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China's Stock Market Plunges 8 Percent on Margin Crackdown

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China’s stock market plunged nearly 8% Monday morning due to the country’s securities regulator’s crackdown on 3 major brokerage firms—Citic Securities Co., Haitong Securities Co. and a unit of Guotai Junan International Holdings Ltd. They are being held accountable for extending “margin trading” contracts, which is when money is being loaned specifically for stock purchases. As punishment, the firms are forbidden to offer credit to new customers for 3 months.

Share prices of the brokerage firms were hit the hardest, with some reaching the daily loss limit of almost 10%. Banks and insurance companies were also under heavy pressure to sell.

Included in this group is Industrial & Commercial Bank of China Ltd. , Agricultural Bank of China Ltd. , China Life Insurance Co. Ltd. (LFC - Free Report) , and Ping An Insurance Group Co (PNGAY). All of which could see pressure in Tuesday’s session for their ADRs which trade in the U.S. market.  

Bubble Bursting?

Despite this steep drop in stock prices, the Shanghai Composite Index (SHCOMP) has been up 55% in the last year and up 33% for the past 3 months.

Investors and analysts see the decision made by the securities regulator a moment of foreshadowing; now, restrictions are more likely to be placed on credit-financed trading by China’s government. There is also a fear of a bubble forming, which could have a widespread negative effect on the broader economy.

However, since China’s financial system is mostly closed off from the rest of the world, and its government allows only a limited amount of foreign investment, this situation is unique to China and has not affected other world markets so far.

Monday’s market dive seems to be only the beginning of a list of problems for China. In particular, China’s market is dominated by murky state-owned companies that do not have the transparency standards that many in the West are used to. Another problem is that debt seems to be fueling recent stock price increases. Debt-related stress is seeping into other parts of China’s economy—property, for example—as well.

Clearly, debt problems are starting to build in China, though it remains to be seen how the country can navigate the near term issues. Many have predicted a crash in China before, but we will have to see if the margin rule change merely cools off the Chinese market, or if Monday’s crash is a harbinger of things to come instead.
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