China’s property bubble is now on the verge of collapse. Transaction volumes are significantly down and declining volume is how property bubbles always burst. In simple terms, the pool of greater fools eventually runs out.
In China’s case, the pool of fools is heavily involved in “loan shark” schemes where speculators hope property values rise fast enough to cover the interest.
Ponzi Loan Shark Operations Fuel Bubble
In this article we will show how the ponzi shark loan scheme works and why we think the regime in China will fall. Our research is based on sources INSIDE CHINA
This is how this Ponzi scheme works:
Local officials, [required by] the government to produce double digit GDP growth numbers, give real estate developers permits to build housing projects in return for bribes. They also get bribes in return for allowing the shark loan companies to operate under their jurisdiction. Some of them are active partners in shark loan businesses. Every scheme has a ring leader whose job is to collect money from all the participants in the Ponzi scheme. When some of these Ponzi schemes blow up, the party leaders always get bailed out first.
Most of the funds that are collected in this classic Ponzi finance go to local land purchases and real estate development. Part of the funds are used in order to pay back the rolling loan. The short term interest rate in this black market is very high and ranges between 20%-150% annual rate. The sources of the Ponzi funds are diverse, as ordinary citizens, banks with corrupted bank officials, and state enterprises play the game.
A reader wrote to us this email two weeks ago, which triggered our in depth research:
“My hometown is Zhejiang, now I live in shanghai, my sister pledged her home to bank, she lived in Hangzhou, she bought her home around 500,0000rmb five years ago, now her home worth 2 million RMB, so she can get huge loan from bank, she gave this loan to a shark loan company with 30% return every year, she has been doing and living on this for 4 years, she is a middle school teacher, she earned 4000rmb per month, but with this lending arrangement, she has been able to buy a car, the interest income is 6 times of her salary, One of my cousin’s father lost all his principle of 4 million since one scheme blow up in 2008. That is my personal experience. …
Fractional Reserve Lending On Steroids
I got that story and link from someone in China who has been attempting to get me to post it. I wanted to verify it first.
I sent the above link to Bill Hopen, my sculptor friend (please see Inside China: A Sculptor’s View) and asked him what he knows about “loan sharking”. Bill is married to a Chinese and lives in China part-time.
Bill Writes …
Yes, that sounds typical. That is how China works in Wen Zhou area also.
It’s not “loan shark” as in “I will break your legs if you don’t repay”. However, there are circles in neighborhoods, or churches, community groups that are kind of like informal credit unions. People pool money into a large sum and then bid for its use month by month. 5% a month is the typical rate of interest.
Chinese are crazy for busting a move financially. No one saves in banks. Instead, they keep piles of cash elsewhere.
If you get sick, you must have cash or you die if you cannot pay immediately for care, for hospital, for medicine. You are literally wheeled out into the corridor to die if you don’t have money for oxygen. I am not exaggerating. There are no credit cards in peasant culture, but there is credit.
Families lend, friends lend, and they all rely on each other for cash reserves. The ties of honor and reputation are all that enforce repayment. It is a great shame if you can’t repay. Face is everything. Many simply repay by “rolling the debt” borrowing more to pay the vig.
I have had to bail my mother-in-law out several times. The accumulated interest was greater than the principal she originally borrowed.
Parents of lend to their children to buy their condo with the understanding it will be repaid or they will come to live in their old age under that roof. Almost no one has the 20 to 30% down to buy a place. The down payment is typically borrowed at terrible interest or comes from a “marriage gift” which had its origin in borrowed funds, not from savings.
It’s like fractional reserve lending on steroids. Everyone works their ass off to pay the loan, pay the vig, and save their face so they can borrow more if needed. A collapse of the bubble could cost lots of folks their life savings. This makes the financial aspect of Chinese society much more fragile than it appears on the surface. There is a lot of interconnected personal debt below radar.
Also I don’t know how one would track “the money supply” in this setup. All is not what it seems.
Hope this helps your picture of China.
Peter Navarro Video on Shark Loans
Soon after I received verification from Bill Hopen, Peter Navarro came out with an excellent video on the Shark Loan Phenomenon
There is no embeddable link, but the video is well worth watching.
Click on the above link to play.
Bubble Prices – Whopping 22 Times Income
Please consider Beijing home prices rise to ’22 times income levels’
A typical Beijing flat costs about 22 times average incomes in the city, state media said Monday, highlighting the challenge China faces providing affordable housing amid a property boom.
A 90-square-metre (968-square-foot) apartment in Beijing cost 1.6 million yuan (236,000 dollars) last year, the China Daily said, citing an independent report.
That compared to an average household disposable income of around 71,000 yuan in 2009, according to city figures.
Demand Dries Up
Has the bubble burst? It appears so. The Financial Times reports Cooling Property Market Tests Beijing’s Nerve
It feels like the calm before the storm at the Heavenly Famous Garden housing complex in Tongzhou, a booming commuter town on the outskirts of Beijing. The showroom is empty and for the past two months not a single flat has been sold, yet prices have not budged. Something has to give.
It is situations such as this that are testing the nerve of Chinese authorities as they try gradually to cool an economy that was at risk of overheating earlier in the year.
Tongzhou is one of the more extreme examples of the recent property boom. The town, about 20 miles from Beijing, has become a popular option for middle-class families priced out of the capital. The local government has big ambitions – two years ago, it announced plans for a 500-metre tower, which would be 50 per cent bigger than the tallest building in Beijing.
The Heavenly Famous Garden complex shows how quickly the market has run into a wall. Flats next to a new light railway to central Beijing were put on sale last summer and by this April prices had doubled to Rmb24,000 ($3,500, €2,700, £2,300) per square metre. Yet even though a third of the apartments were still unsold, there have been no buyers since the government announced its April clampdown.
One of the country’s biggest estate agents, 21st Century, opened an office in Tonghu Avenue in Tongzhou in early May. Since then, it has sold a grand total of one flat, although the list prices on some buildings have slipped 15 per cent.
Home sales in Xiamen plunge 44.7% in first half of year
Property bubbles always burst with a collapse in sales. Here is a second article highlighting demand falling off a cliff.
Please consider Home sales in Xiamen plunge 44.7% in first half of year
According to the Xiamen Municipal Government, the sales of commercial residential housing in the first half of this year in Xiamen was 1.257 million square meters, a decrease of 44.7% compared to the same period last year.
According to statistics, the total sales of commercial housing in the first half of the year in Xiamen was 2.336 million square meters, a decrease of 23.2% compared to the same period last year. In June the sales were 331,000 square meters, dropping 2.8% compared to May.
The sales of commercial residential housing in the first half of this year was 1.257 million square meters. The sales in June was 115,000 square meters, a drop of 8% compared to May.
In June, the sales of residential housing in Xiamen’s 4 mainland districts accounted for 72% of the total. Affected by this, the city’s average price of commercial housing was 9,453 Yuan / square meter, a drop of 19.1% compared to May.
For icing on the bubble bursting cake, please consider Tianjin Says ‘Wait a Minute!’ to Wen as China Property Slumps
Three dozen cranes tower over the Tianjin West Railway Station, part of a 501-billion yuan ($74- billion) government-funded building boom in this city of 9.8 million southeast of Beijing.
Like hundreds of other local Chinese projects, Tianjin’s construction is financed in part by land sales that are dropping as China’s real-estate slump takes hold. Property sales slid at an annual 8 percent rate in June. Selling land produced 41 percent of Tianjin’s income last year, according to China Index Academy, a Beijing real-estate research firm.
A cascading collapse in local finances could force the central government to shore up banks that lent to local government entities, said Jim Walker, chief economist at Hong Kong-based Asianomics Ltd., in a June 7 interview. Banks could “easily” be saddled with bad loans of more than $400 billion over the next two years, he said.
“These local-government vehicles probably hope their projects will be able to service their debts,” Walker said. “If they don’t I doubt they’ll worry about repaying the loans; they will just assume that somewhere else in government will have to take on the bad debt.”
After their success in propelling growth, local authorities are now faced with the consequences of Premier Wen Jiabao’s crackdown on the real-estate bubble. Falling property sales risk an erosion of revenue accounting for as much as 30 percent of local budgets, according to Standard Chartered Bank.
The China Se Shang Property Index has tumbled 42 percent in the past year, underperforming the 23 percent drop in the benchmark Shanghai Composite Index.
“Local governments were encouraged to invest in these projects and now they’re feeling like, ‘Hey, wait a minute!’” said Barry Naughton, author of the 2007 book “The Chinese Economy:
No Housing Bubble Says Roach
On June 15, I blogged Stephen Roach says China’s Housing Boom is Not a Bubble; I say “Nonsense”
The property boom in China isn’t a bubble because it’s supported by “solid” demand for residential housing, according to Stephen Roach, chairman of Morgan Stanley Asia Ltd.
Ridiculously strong demand is a necessary requirement to produce a bubble. The second requirement is a price increase that exceed the ability of buyers to repay the loans or sell to the next “Greater Fool”.
In the US, home prices rose several standard deviations above rental prices and above wages. The same has happened in China. Thus, China’s property boom is in a bubble state.
Please consider 10 Signs of Speculative Mania in China and a followup article, Email from a Chinese on China’s Real Estate Bubble.
No one knows when willingness of buyers to pay absurd prices will change, but sentiment will change. Perhaps China’s property bubble will expand further, but bubble sentiment always pops by definition, and China is in an enormous bubble.
It looks like demand has dried up. Whether or not it can be revived by more stimulus remains to be seen but I rather doubt it. Once enough people get burnt in real estate “loan sharking”, that demand will be gone for good.
How to Evaluate Bubbles
Evaluation of housing bubbles always comes back to two things:
1. home prices vs. income
2. home prices vs. cost to rent
If those get out of line from the historical norm, then there is a bubble regardless of “strong demand”. Actually, it takes “strong demand” for prices to get far out of line.
In the US, demand was so strong that people camped out overnight and entered lotteries for the right to by condos in Miami. In China, demand was so strong that people resorted to Ponzi “Shark Loans” to buy a house.
In my book both of those are signs not of “strong demand” but of speculative blowoff top, bubble mentality. Judging from volume that has dried up overnight, it appears China’s bubble has burst.
Mike “Mish” Shedlock
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