China 's Illusion Fading

IT BEGINS: China To Do 2-3 TRILLION Yuan Bailout Of Indebted Local Governments

Little by little, this notion that China is a rock of financial stability (at least compared to the US) is being chipped away.

Reuters is reporting that the central government in Beijing is about to shift 2-3 TRILLION yuan  ($308-$463 billion) in local debt to the Federal books.

Basically, local governments have borrowed like crazy, and there's been a fear of a massive wave of defaults, especially as revenue from real estate dries up.

Also there's no local bond market, so these are debts owed to banks, meaning that this bailout of localities is also a bank bailout (surprise!).

The expert on this issue is Northwestern poli-sci professor Victor Shih, who points out that China has been able to maintain the illusion of growth without government debt precisely through these local authorities.

Others have likened local governments to the infamous SIVs from the US financial crisis -- pockets of leverage hidden from public view.

That this is happening now is potentially a big moment. Remember, throughout the US crisis, there were a series of bailouts that, at first blush, would have appeared to put a halt to things. If history is any guide, this kind of big bailout is closer to the beginning of the story.