“A belated Happy New Year to you and as always may I commend the excellent service which you and Eoin provide.

“I have come across a very interesting article in the Australian Financial Review of Feb 2 & 3, 2013 enclosed herewith.

“The headline is self explanatory. “ China 's risky real estate game”. It seems that the Chinese Real Estate Bonds and “Corporate Debt High Yield Market” has gone from zero to 25% of the Asian High Yield Bond Market, and is obviously worth Billions! As per the article in the first 20 days of January some “15 USD Bond Raisings” in this sector have been placed. If the figures are to be believed according to ratings agency Fitch some 2 USD Trillion in real estate loans have been placed through the Chinese Property Bond Market.

“It seems to me that from the tone of this article very few regulations and/or oversight by the PBOC have been instituted. Already there have been cracks in this market as per the 2 nd page, 3 rd column, where the Shanghai branch of a small bank (Huaxia Bank) at first defaulted on a repayment of one of the short term property placements (I don't think it was a Bond), which was subsequently honoured but without interest payments.

“It is interesting that this issue has been brought to the fore by GMO who of course over the last few years have been Mega Bears. They also predicted a much lower US Stock Market in 2009 which obviously did not materialise.

“However 2 Trillion USD in short term Property Bonds being issued both to Chinese and foreign investors is a much bigger issue to consider and assess.

“Do you have any opinion or feedback on this issue or does the collective perhaps have knowledge about the size and regulation problems surrounding this market and how it is regulated by the Chinese Authorities?”

Eoin Treacy's view Thank you for this informative email which I'm sure will be of interest to subscribers. You may recall the collapse of private lending networks in the manufacturing hub of Wenzhou in the 2 nd half of 2011. Monetary tightening had cut off access to funds for high yield borrowers and they had resorted to high interest loans from private consortiums to fund their operations. As one collapsed, it set off a chain reaction among others in the network. The result of this mini-crisis was that measures were taken to make more credit available to small to medium-sized companies. We might consider the situation as a precedent for what might happen should one of the larger networks fail. (Also see my trip report from China posted on October 26 th 2011).

We might ask to what the extent is any shadow banking system monitored by its respective regulator, but what seems clear is that the PBOC is aware of the challenges facing the sector. The size, lack of transparency and reckless way in which such high yield transactions are put together places them very squarely in a highly risky category of investment. As such, a caveat emptor approach to the sector is appropriate. The government will ensure the survival of the banking sector but it is debateable how many bond holders would be saved in the event of widespread defaults.

The simple question is how likely is a Chinese credit crisis right now? The thrust of easing measures to date have been aimed at supporting the banking sector which suggests measures are being taken to bolster the sector. Let us also not forget that stock market valuations are still attractive. Since the central bank is currently engaged in an easing cycle and since credit is most at risk from tightening, the potential for such a worst case scenario, described in the article you supplied, currently looks remote. However, when the central bank next moves towards tightening, which could be a few years hence, the issue of the high yield credit market could be entirely more relevant.