When China announced a nearly $600 billion package to ward off the 2008 global financial crisis, city planners across the country happily embarked on a frenzy of infrastructure projects, some of them of arguable need.
Chengdu, the capital of southwestern Sichuan province, answered the call for stimulus action with a bold plan for a railway hub modeled after Waterloo railway station in London.
Except London's Waterloo was not ambitious enough.
I was shocked when I finally got to visit Waterloo. It was so small, said Chen Jun, a director at Chengdu Communications Investment Group, which built the new Chinese terminal. I realized we would probably need a station a few times bigger to meet the demands of our city.
In a manner typical of many infrastructure projects in China, Chengdu more than doubled the size of its planned transport hub, borrowed 3 billion yuan ($473 million) from a state bank to finance it, then set out on a blistering construction timeline that saw the finishing touches put on the project two years later.
But instead of getting the accolades they expected for helping to stimulate the economy, Chengdu Communications and many of China's 10,000 local government financing vehicles (LGFV) have now come under a harsh spotlight for the grim side-effects of the construction binge.
China's local governments have piled up a mountain of bad debt, some of it to finance bridges to nowhere and other white elephant projects, which now threatens to constrict growth at a time when the global economy is sputtering. It is adding to other systemic risks in China, including a sharp downturn in the property market and a rapid rise in problematic loans.
Local governments had amassed 10.7 trillion yuan in debt at the end of 2010. The government expects 2.5 to 3 trillion yuan of that will turn sour, while Standard and Chartered reckons as much as 8 to 9 trillion yuan will not be repaid -- or about $1.2 trillion to $1.4 trillion.
In other words, the potential debt defaults could be even larger than the $700 billion U.S. bail-out programme during the 2008 crisis.
Reuters reported in mid-year the government was working on a relief plan for local governments, including allowing them to tap the municipal bond market for the first time as an alternative to bank loans, which are becoming harder to get.
The risks of default are rising. Nearly 85 percent of the local government finance vehicle loans in northeast Liaoning province, for instance, missed debt service payments in 2010, an audit report posted on the Liaoning Daily website said.
But in visits and interviews at city-run vehicles around China, officials appeared unworried. They say they were only following Beijing's directives to keep growth on track, and the central government would surely step in to bail them out.
Perhaps their complacency is justified. Beijing, which holds more than $3 trillion in foreign exchange reserves, certainly has the resources to rescue them, and has done so in the past -- it set up asset management companies to help China's top banks clean up mountains of bad loans in the late 1990s.
But China is also vulnerable to a global downturn, and would need every piece of its economy performing well to avoid a serious slump. The infrastructure boom insulated the economy from a collapse in exports in 2008. Beijing has less firepower now. Inflation is uncomfortably high, and dumping more money into the economy would only make things worse.
Barclays Capital has predicted a global recession would trigger a hard landing in China, with gross domestic product sinking well below the 8 percent mark seen as the minimum for assuring enough job creation to keep up with urban migration.
A severe economic slump would depress land sales, a vital source of funding for local governments, and make their debt load even more precarious.
In Chengdu, Chen leans back on a sofa in his office, smiles and readily concedes Chengdu will have big problems covering the bills for its version of the Waterloo train station.
We're still unable to reflect on our accounts the problems that may arise from our investments into Chengdu's railroads, Chen said. What happens next is that we may face some trouble repaying our loans when many of them come due.
Chengdu Communications had liabilities of 18.9 billion yuan at the end of 2010 against current assets valued at 11.7 billion yuan.
Chen is not unduly concerned. He thinks he has a solution, one local governments across China have also grasped: Real estate. Chen, the chairman of six other state companies in the city, intends to build huge residential and commercial projects around stations such as Waterloo -- with borrowed money, of course.
The problem with that idea is that Beijing has been taking increasingly urgent steps to halt a speculative property boom and has told state banks to cut lending. Domestic investment -- much of it in property and infrastructure development -- accounted for 70 percent of China's gross domestic product last year, a far bigger share than in developed economies.
According to the McKinsey Global Institute, the proportion of China's total debt to gross domestic product was 159 percent at the end of 2008, before it began the massive stimulus programme that has racked up piles of local government debt.
Local governments have long had to tap other sources of income to supplement their meager share of the country's taxes. Beijing controls the bulk of tax revenues to prevent local officials from spending wastefully, and as a way of redistributing wealth between poor and rich provinces.
So they raise money by selling or taxing property or borrowing money. They are barred from borrowing directly from banks as government entities, however, hence the proliferation of their financing vehicles.
Local officials have a strong interest in keeping property prices high, since it is a key source of revenue. China Real Estate Information Corp., a Shanghai-based property information and consulting firm, estimates 40 percent of local government revenue came from land sales last year. Land also is often used as collateral backing the loans to their financing vehicles.
So throughout China, a building boom financed with massive bank borrowing is being securitized by land prices that local governments fervently hope will stay high, even as Beijing tries to tamp them down.
The underlying problem here is that local governments have a lot of expenditure mandates for infrastructure, for social services, and they don't have enough regular revenue to cover it, says economist Arthur Kroeber.
Wuhan, capital of central Hubei province, is known as one of China's four ovens, cities where summertime temperatures can soar to 40 degrees Celsius. Its strategic location at the intersection of the Yangtze and Han rivers has made it a major transportation hub and in the past three years the city has been feverishly building bridges, railways and expressways.
Wuhan Urban Construction Investment and Development Co., the vehicle set up to finance much of this infrastructure, had taken out 68.5 billion yuan in bank loans as of September 2010, a sum far in excess of its operating cash flow of 148 million yuan.
Perhaps for that reason, city officials found a novel if unpopular way to pay for the three new bridges they have built across the Yangtze, adding to the seven already spanning the world's third-longest river after the Amazon and Nile.
Besides the usual bridge tolls, Wuhan requires residents with cars to cross them at least 18 days a month, at 16 yuan a round trip.
The city of 9.8 million is expanding its subway system by adding another 215 km of track by 2017, with financing coming from big state-owned banks. Like other cities, Wuhan is counting on land sales to secure the loans. Its land authority says land prices for high-end residential property have more than doubled since 2004 to 11,635 yuan per square meter today, despite a proliferation of housing developments.
For that reason, investment bank Credit Suisse called Wuhan one of China's top 10 cities to avoid, warning in a report this year it would take eight years to sell off its existing housing stock, let alone the tens of thousands under construction.
Wuhan Urban Construction Investment and Development is the largest government financing vehicle in the city, employing 16,000 workers and sitting atop total assets of 120 billion yuan.
Despite its debt woes, Shen Zhizhong, a deputy director at the vehicle's media office, argued his firm should not be blamed for the profusion of red ink.
What we do is all decided by the government. We don't have any project that belongs to us, Shen said, adding it was unscientific to ask his company how Wuhan plans to pay off its debt. We are like a sportsman, not a coach or a referee. How can you ask a sportsman something only known by a coach or a referee?
After building the roads, railways and bridges that China said were so desperately needed just a few years ago, the financing vehicles now resent being made scapegoats for the mounting risk in the financial system.
Chengdu and Wuhan officials insist their own books are fine; the problem lies elsewhere.
Zeng Mingyou, head of Chengdu's economic planning department, said despite a mounting debt load the city was controlling expenses and managing risks.
What is important is that we have risk control measures in place, said Compared to other cities, Chengdu has very good controls in place.
The Chengdu government began reining in its financing vehicles about three years ago after it discovered highways were being built across farmland where there was no traffic, Zeng said.
He also said the city had stopped using land as collateral for infrastructure loans. We can't be taking all our land and using it to back up loans, Zeng said. At some point we'll run out of land. This is why the focus now is on sustainable development.
In Wuhan, Xie Zuohuai, deputy director of the media office at the Wuhan branch of China's bank regulator, said his city, too, was exemplary when it comes to managing its debt.
Wuhan is a model city in implementing Beijing's rules of regulating local government debt, he said in between lighting up cigarettes and stubbing them out in an overflowing ashtray. I'm confident the central government will successfully manage risks, Xie added, echoing a widespread perception that Beijing will come to their rescue if need be.
Any wave of defaults big enough to destabilise major banks or crimp the government's finances could have consequences not only for China's economy, but for global growth and financial markets as well.
That risk appears to be pretty low for now, given the strength of bank balance sheets. The banking system has a bad loan coverage ratio at the end of 2010 of 218 percent to cover any losses, up from 80 percent at the end of 2008 and 155 percent at the end of 2009.
Despite that strengthened treasure chest, bank executives in Beijing, Wuhan and Chengdu say they have stopped lending to local governments entirely, unless their projects have some guarantee of profitability or are too big and costly to scrap.
Right now, most banks have cut off new loans to local government financing firms, said a senior executive at a medium-sized bank in Beijing, who declined to be named because he was not authorised to speak on the matter.
The cities and financing vehicles themselves say credit is harder to come by.
What the banks want to see now is a clear revenue stream, said Chen at Chengdu Communications. Loans for big projects like highways and railroads are now harder to get.
For that reason, Chengdu Communications has become one the city's biggest operators of petrol stations, and Chen says he has so far faced no problems trying to get a bank to finance new ones.
Local officials need to keep their economies humming because they largely earn their Communist Party stripes with projects that boost employment and growth. With the loan spigots being turned off to rein in bubbly property prices, they face the prospect of housing projects grinding to a halt.
Enter the shadow bankers. These are the underground lenders and trust companies who extend credit to people and companies that may not qualify for loans otherwise. They then slice and dice those loans into investment packages, akin to what American banks did with sub-prime mortgages for much of the past decade.
Credit Suisse last week described the burgeoning growth of informal lending as a time bomb that posed a bigger risk to the Chinese economy than even the local government debt pileup.
Credit Suisse estimated the size of China's informal lending at up to 4 trillion yuan, equivalent to around 8 percent of above-board bank lending. Interest rates on these loans runs as high as 70 percent and they are expanding at an annual rate of about 50 percent.
The shadow bankers have lent 208 billion yuan to real estate developers so far this year, nearly as much as formal bank lending of 211 billion yuan. The risks, analysts say, is that even healthy developers become vulnerable to a liquidity crisis, given the short tenor and high rates of these loans.
Formal banks have transferred some risky loans off their balance sheets to the shadow banking industry. As a result, Fitch Ratings has warned, lending has not slowed down as much as official data suggests -- and as Beijing would like.
Official banks have also been restructuring and reclassifying loans to dress up their books, analysts said. For example, they now get to classify local government borrowings as corporate loans, which allows them to set aside less in provisions and thus add to their quarterly earnings. According to Chinese media reports, banks plan to reclassify 2.8 trillion yuan worth of loans.
Banks have to admit to some NPLs (non-performing loans), but they don't want to admit it because regulators are allowing them to restructure these loans, said Victor Shih, a professor at Northwestern University in Chicago who has written a book on China's financial system.
This is unlike the late 1990s when the government forced the banks to admit to a huge amount of non-performing loans. This time round, the strategy is just to not admit to NPLs.
Such an arrangement appears to suit everyone. Beijing wants to keep the financial system from becoming destabilised, especially given the financial sector crises in the West. And local officials are keen to keep growth strong in the run-up to a critical Communist Party Congress next fall, when Party chief and President Hu Jintao is expected to hand power to younger leaders headed by the anointed next leader, Xi Jinping.
Whether they will also hand over a looming financial crisis to him as well remains to be seen.