The Biggest Risk in Global Economy (part 3)

In part 2, your author promise to get some numbers for China property market even though they are very hard to find and wildly unreliable. Now your author indeed came as empty-handed.

The National Statistics Bureau does have some numbers, but those numbers are odd and contradictory. On month-on-month basis, many of the numbers are showing little change for months, which is hard to reconcile with what people hear from news and media. Some brokerage houses have subscribed the data from Soufun.com, unfortunately your author does not have access at this very moment. So your author will tell you another anecdotal story.

A not-so-closed relative of mine based in Indonesia recently went to Chengdu to visit a friend of them. This Chengdu man is a rich folk who got his fortune in his business since the opening up of China. Now this man has retired, and own 3 apartments in Chengdu, and only one of the three was occupied by himself, and the other two are empty, and not let out.

Why are they not let out? The story went, any rents higher than RMB2,000 per month might become unaffordable for local people. For those apartments in the mid-to-high-end specifications with the market value of over a million, RMB2,000 per month simply cannot produce reasonable return. On the other hand, home prices continued to rise, so hoarding apartments by itself is profitable on paper.

Your author is very pessimistic on Chinese real estate market. It is definitely a bubble, and every bubble will burst. The problem is when. Predicting when the bubble is burst is just as hard as pointing out when a rise in asset price become a bubble. But No matter what, it will burst.

What is the consequence of the correction of home prices in China? Although many commentators suggested that Chinese household are in good shape because they are not over-leveraged, and the loan-to-value ratio for mortgages are lower, your author has to remind you that if the downward correction of prices is significant, the once-healthy loan-to-value ratio will become dangerous. Also your author has to remind you that Chinese property developers are quite highly leveraged by bank loans and stuff. If the property market cooled down significantly, property developers not only will receive less money for each apartment they sell, but they also sell slower, impacting there cash flow position. Earlier this year, we saw a round of fund raising of Chinese property developers in the high-yield bond market, some yielding a double digit percentage, suggesting the risks of property developers running out of money. So it might be true that households are not much leveraged (as said by the bulls like Mark Mobius), but home-builders are.

Bank of China (image by Thomas Nugent)

Consequently, the banking system will be under pressure. Although the developed world will have to adopted a more-stringent Basel III, the Chinese authority is asking for even more. The proposal put forward by Chinese regulator requires a Tier 1 capital ratio of 8%, more than 6% required by Basel III. Your author believes that this can be a pre-emptive step to help bank to withstand the pressure should the real estate bubble burst if implemented in time, but we will not know for sure when these will happen. No matter what, should real estate bubble burst, it will have an impact on the banking system, no matter what Tier 1 ratio is required. This will in turn slow loan growths and credits to businesses, and may require additional capital for banks. As always, real estate bubble burst almost invariantly led to recession, and a serious one.

~ THE END ~

Read Previous Parts:

Part 1

Part 2

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About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.