[Viewpoint] Blowing bubbles in China

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[Viewpoint] Blowing bubbles in China

Moody’s Investors Service, Standard & Poor’s and Fitch Ratings can’t be happy.

Last week, the world’s leading credit-rating giants got scooped on the biggest rating decision of them all: whether to strip the U.S. of AAA status. Worse, the U.S. was downgraded by a company that few people have ever heard of - and a Chinese one at that.

While Moody’s, S&P and Fitch ignore the wreckage that America’s financial infrastructure has become, Beijing-based Dagong Global Credit Rating Co. was able to see right through a corrupt system that enables debt-addicted developed nations to appear fiscally clean. It recently rated U.S. debt at AA, two levels below the top grade.

Dagong is right to turn the ratings world on its head, although rating China higher than the U.S. involves a bit of hubris. Anyone who thinks China deserves a top rating or is devoid of debt land mines isn’t looking very hard, and worrisome bubbles are developing in a variety of sectors. Dagong’s rating of the U.S. raises some vital questions. One is whether a general bias toward the West plays a larger role in ratings than the ability of governments to repay debt.

An alien arriving from outer space might take one look at America’s balance sheet, conclude it’s an emerging nation and buy Indonesian debt instead. The same goes for Japan and its demographic time bomb. France, Germany and the U.K. possess challenges that might necessitate lower ratings if true objectivity were to enter into the mix.

It has been a humbling 15 years for credit raters. They completely missed the 1997 Asian crisis. They were asleep at the controls as the dot-com bubble burst. They lavished top ratings on junk and helped turn the U.S. subprime crisis into a global one. They were slow to fathom Europe’s debt fiasco.

Dagong Chairman Guan Jianzhong is absolutely right when he says: “The essential reason for the global financial crisis and the Greek crisis is that the current international rating system cannot truly reflect repayment ability.”

It’s the right message but the wrong messenger. Hedge fund managers aren’t betting against China gratuitously. It’s in no one’s interest to see the third-biggest economy crash. The idea that China’s national balance sheet is sound is a reach, though.

New York-based hedge fund manager Jim Chanos, of Kynikos Associates Ltd., says the massive stimulus efforts that saved China from the global crisis of 2008 are creating unbalanced growth. They are fueling bubbles and may be setting China up for a bad-loan debacle, he says.

A report by Fitch last week makes for interesting reading. The epic credit boom of 2009 was so successful that China is struggling to keep a lid on growth. Herculean efforts didn’t stop the economy from zooming along at 10.3 percent in the second quarter. The concern is that the data is understating the long-term costs of this growth.

In the first half of this year, Chinese bank lending was 28 percent higher than official numbers suggest, Fitch says. The reason: more and more loans are being repackaged into investment products, distorting the data.

Anyone arguing that China doesn’t have a housing bubble on its hands may want to reconsider. We don’t know how far the “Enronization” of Chinese credit goes. It seems clear that financial institutions have been engaging in complex deals that hide the nature and size of lending.

Repackaging loans and moving them off the balance sheet is exactly what got corporate America into trouble and almost killed Wall Street. Such practices raise the odds that China is paving the way for a wave of bad debts.

No one doubts China is booming. Less clear is the quality of that growth. It’s one thing if stimulus efforts create a broad middle class of consumers to replace exports. It’s quite another if China’s growth rests on a shaky foundation of soaring asset prices.

It may not be a coincidence that the Agricultural Bank of China didn’t impress the bulls last week after its initial public offering. Investors may be wondering about the ability of lenders to collect on loans. If you think Wall Street lacks transparency, just imagine investors trying to get to the bottom of China’s state-owned banks. China is working to cap housing prices, slow credit growth and halt efforts to move liabilities off of balance sheets. Doing so is more art than science. Move too aggressively, and the economy becomes more volatile. Act too timidly though, and today’s imbalances morph into tomorrow’s crisis.

The biggest problem with Dagong’s decision to rate China above the U.S. - AA+ with a stable outlook versus AA with a negative one - may be its faith in the power of growth. Just because China is booming today doesn’t mean it will be five years from now.

Few trust our debt rating system, but even fewer should take China’s bright fiscal outlook as a given.

*The writer is a Bloomberg News columnist.

By William Pesek
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