Why China's Property Bulge Is Nothing Like the U.S. Mortgage Implosion

 |  Includes: IYR, KME, TAO
by: Jim Trippon

China Economy Recovers Despite "Bubble" Rumors. Will China's Economic Growth Continue?

Why China’s Property Bulge is Nothing Like the US Mortgage ImplosionClick to enlarge

The volatility roiling global stock markets isn’t only the result of the European debt contagion. The financial and mainstream media are apparently unable to cope with the fact that China is recovering handsomely while the global economy ping pongs from one crisis to the next. Commentators are looking for a fatal flaw in the Chinese success story and the usual target is China’s ongoing real estate inflation.

Real estate bubbles generate a lot of fear because of the spectacular implosion of the U.S. real estate and mortgage market, which then caused a global financial disaster. Both China and the U.S. responded to the financial mess by stimulating their economies with hundreds of billions of dollars. Most Chinese stimulus money went to infrastructure projects like a national bullet train system. U.S. funds generally went to projects with shorter-term benefits.

Why China’s Property Bulge is Nothing Like the US Mortgage ImplosionClick to enlarge

In fact, Beijing mandated a flood of lending by Chinese banks which caused a dramatic increase in money supply and boosted China’s economic expansion in the last quarter by 11.9 percent (annualized). U.S. banks have not eased up on their tight lending policies despite the government bailout they happily accepted.

One downside of China’s monetary expansion policy is a very rapid acceleration in property prices in major urban areas. Chinese property prices, based on a survey of 70 cities, were up 12.8% year-over-year in April, the largest spike since 2005, and an increase of more than one percent compared to March.

Real estate inflation at this rate is partly to due to speculation, and in some cases speculation by regional government authorities. It is an unsustainable trend and obviously dangerous. But is it the beginning of an economic disaster like the U.S implosion?

Are Chinese banks stronger that U.S. banks?

Nervousness about this issue is affecting stocks so it is important to compare the situation before the U.S. mortgage meltdown with Chinese real estate inflation.

First, it is important to recognize that Beijing actually recognizes and acknowledges a problem in the sector. China is taking action, whereas Washington & Wall Street believed that the U.S. property boom was real, and somehow bound to expand infinitely. Beijing is clamping down whereas the U.S. loosened controls at every step on the road to ruin. This, in point form, is why these situations are not the same:

  • The U.S. industry tolerated “liar loans”, no down payment mortgages, and “NINJA loans” (no income, no job, no assets). China requires a 20-30 percent down payment on first home purchases.
  • Property speculators and “flippers” were allowed to operate in the U.S. without regulation, helping to inflate bubble. But China’s banks are now requiring a 50% down payment on second homes to shut out speculators. Commercial banks can refuse to issue loans to buyers of third homes in areas suffering from excess rises in property prices.
  • To curb speculation, banks can also halt loans to buyers who can't prove they have lived, paid taxes and social insurance for at least one year in the cities where they intend to buy houses. The Chinese government also mandates 20% cash down at land auctions. The U.S. had no such curbs on speculation although the flipping and speculation was common knowledge.
  • U.S. banks proved to be undercapitalized for the risks they were taking, hence the bailout. Beijing has raised reserve requirements three times for Chinese banks. They're at 17% for large banks, just under the all-time high in China’s reserve capital requirements, to deal with potential bad loans.
  • The U.S. accelerated its debt bubble by packaging and selling bad mortgages worldwide in opaque financial instruments called CDOs, which were highly rated by credit agencies being paid by the banks for their rating. China has no such practice.
  • The bursting of the U.S. bubble went nuclear when a derivatives product called a credit default swap (really an insurance contract on these loans) was allowed to be sold unregulated. A fifty to sixty trillion dollar market in CDS insurance policies was allowed to balloon with no public record of the counterparties and no restrictions on companies like AIG which sold insurance far beyond their ability to pay. The U.S. has encouraged China to develop a derivatives market but China has declined. The U.S. has still not placed controls on this practice.

We can expect more increases in China’s bank reserve ratios as well as clampdowns on property speculation by cash-rich corporations and regional governments. Beijing is using tools that work only in a command economy, in an ongoing effort to damp down the real estate market, but not so harshly that it might cause an implosion. This suggests an interest rate increase (bad for stocks) is unlikely in the near future.

Why China’s Property Bulge is Nothing Like the US Mortgage ImplosionClick to enlarge

As some respondents to my blogs have said loudly in the past, there are most definitely problems in commercial real estate in some Chinese cities. But, will China implode, just as the U.S. mortgage and real estate market did? The two scenarios couldn’t be more different.

Will China’s banks collapse under the strain of some inevitable defaults? Although China’s banks are well capitalized and home buyers have made real down payments, there might potentially be some strains on the system. But Beijing itself has the reserves to bail out any failed lender.

Unlike the U.S., China won’t have to bail itself out with newly printed money and Treasury debt, most of which was funded by China.

Disclosure: No positions