Tag Archives: property bubble

China’s Property Bubble: Bursting or Deflating?

Talk of a Chinese property bubble bursting is becoming newly fashionable, at least in the Western press. Yet Beijing, as a matter of policy, has been driving down real estate prices since early 2010 through a mix of administrative controls and credit restraints.

These policies have had an effect. In November, new home prices fell month-on-month in 49 of the country’s 70 largest cities, with four showing year-on-year falls, according to the National Bureau of Statistics. Standard Chartered Bank pegs the fall in prices in the Tier 1 and 2 cities at 10% from the peak. More dramatic has been the decline in the number of new home sales, especially in big cities where property markets have been frothiest. Residential real estate sales in Shanghai were down 16.5% in the first 11 months of this year, for example. Tales of unoccupied properties and restive investor-buyers abound.

Against a background of slowing economic growth–and a growing realization of how great a share real estate accounts for in China’s GDP (10%+, more than the share in the U.S. just before the sub-prime mortgage crisis blew up)–the fall in prices has opened the debate about whether the current property curbs should be eased. It boils down to whether you think the overheated property market has been sufficient and sustainably cooled, or not. Steve Dickinson of the China Law Blog has an example from Qingdao about how local officials’ views can be diametrically opposite to those of central governments. (While we are on recommend reading, Patrick Chovanec’s piece in Foreign Affairs provides an excellent primer on the why prices ran up as high as they did.)

However that debate breaks, the two core reasons for the run-up in real estate prices–low real interest rates and the dependence of local governments on land revenues–are not being addressed. That is where the real worry should lie as they speak directly to the ticking time bomb of local government debt, and the danger that poses to the banks who have funded it. This Bystander believes as a result that prices could a further 10% to fall in the larger cities, but that Beijing won’t want them to fall much below that. Policymakers are already showing some targeted local relaxation of the credit constraints to preempt a wave of real-estate bankruptcies. The bubble is being let down, beyond doubt, but it has been for a while. It is only now that we are starting to see, in American investor Warren Buffett’s phrase, who has been swimming naked.

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A China Banking Crisis: Possible But Not Likely

The prediction that China faces a 60% risk of a banking crisis by mid-2013, made by Fitch Ratings senior director Richard Fox in an interview with Bloomberg, falls into that category of eye-popping but not inconceivable.  Fox’s number comes from a risk model designed by the credit-ratings agency to predict banks’ vulnerability to systemic stress in the face of sustained rapid credit growth, rising property prices and an appreciating real exchange rate.

China has ticked at least two of those boxes for a long while, and indeed, Fitch’s model put China into the most at-risk category last June, though seemingly not many noticed at the time.  The model is not infallible. It raised a red flag about Ireland and Iceland ahead of their crises but not Spain’s. Countries can also retreat from the at-most-risk zone. Brazil, France, Denmark and New Zealand are recent examples. We think China is likely to join them.

Likely though not certain. A bursting property bubble and the local government debt bomb going off (and the two are so closely linked that the one would likely trigger the other) are the banking system’s greatest vulnerabilities. Policymakers are tackling both, though neither are susceptible to a quick fix. As the raft of piecemeal measures over the past 18 months to cool property markets, soak up excess liquidity in the economy, get local government finances and governance on a tighter rein and shore up banks’ capital reserves attest, it is painstaking work.

Given the scale of China’s lending binge over the past couple of years, it is inevitable that the banks will end up with some odorous piles of bad debt on their books. The question, of course, is whether they are mountains or molehills. The rapid pumping up of capital reserve ratios and the bank-by-bank way they are being required suggests the regulators have some fix on their magnitude and which are most threatening. It is the unexpected, though, that blindsides even the best layers of plans.

Prudent macroeconomic policy is the best way of avoiding a banking meltdown anywhere. As we have noted, the shift in policy Beijing is now trying to pull off to minimize what it sees as politically threatening social disparities caused by full-pelt economic growth gives the economic planners additional priorities that will complicate prudent macroeconomic management. Further, some of the tools at Chinese policymakers’ disposal are still rudimentary, one reason that the new five-year plan makes much of the need to continue financial reform. Yet they do have one big advantage in managing a potential banking crisis: administrative guidance over both the dominant banks, which are state-owned, and their big customers, similarly state-owned. That guidance is not always followed to the letter, but if a systemic crisis loomed both banks and state-owned enterprises would soon find guidance coming with arm-twisting.

Beijing has already bailed-out the big banks once from their bad loans in the past decade, and it could do so again if necessary. It could also, we should say, would also, spread the stress of a developing banking crisis to avoid it causing a systemic failure. We still don’t think it is likely that it will have to absent that black swan, and the more progress there is on structural reform of the financial sector, the longer the odds get, but it is not impossible that it might.

Footnote: Economist Michael Pettis makes the point about the political protection of China’s banking system much more elegantly in a post on why the yuan won’t become a reserve currency any time soon (a point on which this Bystander also agrees):

It is worth pointing out that the Chinese banking system is one of the least efficient in the world when it comes to assessing risk and allocating capital, and would be bankrupt without repressed interest rates and the implicit (and sometimes explicit) socialization of credit risk.  Beijing accepts this because of the tradeoff that gives it banking stability.

Beijing greatly values this stability, even at the expense of capital misallocation, and is in no hurry to give it up by opening up the financial markets and, what’s more, for political reasons I think local governments will resist ferociously any further corporate governance reform.  Remember that the phrase “corporate governance reform” in the banking context is just another way of saying that credit decisions will be made on the basis of economic considerations, and not on the basis of government preference.  That particular reform will be politically contentious.

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New Bank Lending To Property Developers In Question

The big four banks hit their ceilings on new property loans for the year by the end of October and are making no more until 2011, according to state-run China Real Estate Business. This will mainly affect small and medium-sized property developers; large property firms’ borrowing, including that by state-owned developers, is weighted heavily towards the early months of the year. Real estate investment reached 3.8 trillion yuan ($572 billion) in the first 10 months of this year, up 36.5% over the same period a year earlier, according to the national statistics bureau.

We expect the central bank to cut the quota for property-development loans for 2011 as it continues to deflate the real estate bubble, while keeping overall loan limits little changed. The new-loan target for banks for this year is 7.5 trillion yuan, a sharp cut from from 2009’s stimulus-fattened 9.6 trillion yuan of new lending. So far, 6.9 trillion yuan had been committed by the end of October, according to official data.

Last month saw a larger than expected increase in new lending that, if sustained, would bring 2010’s total lending in at an above-target 8 trillion yuan. With policymakers increasingly concerned about inflation and the levels of liquidity in the economy, any money that can be drained off is being so.

Update: Xinhua reports that the big four state-owned banks, the Industrial and Commercial Bank of China, China Construction Bank, Bank of China, and the Agricultural Bank of China, say they have not suspended real-estate lending for the rest of the year, though details remain sketchy. This Bystander smells a non-denial denial. We hear that the big four are being highly selective about developments they will consider lending to, and aren’t necessarily moving at any speed even for those. So while the banks haven’t suspended new lending against real-estate development, they are just not making any loans.

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Are China’s Regulators Pricing In A Real Estate Bubble Burst?

China’s latest stress tests for its banks include a simulation in which property prices fall by almost two-thirds in the most overblown markets, according to a Bloomberg report. Previous stress tests had no more than a one-third drop in property prices as a worst case.

The latest tests, apparently ordered last month, suggest regulators are increasingly concerned about the property bubble bursting, leaving banks with huge bad loans on their books in the wake of last year’s record $1.4 trillion of new loans. Authorities have been reining in new property lending since April. This has halted the growth in property prices but in the 70 cities monitored prices were still up 11.4% in June over the same month of 2009.

The fear is that a 60% stress test implies the banking regulators expect that sort of fall in some cities. That would not be an unreasonable assumption given that prices in cities like Beijing and Shanghai have doubled in this bubble. (Our abacus reminds us that a 60% fall in a price means it had to rise 150% in the first place to end up where it started). In which case, a second bail-out of the big banks’ balance sheets can’t be far behind, though heaven knows what can be done about the shadow banking system. Not much that is too big to fail there, though in the aggregate it will be a mess.

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China’s Q3 Economic Outook

The eurozone debt crisis has changed the short-term plans of China’s economic policymakers. The second half of this year was meant to be when the stimulus measures put in place for the global financial crisis were unwound  and the assets bubble they produced deflated in measured manner so growth could continue at a brisk but not dangerously rapid pace. Instead they are having to deal with the consequences of the fiscal austerity measures being put in place by indebted European governments.

Those will affect China directly as Europe is the main export market for its manufacturers and indirectly though the brake they will impose on global economic recovery and an increased risk of a double-dip recession. For now, China’s leaders are signaling that they will do what is necessary to sustain growth. That will mean no rush to wind down existing stimulus measures and a readiness to provide more should a slowdown in the growth rate warrant it.

Absent spectacularly negative events in Europe, we don’t think that will be needed. We still expect the economy to grow by 10% in the third quarter, thanks to strong domestic demand, recovery in the U.S. and the revival of world trade. That would be down from the 11.9% growth rate of the first quarter, but still comfortably above the 8% level that sends political alarm bells ringing in Beijing and opens the public spending coffers.

The uncertainty that pervades policy makers will likely mean a pause in their slow but steady tightening of monetary policy already underway. Fixed asset growth is slowing, showing that some of the measures the authorities have been taking to deflate the property bubble are having an effect (the euro crisis has taken care of the bubble in stock prices). The central bank has raised banks’ capital reserve requirements three times this year to rein in the lending that is fueling the property boom. However, new bank lending is proving more intractable than the central bank would like: 3.4 trillion yuan ($498 billion) of new loans were made in the first four months of the year, on track for a number for the full year closer to last year’s 9.6 trillion yuan than this year’s target of a reduction to 7.5 trillion yuan.

Similarly consumer price inflation is bumping up against its targets (3% for the year). Beyond soaring housing prices, food prices are up following a long run of wretched weather in key crop growing areas. Commodity prices are rising worldwide and labor cost pressures are increasing beyond the well publicized wage rises at Foxconn and Honda. Both those trends showed up in the 6.8% increase in the producer price index in April. Key questions are how much of those price pressures can manufacturers pass onto domestic and export customers, and with what effect on sales. None the less, inflation pressures aren’t so great that the central bank needs to raise interest rates again. Given the overall uncertainty over the economic outlook, it has no great desire to do so anyway.

Keeping the economy steady and growing until it is clear what the fallout from the euro crisis is remains the priority. A wild card for the economy is the leadership succession. We are seeing evidence of the behind the scenes factional jostling for position breaking through in foreign policy every now and then. No reason to suppose that couldn’t happen with economic policy, too, especially as the two are now so connected. Arguably with the yuan revaluation issue, it already has.

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More Drips Of Regulation To Cool Property Market

The latest measures announced to cool the property market will effect mainly a handful of cities in eastern China where real estate bubbles are most rampant. Anyone buying a second home now needs to put up a 50% deposit, up from 40%, while the mortgage rate for second homes has also been increased. The minimum down payment for first homes bigger than 90 square meters has been set at 30%. Banks are also being guided not to make loans for third homes and to require a year’s local residence for any home loan. They have already been told not to make loans for property speculation.

The constant flow of regulatory measures to starve property speculators of credit is having some effect, if more slowly than the authorities would like. New bank lending totaled 510.7 billion yuan ($75 billion) in March, down from 700.1 billion yuan in February. But that still leaves total new loans for the first quarter at 2.6 trillion yuan, above the government’s target of 2.25 trillion yuan, and 30% of the 7.5 trillion yuan target for the year as a whole. That suggests more measures will be forthcoming as the government seeks to avoid a generalized increase in interest rates while it believes the resurgence of growth is still fragile and stimulus-spending fueled.

Update: The Housing ministry has piled on, too. It announced Monday tighter regulations on property sales by developers, banning payment before project completion unless approved and stopping developers from delaying sales in the hope of cashing in on a rising market.

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Tightening The Monetary Policy Wrench

China’s tenth turn of the bank reserves ratio wrench was more vigorous than the previous ones but just as likely to be as ineffective. The People’s Bank of China said today that it will raise from December 25 the proportion of deposits that banks must hold in reserve by one percentage point to 14.5%. The nine previous increases were by half a percentage point.

This tightening of monetary policy will make $47 billion unavailable for lending, by the central bank’s reckoning. The move has been signaled earlier this week and goes hand in hand with five interest rate rises (expect a sixth before year’s end) and a freeze on net new lending for the remainder of this year. Quarterly lending quotas for banks are expected to replace annual ones for 2008.

Policy makers remain worried that the plentiful credit sloshing around the economy is only lifting up share and property prices in a way that can only end in tears — not the crying game that Beijing wants in Olympics year especially.

The central bank has been using increases in the reserve requirements as its main mop for the huge inflows of dollars coming into China from a record trade surplus and foreign direct investment inflows that have exceeded $1 billion a week for the past five years. But that flood of money is coming at it faster than it can mop. Ever higher reserve requirements have done little more than sterilize most of the domestic inflationary impact of the dollar inflows and the PBOC’s management of the yuan’s exchange rate.

But banks still have enough more than enough cash available for lending. So further turns of the wrench seem inevitable. A reserve requirement of 20% by the end of 2008 isn’t inconceivable along with more interest rate rises and administrative measures. But as central banks around the world learn the hard way, deflating a bubble gently is no easy matter.

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