Someone asked me to research the scandal involving China’s “Wealth Management Products” (WMPs). Cynically, “WMP” stands for “Weapons of Mass Ponzi”. Here are some links.
A WMP is a “guaranteed” investment with a high rate of return, typically 4-5% or 10%. (China has higher inflation than the USA, making 5% not as attractive as it would be in the USA.) However, banks are not required to list the WMPs as liabilities on their balance sheets. It’s a system designed for abuse. It’s a type of “shadow banking system”.
So what we’re talking about is billions of dollars of investor money floating on and off (mostly) small Chinese bank balance sheets and flowing through China’s under regulated, underground banking system.
The big Chinese banks have voiced their concern. The Bank of China’s chairman called WMPs a Ponzi scheme right out.
There are similar products to WMPs in the USA. They are called “structured products” or “structured finance”. A guaranteed high return would be too obvious. Instead, they’re linked to other assets, with a cap and floor on gains and losses. One example is “A 1 year structured product linked to Yahoo stock paying a 3% yield. For every 1% that Yahoo goes up or down, the value of the structured product goes up or down 0.5%. The gain is limited to 10% of the gain in Yahoo stock, and the loss is limited to 10% of the loss.” Structured products are fancy derivatives designed to hide the profits for the bank. The bank issuing the structured product hedges with options, futures, swaps, and other derivatives, making a guaranteed profit. Following my example, the bank could hedge with options and make a guaranteed profit.
In effect, the bank is borrowing money from the structured product buyer at a cheap rate. Even worse, the structured products are unsecured notes. If the bank goes bankrupt, the structured finance investors become unsecured creditors of the bank. If you buy a structured finance product in the USA, you are lending the bank money as an unsecured creditor. The bank uses the proceeds of the structured product sale to finance its other operations.
Amusingly, the SEC passed a rule saying that, whenever a bank sells a structured finance product, they must also submit a Python program that shows how the valuation rule works.
You’re an idiot if you buy a structured product in the USA. The returns are lousy compared to just buying the underlying and some options, *AND* you’re an unsecured creditor of the bank. Similarly, you’re an idiot to invest in a WMP in China. There’s no such thing as a high guaranteed return. Usually, it’s a Ponzi. Sometimes, the WMP seller makes risky bets, knowing they can declare bankruptcy if their gamble fails.
The current scandal involves Hua Xia Bank and Pu Tingting. As usual, the blame will be put on one person, rather than blaming a corrupt system.
The advertised yield on the product issued by Hua Xia Bank was 11-13 percent over one year, more than triple the one year, state mandated 3 percent deposit rate.
Allegedly, Pu Tingting was not authorized to sell those WMPs. Hua Xia bank claims they are not responsible for the default and loss. Will China’s government bail out the investors who lost money? Will they be stuck holding the bag? Whoever knows can profit. Someone can buy up the notes cheaply, and then lobby for a bailout. Pu Tingting was an employee of Hua Xia bank. That makes them partially responsible, although China’s government can do whatever they want to resolve any problem.
When you’re running a Ponzi scam, you need a steady stream of suckers to keep it going. With the implosion at Hua Xia, people might pull their money out of *ALL* WMPs in China. This will cause other defaults. Also in a Ponzi, the first people to withdraw profit (or lose less). Knowing a crash is coming, insiders who withdraw early may do well.
A pro-State troll says “HAHAHA!! This proves regulation is needed!” The State causes and exacerbates the problem. With a policy of high inflation, investors are forced to chase returns. A guaranteed 5% return seems juicy, but when inflation is 20%-30% or more it isn’t that great and it’s believable. High inflation forces people to invest their savings, enabling criminals to trick stupid people. With gold as money, you can hold gold and be practically guaranteed to preserve your purchasing power. Sound money enables financially clueless people to protect themselves, by holding physical metal.
Another problem is limited liability incorporation, which limits losses in a scam. Paradoxically, the State protects Ponzi scammers, putting them in the relative safety of prison, rather than getting lynched by their victims. Another problem is the bailout economy and “too big to fail”, limiting losses. For example, the SIPC coverage limit was retroactively raised to $1M, protecting some of Bernard Madoff’s politically connected victims. Similarly, China’s government may decide to bail out Hua Xia and the WMP investors.
Another problem is that most of the leaders in our society are criminally insane. This enables Ponzi scammers to fit in well with the leaders, because they have the same personality type. Then, the Ponzi scammer’s victims feel comfortable. “He must be an honest person. Otherwise, all the insiders he hangs out with would have noticed that there’s something wrong with him.”
Another problem is that banksers write financial regulations, and then other banksters are hired to implement and enforce the law. The WMP problem in China is exacerbated by laws that China already has. China’s government controls interest rates. China allowed the banks to not include the WMPs in their books.
In the USA, the government indirectly fixes the guaranteed rate of return via the Federal Reserve. There is no law forbidding higher returns, but it’s impossible due to inflation and market volatility, the expansion and contraction of the money supply. In China, the government has explicit limits.
China has a “modern” economy like the USA. The WMP products are pretty flagrant Ponzis. By offering a high guaranteed return and placing them off the banks’ balance sheet, it’s a system designed for scammers. The USA’s “structured finance” products are similar to WMPs, but the extra complexity helps hide what’s actually happening. The only “advantage” of a more sophisticated financial sector is that financial crimes are hidden under more layers of derivatives and complicated calculations.