Counting the Cost of Gov't Intervention in Stock Market
Two months into the government's unprecedented efforts to save the stock market – which had its most turbulent week starting on August 18 since state-backed investors intervened to end volatility in early July – it is time we consider what comes next.
On August 14, the China Securities Regulatory Commission announced that the China Securities Finance Corp. (CSF), which has played a central role in the government's campaign to bail out the market, sold an unspecified amount of stocks it recently bought to Central Huijin Investment Ltd.
It would be wishful thinking to believe that this means the CSF has more money to continue buying stocks. Rather, the deal marked an end to operations that have plowed nearly 2 trillion yuan into the A-share market since it took a nosedive in mid-June.
The sheer volume of the capital involved and the consequences that may follow over a long period demand that we seriously reflect on what was done and what should have been learned.
The money the CSF used to buy the shares primarily came from commercial banks. It will need to repay those loans quickly with the funds it received from Central Huijin, which raised the funds it needed for its purchase by issuing bonds. Costs aside, Central Huijin's mandate is to hold stakes in financial institutions on behalf of the state. Supporting the stock market is not its job.
When announcing the share transfer, the securities regulator also said "the stock market goes up and down according to its own laws and the government will not intervene under normal circumstances." Perhaps this statement is intended to signal that the government's intervention has concluded.
The announcement also said that the CSF "will continue to play a stabilizing role in many ways should the market experience severe and abnormal fluctuations and possibly trigger systemic risk." The emphasis here should fall on how the government defines "abnormal fluctuations" and "systemic risk." Ambiguity on these two important questions will have grave consequences.
It is still too early for a thorough review of the costs and benefits of the government's involvement in the stock market, but some judgments can be made. To start, the regulator should not have tried to get the stock index to go up. Also, the CSF seemed to have picked stocks randomly, pouring capital into valuable and worthless companies indiscriminately. Critics have questioned the wisdom of these actions, and some voiced concerns about insider trading.
Many other issues remain to be resolved. The first is defining the role of the CSF. The institution has become a de facto stock market stabilization fund in that it snaps up shares few others want, and the government has said this will remain its mission for years. Critics say the very existence of the fund distorts the market, not to mention that trillions of yuan are at stake. Deciding what the CSF can do with the money – now that its main job has changed – should be done according to the law.
There is also the question whether the restriction on stock sales imposed by the securities regulator on listed companies' major shareholders and executives will create barriers for trading and discrimination against certain shareholders.
Also at risk is the sense of rationality that the government has tried for years to instill in stock investors. Ever since the CSF stepped into the market, speculators have started gambling again, to the detriment of the market. The message some investors took away from the intervention is that the government will always ride to the rescue when the market collapses. The moral hazard this created backtracks on progress that has been made over many years on investor education.
Then there were many conspiracy theories that blamed the fall of share prices on "vicious short-sellers" who were never clearly identified. This was little more than a witch hunt. A functioning market needs investors taking long positions and those selling short. As long as they follow the rules, they should not have to face extra obstacles.
The regulator's best response to these concerns is to let the market return to normal again as soon as possible, allowing it to regain its balance. This will serve the real economy better.
The capital market cannot grow in a healthy manner with the CSF playing the role of savior. It should end this role sooner rather than later.
Due to market volatility, a long-anticipated revision to the Securities Law may be postponed again and the chances are slim that a transition to a registration-based stock issuance system will happen this year. It is important that the revised law ensures that the intervention measures, which were taken out of necessity and as a compromise to stop the market rout, do not become the norm.
The regulator must learn the right lessons this time. Reflecting on what it did wrong would be a start. The future of the market depends upon it doing its job right.
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