Tuesday's Top 10 with NZ Mint: The problem with China's local govt financing vehicles; 'China's real estate bubble may have burst'; Lights out in North Korea; A derivative's derivative; Dilbert

Here's my Top 10 links from around the Internet at 8 pm in association with NZ Mint.

I welcome your additions in the comments below or via email tobernard.hickey@interest.co.nz.

I'll pop the extras into the comment stream. See all previous Top 10s here.

Number 7 is today's must read.

1. Watch the local government financing vehicles - The key domino for New Zealand to watch in the fallout from the European crisis is China.

One of the reasons New Zealand coped so well after the 2008 Lehman crisis was that China's government told its banks to unleash a torrent of lending to local government financing vehicles to invest in infrastructure such as motorways, railways, airports and apartments.

This drove up demand for the iron and coal needed to make the steel used in this infrastructure.

That in turn increased export returns to Australia and helped support demand for New Zealand's own dairy exports to China, and its manufactured exports to Australia. More than half of New Zealand's exports go to the Asia Pacific region, while 7% of our exports go to the eurozone area.

John Key and the government are again relying on the Chinese to manage things so that any fallout is limited.

That all depends on China being able to pull the same trick again of a surge in infrastructure spending.

But Bloomberg reports below that the local government financing vehicles relied on in 2008 are now chocked full of debt they can't service because the projects aren't paying their way and it's much more than most estimated.

Debt accumulated by companies financing local governments such as Tianjin, home to the New York lookalike project, is rising, a survey of Chinese-language bond prospectuses issued this year indicates. It also suggests the total owed by all such entities likely dwarfs the count by China’s national auditor and figures disclosed by banks.

Bloomberg News tallied the debt disclosed by all 231 local government financing companies that sold bonds, notes or commercial paper through Dec. 10 this year. The total amounted to 3.96 trillion yuan ($622 billion), mostly in bank loans, more than the current size of the European bailout fund.

There are 6,576 of such entities across China, according to a June count by the National Audit Office, which put their total debt at 4.97 trillion yuan. That means the 231 borrowers studied by Bloomberg have alone amassed more than three-quarters of the overall debt.

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system.

“You should be more worried than you think,” he said of Bloomberg’s findings. “Certainly more worried than the banks will tell you.

“You know how this story ends -- badly,” he said.

2. The problem of not enough capital - Europe's banks need to raise €115 billion in fresh capital, with the biggest need for fresh capital being in Spain and Italy.

This graphic below explains the problem.

3. Another reason why China may not act quickly - Fortune's China expert Gordon Chang thinks the Chinese authorities may not intervene this time around for a couple of reasons, including because the Chinese political leadership is in transition.

The last time the global economy tumbled, Chinese leaders took action, decisively and quickly.  In July 2008, the Politburo adopted measures intended to boost exports and in November of that year the State Council announced its massive stimulus plan.  This time, Chinese leaders seem tentative.

There are three possible reasons for their relative inaction.  First, they can be underestimating the severity of the situation.  That’s unlikely, however.  Chinese leaders can be accused of many things, but obliviousness—at least when it comes to their economy—is not one of them.

Second, they may realize that, despite the accelerating downturn, there is not much they can do.  In response to the last downturn, they increased the country’s money supply beyond reasonable levels, thereby making monetary policy ineffective, and applied too much fiscal stimulus, burdening banks and lower-tier governments.  They can implement another round of stimulus, but that would only make current problems—principally inflation and the property bubbles—only worse and buy them at most 24 months.  As Fan Gang implied, perhaps they have decided that now is the time to take the medicine.

Third, Chinese leaders may be prevented from acting effectively by the country’s once-in-a-decade political transition, which formally begins next fall and continues for perhaps two years.  Unlike 2008, when the Communist Party and central government moved fast, the current paralysis at the apex of Beijing means that technocrats can now adopt only modest and inadequate steps.

There are reports that Vice Premier Li Keqiang, slated to become premier in early 2013, is already starting to exercise authority over the economy, perhaps chairing meetings but definitely helping to make decisions.  That’s not a hopeful sign as he has built up a solid record of failure in prior stints governing Henan and Liaoning provinces.

Yet in China’s faction-ridden politics, where each grouping is represented in the top leadership, Li will glide into what could become the most consequential post in the Politburo Standing Committee.  He has the backing of President and General Secretary Hu Jintao and, whether or not qualified to run the world’s second-largest economy, Li seems to be sharing duties with Wen Jiabao, who is not in the same faction as Hu and Li.  Because Chinese handovers take an extraordinary amount of time, it could be late 2014 before the new leadership team is finally settled in.  By then, however, it will be too late.

4. The latest rescue deal - Eurozone countries, but not Britain, have agreed to funnel €150 billion euros to the IMF to help bail out countries such as Portugal and Spain, but the Germans remain reluctant.

However, There were some encouraging signs the European Central Bank has increased its bond buying.

Contributions to the Washington-based IMF were controversial inside and outside the 17-nation euro region. The most potent central bank among the euro users, Germany’s Bundesbank, coupled its 41.5 billion-euro input to a promise that the aid not be earmarked for Europe.

Such recycling would violate euro rules, inspired by the Bundesbank, that bar central banks from financing government deficits. As a result, the euro area will lend to the IMF’s general resources, not to a special euro crisis fund.

5. Will China break? - Now Paul Krugman is having his doubts about China at the New York Times:

Consider the following picture: Recent growth has relied on a huge construction boom fueled by surging real estate prices, and exhibiting all the classic signs of a bubble. There was rapid growth in credit — with much of that growth taking place not through traditional banking but rather through unregulated “shadow banking” neither subject to government supervision nor backed by government guarantees. Now the bubble is bursting — and there are real reasons to fear financial and economic crisis.

Am I describing Japan at the end of the 1980s? Or am I describing America in 2007? I could be. But right now I’m talking about China, which is emerging as another danger spot in a world economy that really, really doesn’t need this right now.

Am I describing Japan at the end of the 1980s? Or am I describing America in 2007? I could be. But right now I’m talking about China, which is emerging as another danger spot in a world economy that really, really doesn’t need this right now.

6. Here's a satellite picture of what North Korea and the rest of North Asia looks like at night - Bit quiet. The white patches are where light is emitted.

7. 'China's real estate bubble may have burst' - That's the conclusion from expert China watcher Patrick Chovanec in this excellent Foreign Affairs piece.

This is today's must read:

Real estate woes are already sending shockwaves through China's broader economy. Chinese steel production -- driven in large part by construction -- is down 15 percent from June, and nearly one-third of Chinese steelmakers are now losing money. Chinese radio reports that half of all real estate agents in the southern city of Shenzhen have closed up shop. According to Centaline, more than 100 local government land auctions failed last month, and land sale revenues in Beijing are down 15 percent this year. Without them, local governments have no way to repay the heavy loans they have taken out to fund ambitious infrastructure projects, or the additional loans they will need to keep driving GDP growth next year.

In a few cities, such as coastal Wenzhou and coal-rich Ordos, the collapse in property prices has sparked a full-blown credit crisis, with reports of ruined businessmen leaping off building rooftops; some are fleeing the country. The central bank's decision on December 5 to lower the reserve requirement ratio for the first time in three years signaled a broader move to pump money into the economy. Beijing has directed banks in Wenzhou to extend emergency loans to troubled borrowers. Of course, officials could halt the sell-off simply by handing developers enough cheap loans to allow them to carry their inventory. But such a strategy risks re-inflating the bubble.

The impact of a housing downturn would have a significant impact globally. International suppliers who have been fueling China's construction boom -- iron-ore miners in Australia and Brazil, copper miners in Chile, lumber mills in Canada and Russia, and multinational equipment makers such as Caterpillar and Komatsu -- could be hard hit. Heavy losses on real estate and related lending could damage investment and consumer confidence, undermining the rising tide of Chinese demand that has been a much-needed growth engine for everything from Boeing airplanes to Volkswagen and GM automobiles to KFC and McDonald's fast food.

This is the scariest bit:

Ironically, as Chinese investors start pulling their money out of property, many are putting it into bank- and trust-sponsored "private wealth management" vehicles that promise high fixed rates of return but channel the proceeds into investments -- like real estate developers and local government bonds -- whose returns are themselves predicated on ever rising property prices. Many fear this repackaging of real estate risk is laying the foundation for a follow-on crisis that some are labeling the Chinese equivalent of Wall Street's collateralized-debt-obligation mess.

8. Just what we need - International Financing Review reports that a new product is being developed to help banks offset the counterparty risk they take on with Credit Default Swaps.

It's going to be called a Contingent Credit Default Swap. Just what we need. A derivative on a derivative that helps offset risks taken on one side trading a derivative...what could possibly go wrong...

A new product to offset counterparty risk could be launched as early as January. Single-name contingent credit default swaps, which base their notional amount on a reference entity’s market value, have traded for years on a bespoke basis, but the product is now getting a facelift. Indexed contingent CDS are expected to begin trading in the first quarter of 2012 and could start as early as next month.

The new CCDS will initially trade using indices such as the CDX IG in the US and iTraxx and SovX in Europe. Dealers say that once interest has grown sufficiently, they plan to use Asian CDS indices as well.

David Kelly, director of credit products at data analytics provider Quantifi, said the new indexed CCDS ought to alleviate several simulation problems that existed with original CCDS. “Doing this on a single-name by single-name basis has never been efficient in dealing with counterparty risk,” he said. “Most of the risk has to be dealt with on an index or portfolio-style basis.”

9. Short term funding - Leith van Onselen at Macrobusiness has a useful chart showing the sharp rise in short term foreign funding for the Australian banks in the last year.

Note the sudden spike in short term funding and paralysis in long term. This is precisely what transpired in 2008 when the long term markets for unsecured debt froze and drove the banks to short term markets. When Lehman hit and froze those as well, the banks were left high and dry.

10. Totally Jon Stewart on how Fox News thinks the The Muppets movie communist propaganda...