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China Bank Stocks, Credit Rating Agencies, and Iron Ore Prices

June 6, 2010

Here are three short clips from my appearance Thursday on CCTV News BizAsia.  They cover three topics:

Discussing the recent drop in Chinese bank stocks to record lows for the year, I made the following points:

  • In part, the decline is due to overall jitters in Chinese stock markets over the last couple weeks, caused by concerns over the Eurozone crisis as well as efforts by Beijing to rein in bank lending and property prices.  But it’s also just beginning to dawn on the market just how many Chinese banks will be seeking to raise capital over the next few months.  Besides the headline IPO by the Agricultural Bank of China, dozens of banks will be trying to raise funds.  Even if you’re bullish on the Chinese banking sector, you have to wonder whether there’s enough appetite to buy all the stocks on offer.
  • Given the soft market, it’s not a particularly good time for Chinese banks to be raising capital.  That raises the question why they’re all in such a rush to raise funds now, even amid poor valuations.  Some skeptical investors think it’s because they have no choice, that they desperately need to shore up their balance sheets against all the as-yet-undisclosed bad loans they made in last year’s lending boom.

We also talked about Warren Buffett’s testimony before the U.S. Congress on credit rating agencies:

  • I noted that credit rating agencies, like Moody’s and S&P, have been under fire for some years now for their repeated failures in foreseeing financial disasters such as the Greek debt crisis, the U.S. subprime/CDO crisis, and Enron.  Critics say this failure is due to a conflict of interest.  Originally, these agencies sold their ratings to investors who wanted impartial advice.  After the SEC required securities issuers to obtain ratings, the agencies began charging the issuers instead.  Some say this makes it hard for ratings agencies to be tough evaluators of the companies that, after all, are their paying customers.
  • Buffett, who is the largest shareholder of Moody’s, made an interesting observation during his testimony.  He said that he doesn’t rely on credit agency ratings to make investments, he evaluates the companies and draws his own conclusions.  Fair enough.  But if Buffett doesn’t even find his own agency’s ratings useful, why should other people have to buy them from him?
  • The U.S. Congress is looking at various ways to reform the role credit ratings agencies play, by removing this conflict of interest.  The House approach would no longer require issuers to obtain ratings, and let the market decide if it’s willing to pay for those ratings or not.  It would also make rating agencies liable to investors who relied on their advice, much like auditors.  The Senate version would have regulators, rather than issuers, choose the rating agency.  Regardless of how they proceed, however, credit agency ratings are still deeply embedded into the Basel framework for global regulation of banks.

Last but not least, we talked about ongoing negotiations over the price Chinese steelmakers pay for iron ore.  I mentioned that:

  • The price of iron ore has been extremely volatile over the past year due to uncertainty over direction of the global economy.  The system of one-year contracts that used to govern iron ore sales to China has broken down, creating a lot of uncertainty for steelmakers over input prices.  The mining companies blame Chinese steelmakers for breaching their contracts last year to buy iron ore on the spot market when it fell below the contract price.  China blames the “big three” mining companies, which control 3/4 of the world supply, for using their global dominance to squeeze their buyers.
  • Despite being a major buyer, China’s bargaining position is weaker than it appears.  Last year, China thought it would get a good price on iron ore due to falling demand elsewhere.  Instead, mining companies refused to budge.  In my view, that’s because China was more focused on boosting output and employment through its stimulus, rather than profits.  As long as the Chinese were determined to subsidize growth, regardless of higher prices, they had little real leverage over suppliers.
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