Surprise collapse of regional Chinese bank sets off domino effect
First it was China. The end of May saw the collapse of an obscure Inner Mongolian bank, Baoshang, which had about $90 billion in assets and which had seemed perfectly healthy.
Why it matters: The government blamed misappropriation of funds by the bank's owner, but the damage was done. The interbank lending market in China seized up, especially for smaller institutions.
- Small and medium-sized Chinese banks are collectively as big as the large players, and they're very reliant on interbank funding. After Baoshang defaulted on its interbank obligations, it became very hard for smaller banks to convince larger ones that they were safe. The central bank ended up having to step in with $125 billion of emergency liquidity, and things still aren't back to normal.
Next came investment funds. The GAM Greensill Supply Chain Finance fund, in Switzerland, imploded in early June, followed in short succession by Neil Woodford’s Equity Income fund in the U.K. Then came French asset manager H20 Asset Management, running into similar problems.
- Much like Chinese banks, funds that invest in illiquid securities suddenly find themselves under extreme scrutiny. Each bad apple seems to infect another.
Be smart: This isn't a financial crisis, although it's very similar to how many crises start. Every bull market has a massive "bezzle," to use J.K. Galbraith's famous term. We're seeing the beginning of a rise in skepticism, and a shrinking bezzle. That's good for honesty; it's less good for asset prices.