Yi Xianrong: The crux of financial risk is credit overextending

Excessive credit expansion may not only lead to the flood of liquidity in the entire domestic financial market and the wind of various financial speculations, but also lead to the excessive financialization of China's economy and the blowing of the real estate market bubble.

(Since 2003, China's credit expansion has outpaced that of developed countries.) Excessive credit expansion has not only become the biggest preference of the current domestic government, enterprises and households, everyone wants to overuse the current Chinese financial market, and some of the policies adopted by the government have also led to excessive credit expansion. Photo/Visual China)

Yi Xianrong/Wen Wang Yanchun/Editor

It is necessary to put the prevention and control of financial risks in a more important position, resolve to deal with a number of risk points, focus on preventing and controlling asset bubbles, improve and improve regulatory capabilities, and ensure that systemic financial risks do not occur. In this year's government work report, further emphasis was placed on preventing and controlling risks in China's financial system. In particular, the collective study of the Politburo of the Central Committee on April 25 this year raised this issue to an absolute height.

At the Fifth Plenary Session of the 18th Central Committee in 2015, General Secretary Xi Jinping pointed out that the next five years may be a period of continuous accumulation and even concentration of risks facing China's development. We must put risk prevention in a prominent position, try to prevent it before it starts, worry about it before it happens, and strive not to have major risks. Since the 2016 Central Economic Work Conference, how to effectively prevent and control the risks of China's financial system has become the most important task in economic work in 2017.

It can be seen that the central government has raised the risk of preventing and controlling the risk of China's financial system to such a high level, and there are actually two problems here: one is how to prevent the risks of China's financial system; the other is how to control the risks of China's financial system. How to prevent the risks of the financial system means to explore the root causes of the risks in China's financial market, only in this way can we prevent financial risks; for how to control the risks of the financial system, it is necessary to accurately judge how big the current risks in China's financial markets are. Where are the risk points? What is an asset bubble? Where is the bubble again?

<h1>One</h1>

The outbreak of the 2008 U.S. financial crisis triggered the worst global recession since the Great Depression of 1929. Eight years have passed since the crisis, but the Great Recession that it brought about does not seem to have come to an end. It can be said that the outbreak of the financial crisis in the United States in 2008 not only surprised economists around the world, especially macroeconomists, but also made governments and markets question economists who could not predict the outbreak of this financial crisis.

For example, in a 2007 speech, Fed Chairman Ben Bernanke said that the US subprime mortgage crisis would not have a significant impact on the macroeconomy because the subprime mortgage crisis generated far fewer bad bank debts than the net value of the banking system. Therefore, some later analysis believed that the macroeconomic theoretical model at that time showed incompetence in predicting the 2008 US financial crisis, and there was no cure for treatment, mainly because the macroeconomic theory at that time ignored the financial system, especially the banking system. This is the main reason why modern economics has failed to predict this crisis.

Therefore, after the 2008 US financial crisis, the literature on the causes of financial crisis in macroeconomics has exploded, and many researchers have introduced financial factors, especially credit and monetary factors, into the framework of macroeconomic general equilibrium models. In 2016, the American Economic Association awarded the Clark Prize (the most promising American economist under the age of 40) to Princeton University economics professor Sanniekovo because of his 2012 article "Introducing Macroeconomic Models of the Financial Sector" published in the American Economic Review, which incorporated financial factors into macroeconomic models.

But can the integration of money, credit, and financial institution behavior into the framework of macroeconomic general equilibrium models or modern financial theory accurately predict future economic or financial crises? In fact, modern financial theory is also unable to predict the occurrence of economic crises, and it is also impossible to provide feasible and sustained effective solutions to economic crises when they occur.

Because modern financial theory or macroeconomics general equilibrium theory is trying to become a quantitative science like the natural sciences, ignoring the human behavior factors and the complexity of social systems, and basing its theories on a series of untenable or erroneous assumptions, such as the market can be adjusted to an optimal state; the self-interest behavior of the financial industry can maintain the stability of the financial system. Most modern financial risk management models are largely based on these deeply flawed assumptions of financial theory.

It can be said that this kind of financial risk management model with serious flaws and assumptions is equally impossible to effectively control and control financial risks and accurately predict and understand financial crises. In particular, the current generation of financial policy makers and financial practitioners are mostly trained by this set of financial theories, mostly captured by this set of "exquisite" financial theories, so the financial industry as a kind of "fetishism", not only can enhance the level of wealth, promote economic growth, so that excessive use of financial markets and various financial instruments has become the norm of this society, and believe that through the financial quantitative model can achieve the most optimal policy selection and management, you can adjust financial risks to a controllable range. Especially in economies like China, which have transitioned from a planned economy to a market economy, this phenomenon is even more obvious.

There are flaws and uncertainties in macroeconomic theoretical models and modern financial theories, and using these theories to assess whether there will be a financial crisis in China, the reasons and mechanisms caused by the financial crisis can only be discussed as different, and it is difficult to reach a consensus.

<h1>Two</h1>

Generally speaking, finance is the allocation of resources across time and space through credit, that is, the pricing of credit risk. And credit cannot be guaranteed through an effective legal system, or effectively incentivized and constrained by these acts, then it is inevitable that any party will overuse this commitment. In such cases, such parties are able to take the proceeds of the excessive use of such promises to themselves, and the costs to society as a whole or to others. It is also inevitable that financial market parties engage in high-risk investments. If credit expansion is limited to reasonable boundaries, the cost and benefit distribution of credit expansion of the parties can be attributed to the users themselves, and the parties' behavior will become cautious. This is the most important financial theory issue facing the global financial market at present, and it should also be the basis and focus of China's financial system reform in the future.

At the same time, not only has the unlimited credit expansion of enterprises and individuals or the excessive use of the financial system become the norm for the behavior of these subjects, but it is also a means used by modern governments to adjust social distribution and other relations. Because the excessive use of the existing financial system is not only diverse in ways and tools, but also very convenient to use. This is due to the characteristics of financial products, that is, the timeliness and explicitness of financial investment returns, while the costs and risks are potential or hidden. This not only facilitates the government's excessive use of the existing financial system, but also reduces resistance from all sides of society.

On the surface, this form of excessive credit expansion by government can be used by government policies to smooth out wealth and income relations between different enterprises, between different groups, between different classes, etc., and in fact it may also become the most costly redistribution method. This endangers not only the interests of the recipient, but also the interests of the taxpayer. Because the risk of this overuse of the financial system is ultimately borne by society as a whole.

For example, the US subprime mortgage crisis allowed low-income residents to buy housing through overextended credit and caused the securitization market to over-prosper, but eventually led to the outbreak of the US financial crisis and the collapse of the entire financial system, and the cost was borne by the whole society. Similarly, in the wake of the 2008 U.S. financial crisis, China built china's rapid economic growth and inflated the housing bubble through excessive credit expansion, which was also the result of excessive credit expansion. It has also become a source of risk for China's entire financial system.

For example, the degree of credit overextensition in China over the past few years can be reflected in the rapid expansion of the scale of the central bank's balance sheet, and it also shows the rapid expansion of the scale of China's financial industry in the past decade. In the past ten years, the asset scale of the banking industry has risen from 50 trillion yuan to 236 trillion yuan; the insurance industry has risen from less than 3 trillion yuan to 16 trillion yuan; trust assets have risen from less than 3 trillion yuan to 20 trillion yuan; and the asset management scale has risen from 300 billion yuan to nearly 18 trillion yuan. At present, McKinsey estimates that the current size of China's shadow banking has reached nearly 68 trillion yuan.

This excessive expansion of credit has not only led to the flood of liquidity in the entire domestic financial market and the wind of various financial speculations, but also led to the excessive financialization of China's economy and the inflated real estate market bubble. Data show that in the ten years from 2004 to 2014, the housing prices in Beijing, Shanghai, Guangzhou and Shenzhen rose by 374%, 346%, 505% and 420% respectively. If you add the crazy rise in house prices in these four cities from 2015 to 2016, the house prices in these cities have risen by more than 1,000%. In recent years, China's economic boom has been largely shaped by real estate, which in turn has been the overextension of various credit instruments.

This excessive credit expansion has allowed the gushing funds not to invest in the real economy but into the real estate market, blowing up the real estate bubble. This story continues in 2017. In other words, the excessive expansion of credit has pushed up asset prices across China, which is also the source of risk in China's current financial markets. If the government fails to curb credit overextending, it will not be easy to guard against risks in China's financial system.

<h1>Three</h1>

The excessive credit expansion of China's financial system is also related to the fact that China's financial market has not really embarked on the road to marketization and the government's excessive dominance of the financial market. If China's financial market is dominated by the government, the power of the government will not only become a tool for rent-seeking, but also a driving force for credit overextending. In this case, some people who are closer to government power are prone to break through the existing institutional rules and arrangements and over-expand their credit in order to arbitrage. The prevalence of wealth management products in Chinese banks is the result of the government's severe control of bank interest rates. If there is no such excessive control over bank interest rates, it is entirely up to the market to determine interest rates, and banks do not need to use wealth management products to circumvent control.

For example, the reason why China's stock market has not been able to go well in recent years and has come out of the results that match the sustained and rapid growth of China's economy is related to the Chinese government's excessive participation in the stock market and the Chinese government's big idea of financial reform.

Whether it is the recent documents of the central government or the relevant functional departments of the financial industry, basically believe that the current risk of China's financial market, the biggest problem is that the financial market structure is unreasonable, that is, the proportion of indirect financing led by banks is too high, and the proportion of direct financing dominated by the securities market is too low, rather than direct financing as in the FINANCIAL market in the United States. Such a financing structure will inevitably lead to a high proportion of debt for all domestic enterprises, high financing costs, and difficulties in financing small and medium-sized enterprises. Therefore, the development of direct financing at a transcendent speed and the listing of more enterprises have become a major strategic choice for the development of the national financial market.

However, the structure of a country's financial market depends not only on the country's credit system, but also on the country's market infrastructure (such as a fair and just trading platform, an effective market pricing mechanism, and a mechanism for protecting the rights and interests of small and medium-sized investors). If the basic system of China's stock market is not ready, even if the Credit System required by the Chinese stock market is the same as that of the United States, it is impossible for the Chinese stock market to develop. What's more, China's current credit system is completely different from that of the United States, and it is still an institutional arrangement for implicit government guarantees.

Since the beginning of this year, this kind of great leap forward in the IPO of listed companies is ostensibly to channel the dammed lake of listed companies' IPOs, open a convenient door for enterprise financing, and reduce the financing costs of enterprises. But why are Chinese companies pouring into the A-share market for IPOs, and even many companies that have been listed in Europe, the United States and Hong Kong are trying their best to return to the A-share market? Because the domestic stock market is not standardized, it is most beneficial to listed companies, and even listed companies can use the IPO of the Chinese stock market to get rich overnight. At present, China's stock market is a zero-sum game market, a large number of IPO companies, of course, the hurt is definitely small and medium-sized investors. This is the result of the government's excessive credit expansion of the stock market.

Where are the risk points or hidden dangers of financial security in China's financial markets? As analyzed above, the root cause of the financial crisis lies in the excessive expansion of credit, whether it is the stock market, banks, trusts, shadow banking, Internet finance, etc. As long as there is excessive credit expansion, no matter how to prevent it, financial risks accumulate in the end without a financial crisis. This was true of the U.S. financial crisis of 2008 and the housing bubble in Japan in the 1990s.

Since 2003, China's credit expansion has surpassed that of developed countries. Excessive credit expansion has not only become the biggest preference of the current domestic government, enterprises and households, everyone wants to overuse the current Chinese financial market, and some of the policies adopted by the government have also led to excessive credit expansion.

In short, to prevent and control the risks of the current Chinese financial market, it is not only measurable by a few simple indicators, but to start from the root causes of the excessive credit expansion of China's financial market in the past decade. This lucrative real estate market has not only become the driving force for the excessive expansion of credit in the domestic financial market, but also the source of innovation and development of various credit instruments in China. Therefore, it is most important to gradually deleverage and gradually squeeze out the bubble of China's real estate market, and to minimize the losses that may result from the risk of China's financial crisis; second, we must reflect on the current Development Strategy of China's financial strategy and make new choices; third, adhere to the principle of marketization and reduce the government's dominance of the financial market; fourth, comprehensively reduce regulatory arbitrage, such as bringing shadow banking under supervision and re-establishing the rules of stock market operation.

(The author is Dean and Professor, Institute of Wealth Management, Qingdao University)

(This article was first published in Caijing magazine on May 29, 2017)