This week the bank came: not to us as we do not borrow, but to a big factory nearby. They took the bosses Benz, an Audi and a BMW. The factory closed on the 30th of September, which is the end of the quarter and the day of reckoning in this case. This area is almost totally dependent on the timber industry. If you are not in the timber business, or servicing the timber business, you are probably not in business at all, so the closure of this factory and another large one on the same day, means serious trouble.
This little town has about 20,000 permanent residents and around 8,000 workers from poorer parts of China who come here to work in the timber factories. These outsiders hear of the work opportunities from friends and relatives and make their way here on trains and buses without pre-arranged work. They just lob here and walk around checking out the chalk boards at every factory gate until they find themselves a job. It used to be easy, but not now. They are gradually drifting back to the inland provinces and to penury.
All the talk now is of tough times. The collapse of these factories is no surprise, it has has been coming for a long time and in some ways is a continuation of the Lehman Brothers train crash, but it would have happened eventually. The industry was booming up until the the start of the Great Recession. All you had to do was start producing and wait for the customers to come. And they did come, from all over the world and from all over China. This area supplied 60% off all the solid wood flooring sold in China. (Just think about that for a second!) Cash was easy to come by. If you had land, the banks were willing to lend, and if you didn't have land the gray lenders would lend on a promise - at a price. Every boss had a big Audi and a young girlfriend or two. Nights were spent in tea shops and bars. It was party time.
Decoration in the home of a minor timber boss.
A marquetry castle built on borrowed money
But the crash did not come immediately after Lehman as it did in the West. There was plenty of momentum left in the Chinese economy and so the domestic market rolled on. In part that was because people here are not so economically literate and certainly not so well informed. I remember thinking at the time that this was a very good thing. Imagine what would have happened if China also stopped when the music stopped in 2008. Luckily they also had the Olympics to think about and then the Shanghai Expo in 2010. Of course, they also had the Szechuan earthquake in 2008 and that was far bigger news than the collapse of some unheard of bank in the US.
The Chinese banks were by 2009, of course, aware of the implications and so they responded by tightening credit to SMEs, but all that did was to boost the gray lending market. The buckets of cash held by all these bosses were still sloshing about and the sharks were happy to pay them 20% because they could re-lend at 30% - and more for short-term money. These local timber factories should have been reining in spending at this time, but many of them went aggressively after domestic market share, opening their own retail networks across China. And to make matters worse, firms were still able to expand their lending from banks if they had guarantees from other strong firms. This could happen, I think, because of the absence of a sophisticated title registry for land and also because banks did not have a central database where they could check what loans were already made against what property. I am not sure if I am right about this, but if there is such a system, the fact that multiple loans and guarantees could be made without substance shows that it does not work. The fact is that corruption subverts whatever system is put in place anyway.
So the house of cards continued to be stacked higher. All that was necessary to bring it all down was a tiny gust. The slowdown in the construction market here has not been sharp, but that is another complicated story so I won't talk about that now, but there has been a deep slump in the "decoration market". What that means is that, even if apartments are being built and even if some of them are sold, they are not being fitted out. If no one is doing fit outs, then there is no demand for flooring. This has naturally led to cash flow issues for many factories in the last two years or so.
One weekend in late 2011 some fool-son of a factory boss blew a few million in the casinos of Macao. That caused the collapse of the business because no one was in a position to come to the rescue. This was just one of many money-losing scenarios that occur when money comes easily. Another boss I know bought the family's first brand new car at about the same time. His son soon ran someone down causing serious injuries resulting in bills of several hundred thousand RMB. Soon after he managed to get the money together to settle this, his wife hit someone resulting in another bunch of huge bills. The factory bosses no longer had the cash to make further loans, indeed they were now calling in their money.
At the end of 2011 a loan shark with a basement full of luxury cars in an office tower here in the city jut a few blocks from where I live woke up one morning knowing that the game was over. I don't know all the details, but he was only in his 30s and the story goes that he had a few years earlier conspired with his mate who was managing a local bank branch. He borrowed a million with no collateral and immediately put it into another local bank, obtaining a gold credit card in the process. From these humble beginnings and an overdose of self-confidence he was able to leverage his cash and that of his young factory-owning friends into a multi-billion Yuan loan business. On that day in late 2011 the police arrested him and his bank manager mate as well as a bunch of officials who had turned a blind eye in return for certain incentives. The collapse of this illegal lender wrought havoc the village where I have my factory. There was a whole bunch of reciprocal loan guarantees that were being called in. Many businesses went to the wall and those that survived were now crippled by debt including the two factories that limped on until last week.
In the two years since that first collapse the banks have continued to withdraw their support. That was easier said than done because they were in up to their necks and they did not want to precipitate a crisis, so they trod softly while cajoling these companies with threats of foreclosure. The local informal-lending network based on family and business connections was in overdrive trying to keep the banks at bay, but the underlying businesses were no longer viable. It was an endless cycle of good money following bad and so the other day, two years after the first loan shark went down, the second wave crashed. People are saying that this wave is going to take out up to one third of the businesses in the village. I cannot say, but I know that it is not a pretty picture. The combined debt of these two firms was about US$25 million and I would estimate their assets at less than $10 million at best. Another factory I deal with has debts of about US$8 million and their annual profits are only about $1.5 million and they have no cash. Half of these debts are from loan guarantees to others.
My sense living here is that this situation is a microcosm of what is going on all over China. I may be wrong and I really hope that other places are faring better than my area, but from what I hear there is not a lot of good news. What we need is for the global economy to pick up quickly so that these business can step back from the brink. What I can say for sure is that the appetite for debt and high living among my timber colleagues has certainly been curbed. The hangover is painful and those that do survive will be a lot more economically literate then they were in the heady days before 2008.
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