Xu Zhong, head of the People’s Bank of China’s research bureau, is in an unusual position. In a nation known for government intervention in free market forces, he recognizes the slippery slope of the moral hazard of the government bailing out risky lending practices. Looking at how local Chinese governments have become over-leveraged, he says the world’s second-largest economy needs a bankruptcy process for local governments, using Detroit as an example. The central government needs to send a message that it will not give blanket bailouts for irresponsible practices, he says, amid mounting concern. The warning comes as the Bank of International Settlements and a wide variety of international finance organizations have been noting the fears.

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China needs to change thousands of years of political history of central government backstopping market risk

The Chinese central government’s “core proposition for the political and economic history ”that has led to “thousands of years” of central government support for local government financing may be coming to a close.

In an editorial on the financial news website Yicai, Xu lamented to perverse incentives that have been created by a central government providing an unrequited risk backstop to local governments, who have issued bonds with little prospect of payback.

“There does not need to worry about local governments chaotically issuing debt,” he wrote, pointing to “the immense risk of the local bond market and its negative impact on macroeconomic volatility have become China’s ‘gray rhinos’ that are of global concern.”

He pointed to 20 cities and counties that were “guilty of illegal debt guarantees” and a continued reliance on the central government backstopping bad bonds that, in a free market, never would have had much chance of success.