China Says "Stuff It": The Sequel

I emailed Janet Tavakoli and asked her what she thought about the announcement by the Chinese government that they were going to allow State Owned Enterprises to default on commodity derivative trades.

Not surprisingly, Janet was way ahead of the story. She reminded me that this wasn't the first derivative default by the Chineese and pointed me to what she wrote way back in January:

This did not get enough press, but in early November, Chinese banks (top tier banks like Bank of China and Industrial and Commercial Bank of China) refused to fork over billions in collateral on dollar/yen FX trades which were out of the money after the yen’s October appreciation. The headlines should have read (but didn’t): “Chinese Banks say: STUFF IT.” The Chinese banks won a game of drag race “chicken” with foreign banks. Most credit support annex agreements would say that closing out these trades would be an event of default, and then the cross default on all the trades would kick in with the same counterparty. But the credit of the Chinese banks was better than many of their counterparties, and they renegotiated contracts with the Chinese banks.

What inspired Chinese banks to play and win this game of brinkmanship? The motive may be entirely unrelated to the bath that highly-placed “retail client” Chinese have taken with investments in mini-bombs, er, I mean mini-bonds, sold to them with “AAA” ratings by U.S. investment banks. The latter is just icing on the rice cake.