End Game

by Matthew Glass

  In power, Zhang had proved more sophisticated than foreign observers anticipated. Despite his background in the security services, he quickly grasped that it was not military strength that would keep the party in control in the long term, but economic prosperity. He understood that rebuilding the areas that had suffered most in the disturbances could provide a great stimulus to growth, and that recapturing business lost to competitor countries was key to recovery. Parts of China’s gigantic manufacturing capacity in the south and east of the country had been shut down by the disturbances, while other parts were functioning as normal. Brutally repressing any hint of dissent, Zhang moved rapidly to bring all of it back into operation, loosening residency laws to entice rural workers to return to the cities, forcing banks to lend for reconstruction, and offering huge state subsidies – illegal under international law – to attract foreign customers that had taken their business elsewhere. The west wanted to believe – needed to believe – that China was back in business, and didn’t question its methods. The effect was swifter than anyone could have imagined. Within a year Chinese output was back to where it had been before the disturbances. Two years later it was eight per cent higher.

  Every decision Zhang made was calculated to strengthen China’s economy. No economist himself, he relied on a group of fiercely loyal technocrats whom he quickly promoted through the finance ministry. The most senior member of this group was the finance minister, Bai Shaochun. Under Zhang’s tutelage he was developing political skills and the president was grooming him as his successor.

  Zhang was well aware of the fact that US banks were suffering a fall and was receiving daily reports on the impact on Chinese markets, which so far had been small in scale. But he had no knowledge of individual companies listed in New York. He passed the report from the ambassador in Washington to his closest personal advisor on US affairs, an ex-Shanghainese banker called Qin Jiwei who had spent a number of years working in New York. Qin made some inquiries. That afternoon, in his day villa in the Zhongnanhai, Zhang and Qin met with Foreign Minister Yang, Finance Minister Bai, and Hu Liren, a senior vice-minister of finance who was head of the People’s Investment Corporation, the fund that held twenty-six per cent of Fidelian stock.

  As Bob Livingstone anticipated, the note of the meeting that had been sent by Ambassador Zhu interpreted the encounter as an accusation that China was manipulating stock prices in order to influence the outcome of the US midterm elections. Zhang had ordered no such action to be taken. The first thing he wanted to know was whether someone else had done so.

  Hu Liren shook his head. ‘We are not doing this, President Zhang.’

  ‘No one has ordered this?’

  Again Hu shook his head. ‘No, President Zhang.’

  ‘Could you do it?’

  ‘That is an interesting question, President Zhang.’

  ‘We have studied scenarios,’ said Bai. ‘It is true that with a concentrated activity we could create significant movements in the market. Our holdings are sufficient in volume and diversity. But this would be against our own interests, since it would diminish the value of our holdings.’

  Hu nodded, keeping quiet. Bai could have said more. Their scenarios had shown that if they did choose to use their market power to drive a fall, they could benefit enormously by having sold stocks short before engineering the panic. They could benefit a second time by buying additional stocks at the new lower prices, confident that the market would eventually recover. A fund such as the People’s Investment Corporation operated with a time frame of decades. Against investors whose time horizons were measured in years, or months, or weeks, or even days, that could give them an enormous advantage. And with a fund of half a trillion dollars at Hu’s disposal, the financial gains to be made from exercising this advantage could be staggering.

  ‘These are only scenarios, President Zhang,’ said Bai.

  Zhang nodded. He looked at Hu. ‘So what are you doing with this bank, Vice-Minister?’

  ‘The president is referring to Fidelian Bank,’ said Qin.

  ‘We have sold a small amount of our stock recently as the price has fallen. Two per cent of our holding.’

  ‘Why not more?’

  ‘If we sold more we would collapse the price. It is not in our interest to do this. Also, we have two seats on the board and therefore we cannot be seen to be selling. We can only sell through other companies that are not directly connected with the PIC.’

  ‘But you are selling, Vice-Minister. That means you think it is not a good investment.’

  ‘It has problems, President Zhang. We are aware of this because of our seats on the board. We know certain things the market does not know.’

  ‘What things?’

  ‘It needs cash. It must go to the market for money.’

  ‘Then you have made a bad investment, Vice-Minister,’ said Zhang pointedly.

  Hu bowed his head.

  ‘What will happen when the market finds out about this?’

  ‘That remains to be seen,’ said Bai. ‘The CEO of the bank wants us to put in the money.’

  ‘Could we?’

  ‘Of course.’

  ‘What did you tell him?’

  ‘Vice-Minister Hu led him to believe we would not do it.’

  ‘So what will happen?’

  ‘The money must come from somewhere else.’

  ‘What if there is no one?’

  ‘The American government will not let that happen,’ said Qin.

  ‘Is that what they said?’

  ‘They do not know about it yet. It is an investment bank of a significant size.’ Qin had been in New York in ’08 and was deeply influenced by what he had seen there. ‘They saw the effect ten years ago when they let such a bank collapse and they are scared of seeing that again. A president who allowed such a thing would take a hard blow.’

  ‘ To be technical, President Zhang,’ said Hu, ‘it would not collapse. There is a process for winding up such a bank. This is a new thing that was brought in after the events Minister Qin is describing.’

  ‘But they will not want that either,’ said Qin. ‘It would be very complicated. If necessary, they will seek other banks to buy this one.’

  ‘But the price will be very low,’ said Zhang.

  ‘Not so low if they are scared to wind it up.’

  Bai agreed. ‘And for us, there are certain other things we can do. If the price of this bank goes down, the price of other banks will go down too. We can recover our investment by using this fact. We can use this fact to increase our investment.’

  Hu glanced at him, staying silent.

  ‘All of this is normal investment activity,’ continued Bai. ‘The Americans can have no argument with this. Their own institutions will do the same.’

  ‘Their own institutions do not have the power in the market that we have,’ observed Yang, the foreign minister. ‘Isn’t that true?’

  ‘That is true,’ said Bai.

  ‘Perhaps the Americans are asking for our help.’

  Zhang looked at him.

  ‘Perhaps Ambassador Zhu has misinterpreted. Perhaps they are not saying they are blaming us for it, perhaps they are saying, help us stop this decline.’

  ‘Then that would be asking us to manipulate the market,’ said Bai.

  ‘Yet maybe that is what they are saying.’

  ‘Ambassador Zhu says they are accusing us,’ said Bai, who had seen Zhu’s note of the Washington conversation.

  ‘That is Zhu,’ replied Yang darkly. As foreign minister, he was irritated by the relationship the ambassador had with the president and the frequency with which Zhu went over his head. ‘He is like the boy who has stolen a dumpling. Wherever he looks he sees an accusation.’

  Zhang looked at the foreign minister coldly.

  ‘He might be wrong,’ said Yang.

  ‘Then that is a request to manipulate the market, as Bai says.’

  ‘Maybe it is a request to understand their situation,
President Zhang. They are fearful. There are elections in three weeks.’

  ‘It is not my responsibility to make sure President Knowles gets what he wants in these elections,’ said Zhang curtly. ‘In Uganda, he is trying to show that America is strong. Better for us that at home he is weak.’

  ‘That is true. Therefore he suspects that we are hurting the market.’

  Qin laughed. ‘Minister Yang, a minute ago you said he is asking us to help!’

  Yang shot a glance at him. ‘It could be either.’

  ‘Why would I give him any help?’ said Zhang. ‘What help does he give us? And now he comes with this accusation.’

  ‘If there is a collapse in their market,’ said Yang, ‘that will be bad for us.’

  ‘There will not be a collapse,’ said Bai quickly. He knew that a successful appeal to that fear with the president was certain to win him over.

  ‘How do you know?’ demanded Yang.

  ‘There will not be a collapse. The situation is not one of collapse.’

  ‘Maybe if you do the things to recover your investments it will be,’ said Yang, who understood better than the president that Bai was talking about letting Hu make big bets on stocks falling, which in itself was likely to drive them down.

  ‘That is ridiculous,’ snapped Bai. ‘You do not understand finance.’

  ‘You do not understand diplomacy.’

  ‘Enough!’ said Zhang.

  There was silence around him. Zhang considered what he had heard. He was no democrat himself, but he understood the sensitivity of an American president to events taking place within weeks of an election. And yet if his officials told him that the events were not of their making, what complaint could his counterpart have? And what right did he have to make accusations?

  ‘Should we reply to this message?’ he said eventually.

  ‘Ambassador Zhu should go back and say the People’s Investment Corporation is acting as an investor seeking value,’ said Bai. ‘It has always acted as an investor seeking value, nothing else. That is enough.’

  ‘We should say we understand the concern of President Knowles and will act responsibly,’ said Yang.

  ‘We act as an investor seeking value,’ said Bai. ‘That is what it is to act responsibly.’

  ‘Then we do not have an argument, do we?’ said Zhang.

  Bai and Yang glanced at each other. They certainly did have an argument.

  ‘He should not think we will help him with this bank,’ said Zhang. ‘When has he helped us? Let him stop the resolution on South Africa.’

  ‘But if there is a threat of a collapse,’ said Yang, ‘we would help.’

  ‘There is no threat of a collapse,’ said Bai.

  17

  ED GREY HAD one of the screens in his office tuned to CNBC constantly. It was around eleven o’clock when he noticed Jim Rosario doing a piece. On the bottom of the screen a headline said Threat to Short Sellers.

  Ed turned the volume up. Rosario was saying that he had heard a rumor that the SEC would be prepared to consider a temporary ban on short selling if it felt that the market was being disproportionately driven down by short activity. He couldn’t report on the truth of it but he had reason to believe it emanated from reliable sources within the administration, demonstrating the government’s determination to keep US markets safe and orderly.

  Everyone knew that Jim Rosario was close to Treasury. When he started talking about reliable sources in the administration, that was the department that he meant. In fact, it probably meant that Treasury had asked him to say it.

  Ban short selling? At first it made Ed laugh. Then it made him angry. It made him want to go out and short a bunch more stocks just to show Treasury what he thought of it.

  And that, when he considered it, was the thing that made him worry.

  Grey knew that if his reaction to the statement was to show what a dumbass idea it was, that would probably be the reaction of just about every other DIV on the street. And if Rosario really was reporting something a Treasury official had told him, Ed Grey doubted that was the reaction the official was hoping to achieve. Somehow he was pretty sure Treasury didn’t want every DIV in the city going out and shorting a bunch of stocks just to thumb their nose at them. Not to mention all the DIVs who were thinking, just in case the rumor was true, they should go and out and short a bunch more stocks while they still had the time. Discounting the possibility that that was what Treasury was hoping for – and the chance of that, Ed figured, was about as high as the chance that every DIV in the city would cease and desist right away – this statement was an error. A very, very bad miscalculation.

  In fact, it could get a lot worse. If people really thought Treasury was serious about this, they’d jump to one conclusion: Treasury must know about something coming down the line that was a lot worse than anything the market knew. It must be getting ready for that thing to hit them. When the administration gave that impression, anything could happen.

  That really worried Ed Grey. It could have pleased him. If this dumbass threat or a fear of something Treasury knew drove the banking sector even further down, he’d have a load more profit. He had north of half a billion exposure through shorted bank stocks now, and if he bought those stocks and closed out the positions he’d be over a hundred fifty million up. But Red River also had a bunch of positions in other sectors of the market, positions that pre-existed the correction in banking stocks, and they were betting on stock prices going up. Already, the fall in the banking sector was beginning to contaminate other stocks. The contagion was seeping out. From stocks it might seep into commodities. Correlations rippled across asset classes. Ed Grey didn’t want to see a collapsing market. He didn’t want a rout. He wanted the banking sector to go down, bottom, and go back up once Fidelian had announced its cash call and everyone heaved a sigh of relief. If the rest of the market dropped like the banks had dropped, Red River wouldn’t be a hundred fifty million up. It would be up to its knees in blood.

  Grey wanted this to be contained. The president’s statement a few days previously in Florida had been perfect, it had had the right tone, the right pitch. But this rumor – if it did come from Treasury – made it seem as if the administration feared losing control. It had the whiff of panic.

  Tony Evangelou put his head around the door. ‘You seen what Rosario just said?’

  Grey nodded.

  ‘What the fuck are they doing?’

  ‘I have no idea.’

  ‘I just shorted another twenty million of Fidelian.’

  All over the city, Grey figured, exactly the same thing was happening.

  ‘Tony, come in and take a seat for a second. You think we should go short some other stuff?’

  ‘I’m tempted,’ said Evangelou, grabbing a chair. ‘Treasury keeps saying stuff like this, we’re going to make more money than we did in 2015.’

  ‘Yeah, but we’re long. Overall we’re long the market.’

  ‘But this is bullshit, Ed. If we’ve got a three to six month horizon, I’m comfortable. Let’s make some hay but it won’t last. We started it, remember? How much could Fidelian need to raise? Five billion? Ten? It’s just one bank. There’s nothing in this. A little overvaluation, but the market’s already gone past that. It has to come back. The fundamentals are fine.’

  ‘Maybe they’re not.’

  ‘You heard something?’

  ‘No, but maybe they’re not. Maybe Treasury knows something.’

  ‘Yeah. I think they’re bluffing. I think they just want to pull us back ahead of the midterms.’ Evangelou laughed. ‘Hell of a way to try to do it.’

  Grey frowned. ‘Maybe we didn’t start this. Maybe we just thought we did. Maybe we opened something up and now it’s going to run. And if it runs … If it runs, if it’s a general collapse, that’s a whole different story.’

  Tony watched him.

  ‘Construction, retail, mining. All the cyclicals, they’re going to go.’

  ‘They’ll
come back. We’ll wait it out.’

  Grey shook his head. Red River was heavily leveraged, more heavily than at any time in the fund’s six-year history. The more successful the fund had been, the more debt he had taken on. If the markets fell, he wouldn’t be able to sit it out. The banks would be after him with margin calls on their loans. That would mean he would have to sell assets to raise the cash. He would be selling those assets into a falling market. Everyone else would be in the same position, all trying to sell assets to raise cash for their banks, all driving prices even further down.

  ‘Get the guys to do a stress test, Tony. I mean a real worst case. Let’s assume we have a twenty per cent fall in equities across the board for a start.’

  ‘We should do forty if you want to make it a real worst case.’

  Grey nodded. ‘Get one of the quants to run the correlations. Maybe we should take out an option to hedge the Dow.’

  ‘Too late. We’ll be paying way too much.’

  ‘You think?’

  Evangelou nodded.

  ‘What if we short another billion?’

  ‘Across a bunch of sectors?’