The 300 employees of Aomi Fluid Equipment here were delighted recently when the owner offered an all-expenses-paid, two-day trip to a mountain resort three hours away.
The owner, Sun Fucai — or Boss Sun, as he’s known — was so insistent that his workers attend that he imposed a $30 fine on any employee who refused the getaway. Nearly everyone went.
Except Boss Sun.
When the employees returned from their holiday, they found that the factory had been stripped of its equipment and that Boss Sun had fled town. “It was entirely empty,” Li Heying, a former Aomi worker, said of the factory. “It was like what happens in wartime.”
The boss, as it turned out, was millions of dollars in debt to loan sharks — underground lenders of the sort that many private businesses in China routinely use because the government-run banks typically lend only to big state-run corporations.
As China’s economy has begun to slow slightly, more and more entrepreneurs are finding themselves in Mr. Sun’s straits — unable to meet debt payments on which interest rates often run as high as 70 percent in this nation’s thriving unregulated, underground loan system. Such illegal lending amounts to about $630 billion a year, or the equivalent of about 10 percent of China’s gross domestic product, according to estimates by the investment bank UBS.
In recent months, at least 90 business executives from this coastal city, a one-hour flight south of Shanghai, have disappeared because of mounting debts and impending bankruptcies, according to a local government report.
Whether out of fear of mafia-style loan enforcers — kidnappings and broken kneecaps are common tactics — or the family dishonor that is its own harsh penalty in China, some of the Wenzhou missing have gone into hiding or fled overseas.
And in the last few weeks, at least three have tried to commit suicide by jumping off high-rises in the city, according to the state-run news agency, Xinhua, which reported that two of them died and the other survived with a broken leg.
That tycoons in a city known for its savvy entrepreneurs are running scared has raised concerns that private business, a vibrant part of China’s economy, may be losing steam — while exposing the high-risk, unregulated financial system on which so many of the nation’s small and medium-size businesses have come to depend.
“There have always been people running away because they couldn’t pay their debts,” said Wang Yuecai, general manager at Wenzhou Yinfeng Investment & Guarantee, which guarantees state bank loans when small businesses are lucky enough to get them. “But recently, the situation here has gotten much worse.”
Last week, Prime Minister Wen Jiabao and a delegation of top officials, including the head of the nation’s central bank, visited Wenzhou, promising to get official banks to lend more to small companies and to crack down on underground lenders that charge high interest rates.
And on Wednesday, China’s state council, or cabinet, announced a series of measures aimed at helping small businesses with tax breaks and new lines of credit.
Beijing no doubt worries that similar problems could surface in other parts of the country.
“This is not just happening in Wenzhou,” said Chang Chun, who teaches at the Shanghai Advanced Institute of Finance. “Some companies borrow from the state banks and then lend into the underground market. Many are doing this type of arbitrage.”
But caging the loan sharks could prove difficult, not only because the activity is so rampant but because the lending is in some ways a result of the government’s own banking policies.
Here in Wenzhou, known for its pen makers, textile producers and big cigarette lighter factories, business owners complain that they are struggling with inflation and rising prices for raw materials. But they also point to a government-created credit squeeze. As elsewhere in China, most bank loans in Wenzhou go to big corporations or to finance projects backed by the government, making it increasingly difficult for smaller businesses to borrow money.
“This informal lending was aggravated by the credit tightening that made borrowing from the official banking system more difficult,” said Wang Tao, a UBS economist based in Hong Kong.
Meanwhile, as is also the case throughout China, the government keeps interest rates on household bank savings accounts so low — currently only about half the 6 percent inflation rate — that people seek other ways to make their money grow.
Many households pool their money into underground lending syndicates, the source of the loans that have gotten borrowers like Boss Sun in over their heads. According to one local survey, more than 90 percent of Wenzhou’s households have invested in such lending pools.
As long as China’s economy was racing along at an 11 percent growth rate, small companies could hope for enough business to stay a step or two ahead of their underground creditors. But there was little room for error.
Now, businesses here and elsewhere in China are being caught short because the national economy has begun to moderate a bit, to a projected 9 percent rate by year’s end, in response to government-imposed measures to fight inflation and let air out of the real estate bubble.
Ms. Wang, at UBS, said the slowing economy and weakening exports would hurt many small Chinese businesses. Already, according to a recent survey by the city’s small-business council, one in five of Wenzhou’s 360,000 small and medium-size businesses have recently stopped operating because of cash shortages.
At Aomi, former workers interviewed here this week said that Mr. Sun, like many other Wenzhou entrepreneurs, not only had borrowed from underground lenders but had dipped into his company’s funds to lend to other private companies at exorbitant rates. That would have left him even more exposed if any of his borrowers’ businesses collapsed.
“He was doing some financial business,” said Ding Shouyu, a former Aomi executive who left the company shortly before its collapse. “But then everything fell apart.”
Other workers said Aomi, a maker of valves, was doing relatively well, and was busy filling orders at the time Boss Sun fled. They said he owed them about $157,000 in wages, which the local government subsequently paid.
Earlier this week, after Prime Minister Wen’s visit to the city, Mr. Sun and several other businessmen who recently fled Wenzhou struck a deal with the local government to return to the city.
City officials did not disclose details of the agreement with Mr. Sun, but the government released a statement saying it would aid Aomi and also ensure Mr. Sun’s safety.
He will need it. A few days ago, newspapers in Wenzhou reported the arrest of seven people suspected of "collecting debts with violence."
Mr. Sun could not be reached at his office Wednesday or Thursday, and did not answer his mobile phone. But in an interview with Xinhua published Tuesday, Boss Sun said he had borrowed millions from banks and private lenders and the interest rates grew "higher and higher."
He also said his personal safety was in jeopardy.
"My capital chain broke completely," he said in the interview. "I was driven to foolishness by the debts and was forced to flee."
Gu Huini contributed research.