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[randomness]

After many months and billions borrowed, the Chinese authorities have finally cracked down on the practice of importing copper as collateral for loans to get around the government's attempt to tighten lending.

Via the FT, Michael Liang gives more details about the Chinese copper scam from my earlier post:

He [the trader] said that on March, clothes makers, food manufacturers, and others who have never bought copper before were massively buying copper from the tariff-protected warehouses, in Guangdong for example.

These enterprises purchased copper just to get L/C [me: letter of credit] financing, in which banks finance the purchase of the imports for 90 days.

The reason that banks love to do this business – and markets have become so competitive and rates so low – is that 1) the transaction is off the balance sheet, and 2) bank clerks get paid a direct commission on the L/C.

The FT adds: "Either way though, you’ve got an impressive example of banks and corporates teaming together to bypass the government’s clampdown on leverage. Indeed, we’re getting a very distinct ‘whac-a-mole‘ feeling here; as soon as Chinese regulators clamp down on one form off informal lending, another one springs up."

Comments

[cerebralpaladin.livejournal.com]

Okay, now I think I understand. It has to do with letters of credit and strange willingness to not have actual collateral remain. The idea is this: you borrow $100K from the bank to buy copper on day 0. The deal says that you have to use the money to buy copper, and you have to pay back the money on day 180. On day 1, you buy $100K worth of copper. On day 2, you either sell the copper, or take out a loan backed by the copper, and you end up with roughly $100K cash (maybe, depending on the deals, you've taken a hair cut and only end up with $80K cash, but the point is you get a bunch of cash). You still don't need to pay back the initial purchase loan until day 180, so you're okay there. And apparently that initial loan doesn't require you to pay it back if you sell the copper early or if you take out another loan also backed by that copper. Let's assume for the moment that the second transaction is actually a sale, just to keep things simpler. So now you invest your new $100K cash from day 3 to day 179. On day 179, you cash out, and you pay back the bank for the initial $100K loan. As long as you've made money, counting the fees and such, over that 180 day period, you end up ahead. You've basically gotten a 180 day unsecured loan that the bank can (for unknown, crazy regulatory reasons) classify as a letter of credit for buying copper. (And of course you can then layer on an additional level of craziness; instead of cashing out, you can presumably make a new deal and essentially rollover the loan, as long as you can keep buying and selling copper on credit.) Of course, the problem is that if you lose the money in the meantime (or if the second copper deal depends on the copper going up in value), then the bank is sitting on a bad loan with no actual collateral. The whole thing doesn't make any actual sense, but...

[r-ness.livejournal.com]

The whole thing doesn't make any actual sense, but...

...but for the crazy regulatory reasons you mention before.