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Monday, February 26, 2018

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.




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