When Wenzhou Sneezes

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Photograph by Patrick Zachmann

Cobbled together At a shoe factory in Wenzhou. Declining margins have brought economic uncertainty to the city

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For a while, business was very good for the Kid. His fund grew to $15 million at its peak. Borrowers were paying back their debts quickly. In one week in May, for instance, the Kid took in nearly $8 million in repaid loans and interest. Many of the borrowers were small-scale real estate developers who needed money to fund projects — but that's precisely why the Kid and others like him face problems now. Continued economic uncertainties and tighter mortgage policies have made property buyers increasingly cautious, and real estate sales have slowed dramatically. The people of Wenzhou "plowed their money into high-interest loans," says Victor Shih, a political scientist at Chicago's Northwestern University who studies China's financial system. "That was unsustainable because the high-interest loans went back into real estate projects. Eventually all of them will go bust."

For Wenzhou exporters facing ever narrowing margins, the temptation to put money into high-interest, informal syndicated loans has been especially high. Cai, the eyeglassmaker, resisted. "I never wanted that kind of money," he says. "It was too dangerous." But many others went ahead. The government estimated earlier this year that 60% of Wenzhou businesses and an astonishing 90% of households were involved in some form of private lending. Problems began to really emerge in late summer, when some large borrowers stopped repaying. In September, Hu Fulin, president of Xintai Group, another eyeglass manufacturer, fled to the U.S. to escape some $300 million in debts. He has since returned, but the situation remains dire — some 90 other company heads have absconded.

The Kid collected about $3 million in August and early September, but says he recovered a mere $50,000 between late September and late October. "Everyone is hoarding money," he says. "Once they get it back, nobody lends it out again — not even to their closest friends." The Wenzhou bubble has burst.

Surface Calm
Everything appears normal in Wenzhou. The streets leading from the city center to the surrounding factory districts are jammed as usual with trucks and delivery vans, new Range Rovers and dilapidated Citroen taxis. Beneath the surface, however, a mad race to collect debts is under way. For much of October, the Kid says he slept only two or three hours a night as he pondered how to claw back outstanding loans. "If people could get their money back just by holding other people at gunpoint, there would have been a riot in Wenzhou," he says. "It seems calm on the surface, but the chaos is underneath." In early October, Chinese Premier Wen Jiabao visited Wenzhou, where he ordered local banks to lend more and promised a crackdown on abusive underground lending. The local government has organized a $160 million fund to help overstretched businesses, and the fund is likely to grow.

The big issue, says Professor Hu, is what happens in January, ahead of the Chinese New Year, when Wenzhou's private lenders traditionally call in their outstanding loans. To come up with cash, indebted locals may unload real estate at discounted rates, which could truly burst the property bubble not just at home but also in Shanghai, Beijing and other cities where they have invested. "Should the liquidity chain in Wenzhou collapse to spark either sell-offs in the property market or the cutoff of liquidity for manufacturing or mining, this local crisis could evolve into a national problem," Xianfang Ren, Beijing-based senior economist for consultancy IHS Global Insight, wrote in mid-October.

Still, Wenzhou accounts for just 1% of China's GDP. Manufacturer Cai says he plans to keep on churning out eyeglass frames, despite his ever tightening margins. "What else would I do?" he asks. And the Kid, if he can ever climb out of the massive hole he's dug, says he'll continue too. "When the market recovers, I'll still be willing to put 30% of my assets in private lending," he says. "If a Wenzhou person has 10 million renminbi, he wouldn't deposit it all in the bank. He'd at least spend 3.5 million on some kind of investment. Wenzhou people aren't stupid." The rest of China fervently hopes so.

— with reporting by Jessie Jiang / Wenzhou

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