A memorial service in Yangshi for Zeng Chengjie.
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Beijing now sees the danger. Regulators aim to limit the risks from shadow banking and strengthen oversight. But, as ratings agency Fitch says, the changes "have a long way to run." The Zeng case matters because it shows how difficult a task China's leaders face reforming an economy entangled in shadowy webs of money, saturated with unknown debts and managed by bureaucrats prone to abusing their authority. Policymakers need to step back from the allocation of money, allow the market to do its job and force officials throughout the sprawling bureaucracy to implement laws impartially and consistently. Otherwise, China's entrepreneurs will remain vulnerable to a system that forces them to take risks with their money, ideas, property — even their lives.
Follow the Money
The road is just a gravel track, winding along a mountainside and barely wide enough for a single car to squeeze past decrepit brick-and-concrete homes. But to the residents of Yangshi village, Zeng's hometown, it is a memorial to a poor local farm boy who made it big. A plaque proudly proclaims that Zeng donated the money to construct the road through this tiny hamlet in Hunan province. That gift was only a part of the charity Zeng lavished upon his poor former neighbors. Every Chinese New Year, he would return and offer relief to the needy, sick and elderly. In his honor, the appreciative town calls the lane he built Chengjie Happiness Road.
The villagers also recall much happier times for Zeng. Liu Jinlian, a neighbor who grew up with him, describes him as a "naughty but kindhearted boy" who spent his days swimming in ponds and climbing the craggy mountains that encircle Yangshi. "He was a local leader," she says. "All of the other kids would follow him around." But Zeng's childhood was also mired in poverty. His parents were farmers and had little money, so after graduating from high school, he took a job as a construction worker at a local firm. Then, in 1986, he left his small hometown in search of better prospects.
Zeng settled in Jishou, a city of 295,000 people nestled amid pine-encrusted mountains in Hunan. Jishou is far removed from the glitz of Shanghai or the grandeur of Beijing, with their towering skyscrapers, Starbucks cafés and Louis Vuitton stores. Here, the architecture is decidedly communist — boxy and utilitarian — and the shops markedly down-market. Zeng undertook construction projects for a state real estate company, but he had bigger ambitions. China was experiencing an explosion of prosperity, and Zeng wanted his own slice of it. There were fortunes to be made for those bold enough to grab them. In 2004, he formed his own company, Hunan Sanguan, determined to develop property on his own.
The biggest problem facing Zeng was finding the money. A farm boy from rural China trying to put up buildings in a small town is not the type of businessman who gets much attention from state banks. "I needed a huge amount of money," Zeng said in the 2009 letter written while imprisoned. "However, at that time the banks were not willing to give me loans." That left him no choice: he became embroiled in shadow banking.
Zeng began to borrow directly from the residents of Jishou. Even in relatively poorer cities like Jishou, there is no shortage of cash sitting around. The Chinese are famously big savers, but the state-controlled financial system gives them few investment opportunities. Everyone from rich business owners to humble street sweepers are constantly on the lookout for more lucrative options. In such an environment, Zeng's offer was practically irresistible. He promised returns of as much as 10% a month, a huge payout compared with regular bank deposits, whose interest rates are capped at about 3% a year. Many rushed to lend to Zeng and others engaged in similar practices, sometimes handing over a large portion of their savings. Government figures show that Zeng attracted more than 24,000 citizen lenders over the more than four years he raised money.
Flush with cash, Zeng went on a building spree. He completed an upscale hotel in the city of Shaoyang, close to his home village, and began constructing a commercial building near Jishou's train station. The most ambitious development was a gargantuan complex in downtown Jishou boasting high-rise apartment towers and a shopping mall. In all, Zeng invested in some 32 projects in Jishou and elsewhere.
Zeng's financing was technically illegal. Chinese companies require government permission to raise funds from the public on such a large scale, and Zeng never received such approval. Borrowing from local residents in the way he did also forced Zeng into a practice that regulators most anywhere would frown upon — like Madoff, he was paying back some people with cash raised from others. The structure of his investments left him no other choice. The terms of the microloans he took from Jishou locals were as short as three months, and often no more than a year, but his real estate developments took much longer to come to fruition. That meant he had to keep paying out to his citizen creditors before his projects could generate sufficient returns on his investments. So Zeng split the incoming money into two pools. One was channeled into his construction programs, the other held as a reserve of liquid cash that could be tapped to pay creditors when they were owed money.