Housing Bubble Bust Could Be a Good Thing for China

Includes: FXI, PGJ
by: Bo Peng

I could not believe my eyes when Harvard educated Chinese economist Prof Li Daokui went on record to say that Chinese real estate bubble is worse than that in US and its bust may cause social turmoil. Since I can't find any evidence of the esteemed professor being actually stupid, I'm left with the only alternative: he's adopted the Fed/Treasury/Bank's playbook of scaremongering, trying to scare the Beijing government into bailing out of banks and the super-rich class. It's quite remarkable how closely he's kept up to date with his former mentors in the US, just as it is pathetic. China's housing bubble is not even in the same ballpark as US'.

Real estate in China has gone through a tremendous run-up over the past decade. In fact, it's been about the only source of credit and leverage in the current macroeconomic structure in China. Similar to the housing bubble in the developed world, it has created a false of sense of wealth, among the lucky few, and found its way onto banks' balance sheet. It's a bubble, and it will go bust.

But it differs from the developed world in several critical aspects.

1) Leverage is not nearly as high.

On the consumer side, housing downpayment has come down to 30% range, from 50-70% early in the decade. Due to deeply root cultural tradition, Chinese consumers still try their darnedest to pay back debt. It'll take at least another generation or two before they learn the modern western secret that the more debt you run up, the less you need to worry about paying it back. Hopefully the modern western secret will blow up and expose the nasty consequences before they get to that point. BTW, credit in China is maintained by more than Confucius value; it's often backed by clubs and knives or, on a societal scale, mass riots. It's a dirty little secret that we Chinese are too embarrassed to tell damnforeigners about.

On the lender side, it's true that Chinese banks are saddled with real estate loans that are in great danger of devaluation. But don't forget there is no securitization in China. Another technical detail is that Chinese big banks are for all practical purposed state-owned. They're backed by the government more than US counterparts. Some may remember the Chinese banking crisis in 1997. It looked much scarier then. If China toughed that one out, then there's no reason for panic now.

So, while real estate in China is no doubt a bubble, to compare it with those in the developed world is clearly misinformed.

2) Real estate bubble bust would reduce a big factor of social discontent.

Percentage-wise very few Chinese have benefited from the real estate bubble. The bubble has left a huge portion of the citizenry, notably the young high-school and college graduates, far out of reach of home ownership. People have been openly talking about a housing bust with glee for a few years now. Beijing apparently knows this discontent very well and has been trying many things to at least slow down the run-away prices, to no discernible success. They need to continue the effort in bringing it down for a soft landing, not a western-style bailout and reflating the bubble.

China has been extremely lucky with their sluggish financial reform. But, as illustrated by Prof Li Daokui, some economists and the banking interest have been quick in adopting the dying western doctrine of Keynesianism based on superficial knowledge and narrow self-interest.

Disclosure: No positions