Has China’s government unleashed a ‘moral hazard’ in the market?
Ling Huawei, a reporter for Chinese business news website Caixin, has an interesting take on the current stock market travails in China.
He says in a Tuesday analysis that the Chinese government had no real reason to intervene in the ongoing market turbulence. He argues the A-share market’s slide isn’t jeopardizing the country’s financial stability and that regulators stumbled by not resisting calls to step in. The upshot is that investors and institutions now expect the government to act no matter what.
Asia Unhedged thinks Ling is right spotlighting the fact that government interventions over the last week have created a so-called moral hazard in the market.
The definition of a financial moral hazard means one person takes more risks because someone else bears the burden of those risks. In short, if the government says “we will backstop the market to make sure no one takes huge losses,” then retail investors have no reason not to make huge purchases with huge risk. This creates some mighty big problems in the long run.
To recap, the mainland’s A-share stock market fell more than 30% in the three weeks through Friday. Over the weekend, government regulators stepped in with new policies to stabilize the market. The moves had their intended effect Monday, sparking a huge rebound. But on Tuesday the Shanghai Stock Exchange Composite Index shed 1.3%.
Some in China argue strongly for a bailout, saying that China is nearing a financial crisis if the losses continue.
“These voices have been so loud that it is difficult for regulators to ignore them,” wrote Ling. But the measures to shore up investor confidence “are inconsistent and prove that policymakers lost their bearings. The bottom line is this: Only a systemic risk that threatens financial stability justifies a government bailout.”
Ling says this isn’t happening. China’s major financial institutions are still safe, so there’s no need for the government to step in.
The people crying for a bailout are the ones who lost money, traders and investors who bet too aggressively on leveraged buys and did not hedge against risk.
“Unfortunately, the securities regulator has again given in to pressure and taken measures that do not suit its role,” Ling wrote.
The cave-in sparked a raft of measures. First the China Securities Regulatory Commission (CSRC) told 21 securities firms to use their own capital, about 120 billion yuan, to buy exchange-traded funds linked to blue chip stocks on the Shenzhen and Shanghai bourses. The firms also promised not to sell any of their holdings until the benchmark index recovers to at least 4,500 points. Then regulators encouraged institutions to resume the margin lending they had originally tried to curtail. Don’t forget the original margin restrictions are one of the causes of the recent rout.
“These are clearly not market-driven decisions,” wrote Ling. “And the intervention raises a thorny question: Who takes the blame if the securities firms suffer losses because they had to make investments against their better judgment?”
The government wants investors to believe it will save them from suffering big losses in the stock market.
“In a healthy market, investors make independent decisions about whether or not to buy or sell a stock. This is how the market prices the value of shares,” wrote Ling. “But in the A-share market, government intervention disturbs the price discovery process because it unifies investor expectations and encourages them to make the same choice. This means investors no longer care about the true value of a stock. They only wonder when the government will step in and how much extra liquidity will be available. In this scenario, investing becomes gambling on the government’s actions.”
Asia Unhedged doesn’t agree with Ling on all points. We definitely agree that the stability of China’s financial institutions was pretty solid going into last weekend. And we’ve said before it also looks like the government is doing a lot of ad-hoc policy moves without any rhyme, reason or transparency. Still, the jury is out on whether the government’s effort to halt the slide will prevail or not, though it seems some unnecessary evils have definitely been unleashed.