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LGFV (Local Government Financial Vehicle) are companies set up, fully owned, and operated by local governments that borrow money from the bankin

LGFV (Local Government Financial Vehicle) are companies set up, fully owned, and operated by local governments that borrow money from the banking and financial system to engage in businesses that are fiscal in nature, like infrastructure investment and public affairs. Local governments can't sell bonds and Central government takes most of the taxes so LGFV is the only way they can finance their projects. Most of that $5.8 Trillion valuation is not going to vanish because they are real investments into infrastructure. Most problems come from wrong cash flow estimates, and lower than estimated returns and some nonprofitable investments. The actual potential loss or haircuts investors are facing is some percentage of that sum. Probably few $100's of billions, maybe even close to $1T. The reason why there are defaults is because Chinese government wants to fight moral hazard problem that comes from bailing them out. The government will allow certain number of LGFVs to default to set an example (like Lehman Brothers) but if the credit squeeze starts to hurt "Chinese main street" they will step in.

sailfast 8y ago
How much accounting regulation is actually enforced on these? How many ghost projects or empty infrastructure with revenue booked using estimated values instead of real sales? I don’t doubt that it won’t be an entire haircut, but to say these function like regular bonds seems odd. Is there a contagion concern here? What other products are collateralized using these? We saw this of course with well-rated packages of loans actually being manure. Anything like packaged LGFVs with hedges? Asking because I have no idea and am legitimately curious about the possible downsides.
duxup 8y ago
Was Lehman Brothers really an intentional "example" or was just the first one to go and nobody was ready to act? I got the impression that they just weren't ready to respond and it was less so "hey let these guys fall to set an example".
Kadin 8y ago
Serious question, as I don't really understand LGFVs: if most tax revenue goes to the central government, how does the local government intend to pay back the financed money? Are all LGFVs tied to projects that are intended to create revenue? I could see that working for land development, maybe some infrastructure... but if they are selling bonds to cover day-to-day public affairs, that doesn't seem sustainable. If those expenses aren't covered by current tax revenue, where are they going to get the future revenue to pay the investors, plus interest, plus ongoing day-to-day expenses at that point? Does anyone know what expectations or models they are using in issuing these, or what the buyers' assumptions are? That would seem to be important. If someone is buying a 30-year note expecting the tax base growth to be 8% p.a. over that 30 years, with that compound growth covering the principal, interest, and still keeping things going down the line, things could get really ugly if growth is even a bit below that. The municipality would have to choose between day to day expenses and interest payments, potentially.
Iv 8y ago
I have a very naive question: What is the problem with letting these LGFV fail and debt disappear with them over a few years? My understanding is that it would create a bit of inflation but the volume would be manageable and inflation is not much of a problem in a growing economy. LGFV do not look like a financial product that can be bought so there does not seem to be any risk of contagion. This is all government matters so the moral hazard can be easily avoided if the government is willing to punish harshly the officials that put their cities in this situation. Financial punishment is not the only way to punish unwise risk taking.

sailfast 8y ago

How much accounting regulation is actually enforced on these? How many ghost projects or empty infrastructure with revenue booked using estimated values instead of real sales? I don’t doubt that it won’t be an entire haircut, but to say these function like regular bonds seems odd. Is there a contagion concern here? What other products are collateralized using these? We saw this of course with well-rated packages of loans actually being manure. Anything like packaged LGFVs with hedges? Asking because I have no idea and am legitimately curious about the possible downsides.

duxup 8y ago

Was Lehman Brothers really an intentional "example" or was just the first one to go and nobody was ready to act? I got the impression that they just weren't ready to respond and it was less so "hey let these guys fall to set an example".

Kadin 8y ago

Serious question, as I don't really understand LGFVs: if most tax revenue goes to the central government, how does the local government intend to pay back the financed money? Are all LGFVs tied to projects that are intended to create revenue? I could see that working for land development, maybe some infrastructure... but if they are selling bonds to cover day-to-day public affairs, that doesn't seem sustainable. If those expenses aren't covered by current tax revenue, where are they going to get the future revenue to pay the investors, plus interest, plus ongoing day-to-day expenses at that point? Does anyone know what expectations or models they are using in issuing these, or what the buyers' assumptions are? That would seem to be important. If someone is buying a 30-year note expecting the tax base growth to be 8% p.a. over that 30 years, with that compound growth covering the principal, interest, and still keeping things going down the line, things could get really ugly if growth is even a bit below that. The municipality would have to choose between day to day expenses and interest payments, potentially.

Iv 8y ago

I have a very naive question: What is the problem with letting these LGFV fail and debt disappear with them over a few years? My understanding is that it would create a bit of inflation but the volume would be manageable and inflation is not much of a problem in a growing economy. LGFV do not look like a financial product that can be bought so there does not seem to be any risk of contagion. This is all government matters so the moral hazard can be easily avoided if the government is willing to punish harshly the officials that put their cities in this situation. Financial punishment is not the only way to punish unwise risk taking.