Saturday, December 26, 2009

Western Understandings, Eastern Worlds: the China Asset Bubble

Over on a post at the excellent blog Peking Duck I left the following comment on a post about the asset bubble in China:


I’m not sure this bubble thing is being read properly. Let me see if I can articulate my thoughts. First, Chinese buy real estate and hang on. Forever. Hence this bubble might simply peter out in permanently high property prices, rather than go ka-boom. I mean, the houses aren’t being sold on 99% credit, I would bet money that most of the mortgages are with substantial amounts up front. Owners will rent and if they can’t rent, they will sit on it. Second, what is the break even point for developers? In Taiwan one need only sell half of a typical development to break even. Developers can keep putting up buildings with 50% occupancy and make money, in that case — I would bet given China’s low costs and massive corruption, the actual break-even point is even lower.

Hence, it’s not a bubble of speculative money driven by easy credit, but an outlet for savings — money that actually exists, not money that exists in some unspecified future. People thus will not be in debt when it “pops” but will rather have manageable mortgages out of current incomes because they paid much up front, with an actual asset to show for their expenditure. Hence what we will see is not KA-BOOM but rather, going out with a whimper of permanent high property prices in large cities, because no one will sell at low prices.

Is this just another case of viewing eastern practices in western terms? It sure feels like it to me, looking at the fact that Taiwanese have cheerfully been scammed by KMT-connected construction firms for 50 years now with nary a complaint. At some point “high prices” will become the norm and part of the lived environment, as they are here, and no one will notice except puzzled westerners who keep waiting for the price collapse that never comes. You are just experiencing the transition right now and calling it a “bubble”. Perhaps, “price orogeny” might be a better term.

But this is just speculation. The real losers will be the future working-class hordes who will not be able to live in the cities.


As a friend of mine noted in a private response, landlords sustain high rents because the alternative is that the price of their massive capital investment falls. Everyone understands this. Therefore rents never fall. Better to let the flat sit empty. Another factor holding up prices is the ratchet effect of land taxes, which are fixed and take a substantial chunk of the building's value. Is China the same? I don't know. Since the ideal of land ownership is so rooted in local culture, people endlessly speculate in property, and new construction is purchased for that reason. With government support and low costs, profits are automated. In other words, as my friend points out, the key is to keep leveraging.

Offered here for your thoughts. Discuss!

UPDATE: Forbes' Gary Epstein has a set of great pieces on the asset bubble collected at Status of Chinese People. One, two, three, four. Epstein notes:

The U.S. government’s $7.2 trillion in debt at the end of June represented 50% of gross domestic product. The Chinese government’s officially disclosed $840 billion in public debt represents less than 20% of GDP. But the People’s Bank of China and the treasury are also on the hook for potentially $1.5 trillion in off-balance-sheet debt owed by cities and provinces and entities they control. They’re also implicitly obliged to backstop $1 trillion, both in loans that “policy banks” were directed to issue, even when they made no economic sense, and nonperforming loans that the government removed from the books of state-owned commercial banks over the past decade.

Add it up and the national government is responsible for debt equal to over 70% of 2009 GDP. That doesn’t count any loans generated this year that might go sour amid a 30% increase in debt balances nationwide. (The U.S. government, in addition to its direct debt equal to 50% of GDP, is responsible for cosigning of mortgage borrowers’ obligations equal to another 18% of GDP.)

Like the U.S. housing industry a few years ago, China’s big developers are highly leveraged and dependent on low interest rates and rising prices. Municipal governments are knee-deep in this asset swamp. They use land sales as a means of funding themselves.

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Anonymous said...

Thank you

Arty said...

Well, the bubble will collapse but it will be different than the US one. First, who is buying Chinese properties? Most Chinese don't even make enough to dream of owning a home in the major city today. China is a land tenure society, the government can literally control the right of ownership and the price if it has to do it(more tools). Of course, China's market is not leveraged like the US/Western one. With 20% or even more down-payment, the leverage is only 5 folds. Far better than the no money down or NINJA mortgage a few year ago or the current 3.5% down-payment required by the FHA today in the US (that's >28 folds).

And let's be more radical and ask if there is really a "bubble." If the housing price is tracking inflation, the real return will be absolutely zero or minor at best. Following by an increasing in real wage in China, you will be surprised how many working class in 10 years can actually live in the city. Can't save up and buy a house? Get a better job or start saving.

As for government investment, personally I will prefer Chinese government to invest internally on real assets (worse comes worse you can still live in it) than buying worthless US treasures. :) You do know it is just a worthless piece of paper with numbers on it.

Ben said...


I believe you are writing out of your sphere of expertise here. One needs to look no further than Japan in the 1980s to see the devastating effect of a real estate bubble. The Japanese share many of the same financial traits as the Chinese and Taiwanese, such as high savings rate and the love for all things real-estate. And 20 years later, the Japanese economy still has not recovered.

I would also like to point out a couple of inconsistencies in your post. First, you wrote:

“Hence, it’s not a bubble of speculative money driven by easy credit, but an outlet for savings — money that actually exists, not money that exists in some unspecified future.”

Then you wrote, quoting your friend:

“Since the ideal of land ownership is so rooted in local culture, people endlessly speculate in property, and new construction is purchased for that reason. With government support and low costs, profits are automated. In other words, as my friend points out, the key is to keep leveraging.”

So which is which? Are they buying with cash or are they buying with leverage? And when I see words like “profits are automated,” it makes me cringe. I lived through the 2000-2001 Internet bubble, and it is deja vu all over again.

Human history is filled with financial bubbles of one sort or another, and the Chinese real-estate market is no exception. I have no idea when this bubble will burst, but I do know that, as Keynes once said, “the market can stay irrational longer than you can stay solvent.” And since I enjoy being rational and solvent, I will stay out of the Chinese real-estate market and let others have all the fun.

Michael Turton said...

Nice post, Ben. I see exactly what you're saying But I think you missed the source of funds to leverage in the "just keep leveraging" comment: export inflows, FDI inflows, and government. In China's case this "bubble" can go on as long as those things continue.

In the Japan case the bubble hit as the government was busy offshoring manufacturing -- it WAS a classic bubble. I think what we're looking at here is more like Taiwan in at the end of the 1980s, when the NT appreciated and everything skyrocketed in price and value....

Which brings me to the next point: the yuan has yet to rise. Brrr...


Anonymous said...

Every market is different -of course the bubble burst in Asia was in 1997, when the overbuilding was mainly in office space- and after projects across the region could no longer be carried by their developers- and the credit dried up -so badly that even partly finished buildings were left to rot.
Real Estate residences -are at least a bit different- although they can be overbuilt as well- your description of buying and holding on- is exactly the way the King Ranch of Texas was built- in good years they bought more land, in bad years they held on.
--people will do that as well as they can, and if cautious up front, they can hold on much longer than the over-leveraged average Americans in the USA- long enough usually to cover the difference by rent, or have the rent make up most of the shortfall in their budget. The other posters are also correct in their macro-economic sense of where money comes from- a big issue is if the export boom in China can be maintained while the local market expands as well,
(Yes, I teach in South Texas)

Ben said...

Well, Michael, only time will tell if the Chinese rea-estate market is indeed in a bubble. I sure hope that this time is different, but they rarely are, if ever.

Anonymous said...

Your last paragraph doesn't make much economic sense.

How would a land tax keep prices high? How would high rents that are never realized keep a property's price high? If you mean the buyer doesn't realize that he won't be able to rent it out or rent it out often at that price, that's called being lied to, not something material that would produce the high price. If you know the true rent, why would the price still be high?

You guys probably don't watch Mandarin TV shows in Taiwan either out of habit or because you don't understand Mandarin good enough, but even if you weren't personally looking for real estate investments you'd know from flipping the tube that people here try to get really low returns from their real estate investments. Like they can be satisfied with a rate of return of 3%! The multiple if you're satisfied with a return like that is huge.

If you think you can better invest your cash for say 5-6-7%, then the real estate market is horrible. But many Taiwanese unfortunately cannot. So the multiples are huge.

Ben said...

American home owners are like Jessica Simpson these days - easy media target, even here in blogosphere.

Here is a little known fact about home ownership in the U.S.:

"Among the 75.6 million homes that were owner-occupied, 24.9 million units, or one in three, were owned free and clear without a mortgage."

This data is from 2007, toward the tail end of the housing bubble. The percentage may even be higher than 33% now since most of the NINJA home owners may have "disappeared."

Feiren said...

I'm an economic illiterate, but it seems to me that asset bubbles have afflicted Taiwan in the past. While homeowners are not in general borrowing money to finance the homes they live in, developers do get easy credit from state-run banks that leads to unsold after unsold development. In addition, there are many speculators who use one apartment as security for another to obtain loans. When the market is going up they flip the houses at a profit and use them to buy more property that can serve as security for yet more purchases. At some point sales of houses stop even if prices do not go down and the banks are stuck with loans that don't get repaid.

Michael Turton said...

yes, I'm aware people get low returns on their housing assets. I've lived here 20 years.

I think everyone has missed the point. The "bubble" occurs and prices spike. Ok, do they come down? Or do they basically become permanently high? If so, is it a bubble? Or what?

Joshua Wallis said...

"Developers can keep putting up buildings with 50% occupancy and make money"

Hey Michael, can you tell me what your source is?

Arty said...

All you really need to know is that real estate is an inflation hedge that you can live in it. The historic real estate return is 0% and track inflation with exceptions of last few years in the US (but now is coming back inline toward the average). Is real estate a good investment? Personally, I will say "Yes," and it is not a Eastern belief. The upper-class of the West has been fooling the public on values of real estate ownership.

Btw, there is a reason that top 10% of US population holds >90% of nation's wealth; it is land ownerships. This is especially true in southern US. Yes, if you don't own at least a home (no mortgage), you are just a poor peasant probably with mentality like Joe the plumber. And the beauty of the "peasant mentality" is that even if you tell them the truth, they won't believe in you :). Much easier and better just take advantage of such mentality.

Michael Turton said...

Source Joshua? A lecture on construction and land laws I attended a couple of years ago. The exact figure is not really relevant, the point is because of subsidies, laws, etc, developers don't have to sell big to make money. As long as they keep putting up buildings, they will profit.


Anonymous said...

Low interest rates means you can buy more house for the same monthly payment.