank loans that banks wanted to sell in order to comply with tightening government rules. Brokers would buy the loans and resell them at interest rates higher than banks offered to depositors. Thus, the loans were removed from the banking system, but became hard-to-manage liabilities in the Chinese financial system as a whole. Just as the government began to show concerns about the rapid rise in all of the different forms of asset management products (which rose to $15.4 trillion by 2017), Anbang appears to have started selling its own wealth products (i.e., loans) on a large scale.

Third, Mr. Wu is not an ordinary oligarch. He is married to the granddaughter of the legendary Chinese leader Deng Xiaoping and has served as a financial advisor to her wealthy mother, Deng’s daughter, who is one of China’s premier “princelings.”  Mr. Wu is said to be close to a number of other princelings (children of high ranking Chinese Communist Party officials), some of whom are thought to be owners and directors of Anbang. As a privately-owned company, Anbang does not disclose details of its ownership.

China’s leader, Xi Jinping, now deemed to be as powerful as Deng ever was, is also a princeling, though apparently not connected to the Anbang princeling set. Indeed, the Anbang case is a good opportunity to warn other princelings not to assume they can rely on their special positions and influence to do things that otherwise would be contrary to government guidance. Indeed, the Anbang case illustrates that princelings (even almighty Deng princelings) can be brought down just like anyone else if they fail to shown appropriate loyalty and obedience to the Xi regime.

Finally, there is the question of why the government took over Anbang the way it did, instead of quietly propping it up or letting it fail. China’s insurance regulator said government officials would run the company for one or two years, until it had been restructured.  Though there was some indication that Anbang’s financial position had soured, and this may have triggered a wave of wealth product redemptions, this does not appear to have been visible in the market before Mr. Wu’s arrest. Some sort of regulatory assistance, together with management changes might have been enough to save the company, but even without assistance it is not clear that Anbang’s failure would threaten China’s financial system, which has tradable financial assets of about $30 trillion.  Anbang may not have been too-big-to-fail, but it’s debt investors have been bailed out.

The answers are not clear, but (a) Chinese bankruptcy practices and laws, revised in 2007, are relatively untried and undeveloped and a $300 billion failure may be more that the government feels comfortable handling – and, not being able to do so might make China look bad, (b) Anbang debt and equity losses might have been considerable -- and would be concentrated uncomfortably on the middle class purchasers of the wealth products and smaller banks and other non-bank lenders that Anbang utilized, but most important, (c) such losses might trigger a general panic in China’s financial markets (many observers believe banks and shadow lenders are under-reserved for losses after a decade of easy monetary policy) and through contagion become a national liquidity crisis?

Thinking of such a possibility must remind officials of the 1989 financial collapse in Japan, the Asian Meltdown in 1998, and the US financial crisis of 2008. Any sort of similar crisis in China could be very destructive to its economy.

So, it is much easier for the government to simply take over Anbang, like the US took over Fannie Mae or AIG, to avoid a market reaction. Investors get paid, the system holds together, life goes on and all the important signals get sent.

However, the most important signal may be that China’s financial system is too weak, overextended and vulnerable to collapse to be left to the free market, so the government has to intervene frequently to hold it together. Thus, the government has committed itself even more so to being the country’s interventionist economic manager and Mr. Xi’s promise when he first took office to let free markets pay a “decisive role” in China’s economy is even more remote than ever. Denial of market forces requires authoritarian forces to replace them. If this continues to be so, China’s long-term future is surely much bleaker than many observers now think. Perhaps it too is becoming a Gray Rhino.

One Cheer For New York's Subway

Ingo Walter

For a habitual subway user in Manhattan since 1970 - and a maybe a dozen other cities around the world from time to time - the drumbeat of subway criticism can get a bit much. Words like crumbling, obsolete, filthy, rat-infested and unreliable roll as easily off the tongues of hassled straphangers as the above-ground chattering classes in their limos and Ubers. Politicians join the chorus when it suits them, talking a good game during short political cycles while earning a solid F for securing their legacy by creating and maintaining vital investments with 75-100 year time-horizons.

And even when useful projects actually get done (there are only two in my lifetime, both unfinished), completion schedules can span generations and leave behind eye-watering cost overruns – capital deadweight that produces exactly nothing of value yet saddles taxpayers with massive debt service for years to come. In short supply today is the kind of far-sightedness that helped create New York’s bridges and tunnels, its parkways, its world-class water system, and of course the original subway infrastructure. And there’s today’s serviceable PATH, finished in 1908 under William G. McAdoo, later Secretary of the Treasury under Woodrow Wilson. (“Let the public be pleased.”)

But wait! Are things really so bad that we need to rebuild from scratch? In some ways they’re even more challenging. It’s a good bet that reimagining a world-class subway system that can secure the City’s future will be the biggest brownfield transport project ever undertaken. It requires reconfiguring and reengineering century-old layouts intertwined with all kinds of critical gas, heat, electric power and communications utilities that have accumulated like barnacles on a ship’s hull over the decades.  Don’t believe it? Look down an open manhole sometime.

Along with rebuilding most of the system’s stations and yards, any serious rehab has to happen while close to 6 million testy passengers have to be moved around the City every day. In all kinds of ways, greenfield subway projects (or greenfield superimposed on brownfield) have it much easier in places like Singapore, Paris, Shanghai - and even London - extending or developing brand new high-speed and local lines on time and on budget, even in the most ancient of cities. Passenger are not unreasonable by nature, but morale does reflect the likelihood of seeing real benefits before they pass from this earth.

Maybe the constant criticism is also overblown in the broad scheme of things. It’s hard to complain about the small part of the subway layout I normally use in Manhattan - especially with a good memory of the way things used to be.

Gone are the graffiti-covered windows blocking the view of station stops, the piles of onboard trash, and even some of today’s clunkers have started new and improved lives after an amazingly attractive renovation, just like an old Boeing 777 after a D-check.

Gone are the aggressive and often physical panhandlers and the omnipresent platform stench that would drive people and companies to seek civilization elsewhere. Even the new generation of (sometimes talented) subway gymnasts has been toned-down. Many conductors, agents and transit police now make an effort, and it shows. Passengers with plenty to gripe about are mostly civil and offer seats to those who obviously require them. And there’s no need to worry anymore about misunderstood eye-contact with fellow passengers, thanks to today’s electronic substitutes for Prozac.  

Except for the glaring omission of efficient subway links to the airports - virtually unique among today’s important business and financial centers - visitors from overseas can get used to our system with a bit of practice. It’s New York, after all, and there will be some good stories to tell when they get home.

So there’s always a bright side, and today’s subway ecosystem has one too. There are plenty of people who deserve credit for things not being even worse, much worse. Sustainability is a different issue. Pendulums swing, and there’s no guarantee that we won’t revert to the bad old days rather than a bright new dawn.  The City has to play the cards it’s been dealt. In New York there’s not that much “greenfield” around to accommodate big new projects that move the needle, and “brownfield” is disruptive and expensive.

On top of that, nobody wants to pay - something that the subway shares with big infra-structure projects around the world. Well thought-through and executed, these projects are enormously productive year after year over decades and sometimes centuries – to the point where even huge development costs fade into insignificance. But the costs fall on people in the here and now, while the benefits are widely dispersed over space and time. So the former don’t want to pay and the latter can’t easily be made to pay. Think a New York subway renaissance will run a deficit in cost-benefit terms? Pure nonsense. So we end up with enormously socioeconomically profitable projects that cannot be financed.

There are plenty of solutions. Tax those who don’t pay but benefit most directly, like landowners and developers enriched by the subway - taxes that may in part get passed along to residents and businesses in higher rents and ownership costs. Those who benefit most directly are made to pay, but nonetheless are better off. Or go for a broader tax net that covers all of New York’s residents and visitors with a permanent City subway tax and hotel surcharge.

Don’t use the subway? Too bad. Your limo battles less traffic the more people do. Commute from the burbs and walk to work? Too bad. The value of the subway is baked into your home value and your ability to resell it. Want to make it progressive? Add features like a nonresident vacancy tax on all those unused luxury condos owned as a bolt-hole by foreigners and finance bigger discounts for the poor and the elderly. There’s plenty of revenue elasticity in a “city of the future” like New York.

New York’s subway is a hidden treasure . All it takes is visionary political leadership, disciplined execution and management, and imaginative financing to unlock it for the future prosperity and vibrancy if the City.

What is the Market Selloff Telling Us?

By Roy C. Smith

The US stock markets plunged 10% this week. The decline was echoed in Europe, Asia and in many emerging markets. Is this the bursting of an over-priced stock market bubble, with more to go, or just an overdue but sharp correction to a fundamentally healthy economy?

Periods of sharp stock market declines can set off panics that can spread to stocks in other countries and to other asset classes, including those not normally correlated with stocks.  If the sell offs are powerful enough, they can generate enough uncertainty in the real economy to cause recessions, as they did in 1990, 2000 and 2008. Is this one, one of those?

The trouble with bubbles is that they are always called “trends” until they burst. Investors love trends – when everyone can agree that these technology developments, or those improved economic indicators confirms their belief that the prolonged market rise is justified by underlying fundamentals.

In November 2017, Goldman Sachs published a report on the global economy entitled “As Good as it Gets,” in which it predicted global GDP growth for 2018 to be 4.0% (and US GDP growth to be 2.5%, since increased to 2.8%) due to a virtuous alignment of positive factors around the world. Many other analysts, including those from the IMF agreed. The world was finally, after many years of stimulus, cheap money and Quantitative Easing, emerging from the last of the Great Recession that had smothered economic performance since 2007.

Surely this is an event worth celebrating with a bit of market exuberance, especially in the more exciting tech areas. But the celebrating really began long before the consensus on the world economy was formed. Indeed, it all seemed to begin with the election of Donald Trump in November 2016. From then until the peak in prices last week, the NASDAQ 100 index is up 47.8%; the Nikkei 225, up 42.7%; the S&P 500, up 37.8%; Euro Stoxx, up 24.3%, and even the Brexit-burdened FTSE is up 15.5%.

Yes, the election encouraged investors to look to a market driven by deregulation, tax cuts, tougher trade policies and an infrastructure boom that might lead to growth rates in the US of 3% to 3.5%.  But not long into the Trump Administration, there were many signs of political disorder and ineffectiveness that some analysts said brought the “Trump Bump” in the markets to an end. However, the markets were continuing to rise -- not so much because of what Trump might do, but because of what he most likely wouldn’t, i.e. dissolve the health care system, create trade wars, or launch missiles at Korea or Iran. The markets could live with the disorderly parts of Mr. Trump, these analysts said, because of the overdue recovery coming through, and Mr. Trump’s pro-business side that was driving the tax bill passed at the end of the year. The market’s supporters were saying that prices were high, but not too high, because US corporate profits were up by 10% in 2017 and the tax bill would add to them.

Still, many economists were skeptical. Even on a “dynamic scoring” basis (counting incremental growth to be created by the tax cuts), the tax bill would still require at least $1 trillion of new federal borrowing over a decade, and its timing of the stimulus was all wrong and sure to increase inflation, interest rates and fiscal drag.  Then, just to emphasize this end of things, Congress further doubled the stimulus last week in passing its bi-partisan two-year budget that added an additional $1.5 billion of unfunded spending. This will boost the fiscal deficit to around 5% of GDP, and total federal debt to around 110% of GDP, the highest level since World war II.  

Indeed, those who read the Good as it Gets report thoroughly discovered that Goldman’s optimism runs out after 2018, and that for 2019, US GDP growth would drop to 1.8%, even after the benefits of the tax cuts, which, the report said, would increase GDP by no more than 0.3% in 2018 and 2019, but disappear thereafter. 

This would suggest that the markets may have risen more than they should have – animal spirits had got the best of them, as often happens. A correction was overdue and has occurred, but it takes a 20% drop over two months to mark an official bear market and we are still a long way from that. But if the spirits roil up a panic, more lasting damage might occur.

John Maynard Keynes said that panics were not so much the result of bad reasoning by individuals as by the way markets are organized and driven by groups of professionals trying to figure out what other professionals will do. The global market capitalization of equity securities today is around $80 trillion, which means a sudden increase in volatility (the 1-day VIX jumped on Feb. 5th from 11% to 37%) can shake loose a lot of profit taking, portfolio repositioning or flight to safety. The nine-year bull market was built on low volatility in a risk-adjusted environment in which stocks returned more than bonds. This may be reversing, as we return to a more normal economy with 2% to 3% inflation and higher interest rates. Normal economies are supposed to be good for business in the long run.

But if the US GDP growth is to slide back below 2% next year, maybe we shouldn’t count on returning to normal just yet.  Is a bout of low-growth with inflation out there waiting for us next?

First published in Financial News, Feb. 6, 2018