Will Hong Kong Shanghai Bank Be the New Credit Anstalt
by Thomas P. Au, CFA, Author & Market Analyst. February 27, 2007
Arguably the biggest story from last week was that Hong Kong Shanghai Bank (HSBC) one of the world's largest banks, has taken a $10.6 billion hit on U.S. consumer loans, specifically in the subprime arena. (Forget for a moment, what happened to smaller concerns like New Century Financial or NovaStar.) These problems are not only bad in and of themselves, but in their potential effects on the global economic system. That's because the bank has ties to China through its original namesake, and to Britain and the United States, through the acquisition of Britain's Midland bank and America's Household International.
Like Austria's Credit Anstalt bank in relation to Germany in 1931, HSBC is located barely outside of China, but with important indirect ties to that country. (The bank's traditional area of strength has not been in China per se, but rather in lending to companies based in Hong Kong or elsewhere offshore China that do business in China.) And HSBC's links to the United States go far beyond what Credit Anstalt boasted. Besides being one of the largest banks around, HSBC thus represents a connection between the world's two most important economies like perhaps no other bank in the world. Thus, a problem in one country could be transmitted through HSBC via a weakening of the bank, to a curtailment of its role vis-à-vis the other country.
The danger arises because the world's two big economic bubbles are U.S. consumer spending and Chinese capital spending. HSBC's recent problems were tied to the former. So far, I haven't heard of issues for the bank in connection with the latter. Even so, the fact that HSBC is having major problems at one end of the spectrum has to be unsettling. And unfortunately I don't know enough about the bank's exposures at the other end to even guesstimate the extent of potential problems before they are actually reported.
At the risk of a slight digression, one knows that the U. S. consumer lending market is on its last legs when lenders like Bank of America considers illegal immigrants a hot market for its loan products, because everything better has already been mined. (I owned, then sold, the stock in the past year when the full extent of the bank's exposures became apparent to me. If I were to take a position today, it would be short.) This seems like a case of trying to suck the last bit of juice from an already oversqueezed lemon, an extreme application of the well known law of diminishing returns. HSBC, through Household International, was on the horns of the same dilemma.
And some think that Chinese capital spending may be in similar straits. Columnist Jim Jubak is a case in point. In his article "Time is Running Out on China's Economic Boom," he rightly points out that "the current spate of growth has been built on non-renewable human, environmental, and capital resources," which is to say that it is soon likely to regress to the global mean as Japan's economic miracle did in the 1980s. And such a regression, while normal for the United States, would represent a hard landing for China. That's because the distribution of wealth in that nominally socialist, and increasingly nationalistic, country is now so unequal (somewhat worse than the United States, somewhat better than Brazil), that large segments of the population would suffer even if the aggregates remained in positive territory.
The collapse of the Credit Anstalt Bank, with its ripple effect on Germany, probably was more responsible than events stateside, for the length and severity of the Global Depression of the 1930s. (And it ended Weimar, Germany's experiment with democracy, bringing about the rise of Adolf Hitler and national socialism.) That's because of its impact on the already-shaky economies of a whole continent, Europe. Because of China's economic clout (represented by the fact that it is now the largest international holder of U.S. dollars), the end of the Chinese economic miracle would have grave consequences for the United States, as well as for the rest of Asia. Hence I take little comfort in the presumed ability of the Fed to ward off the crisis. And because its importance is even greater in Asia than in the U.S., HSBC could have a major role in bringing the Chinese miracle to an end.
Some may find it hard to reconcile these remarks with my "constructive" investment posture for 2007. The reason I am not a full fledged bear right now is because historically, most of the nation's financial crises on one contributor's February 15th list, have originated in the corporate or international, rather than U.S. consumer, sector. (My investments are tilted in favor of industrial, capital goods, and international stocks, and away from U.S. consumer goods and financials.) The non-consumer/non-financial areas are quite healthy for now. Stateside, I believe the resident bear when he characterizes the (consumer) subprime mortgage and securitization markets as a "fungus" but like the resident bull (albeit with less assurance), I don't (yet!) believe that it will have national or global ramifications. Even so, this posture is probably skating on thin ice, because I regard this theme as "warm." And if I hear that HSBC has major problems with industrial exposures, perhaps to China's troubled state-owned enterprises (SOEs), my days as a "bull" will be numbered.
© 2007 Thomas P. Au
Thomas P. Au, CFA | Author & Market Analyst, R. W. Wentworth | New York City, NY | Email