The Los Angeles Times (a newspaper which has its own problems) has come out with an article on Beijing real estate, which features Jack Rodman. Jack, who runs a firm called Global Distressed Solutions, is a bad-loan and distressed real-estate expert who has spent the last several years in China.
According to the article by Rodman’s calculations, 500 million square feet of commercial real estate has been developed in Beijing since 2006, more than all the office space in Manhattan. And that doesn’t include huge projects developed by the government.
He says 100 million square feet of office space is vacant — a 14-year supply if it filled up at the same rate as in the best years, 2004 through ‘06, when about 7 million square feet a year was leased.
To its credit, the government recognized in 2007 that the real estate market was headed toward a bubble, economists say. In an attempt to make real estate more affordable, restrictions were introduced on ownership of second homes and on foreign home buyers. But the measures came too late, accelerating the crash of an already weakening market.
The Beijing Municipal Bureau of Statistics reported this month that housing sales in the city dropped 40% last year.
Chinese economists have predicted that housing prices will drop 15% to 20% in Beijing this year. Shanghai has experienced a similar decline.
Any conversation about Chinese real estate with Jack is likely to be depressing because his terrible stories aren’t much relieved by vagueness. When Jack talks about empty buildings he gives actual addresses.
And it’s not just foreign newspapers that are warning about real estate trouble.
China’s leading independent business weekly, Caijing, also has an article that discusses the real estate mess:
Battered by global financial turmoil, foreign investors are moving quickly to liquidate stakes in Chinese property developers. The market is sinking, and investors are eager for a way out. Real estate developers, including some of the nation’s largest, are fighting to stay afloat. And so far, none have declared bankruptcy.
Most of the real estate has been financed by Chinese banks, which have avoided writing down the loans. Eventually, they will be forced to, and that probably will have a ripple effect throughout the economy.
There have been rumors for over a year that with the forced credit contraction of last year a lot of the riskier real estate developers had to turn to the informal banking sector for loans, and it is not at all clearhow these get resolved in case of payment difficulties.
The government will want to avoid a rapid liquidation of bad loans by the banks. They will not want banks to seize collateral and sell it off for fear that this would cause the market to collapse and would result in the kind of debilitating debt deflation that Irving Fischer described in the 1930s, in which assets are liquidated to meet loan payments, causing asset prices to fall, which puts additional downward pressure on loans, and so on in a self-reinforcing cycle.
Now it is not clear to me that this kind of liquidation is always harmful. A strong argument can be made, and has often been made, that the liquidation process makes a crisis feel worse in the short term, but results in a much faster recovery because at some point very low prices create economic value to businesses of owning the assets, and their use of these assets can fuel a rapid recovery.
The classic case is the massive railroad building program in the US in the 1860s and early 1870s, which left the railroad owners saddled with expensive assets which required passenger and cargo rates that were too high to be useful to most potential passengers.
Many of the railroads were never able to stop losing money.
When these railroads went bankrupt after the 1873 collapse, and were subsequently liquidated, new owners were able to buy them for pennies on the dollar, and so were able to make them profitable while charging much, much lower freight and passenger rates.
These lower rates sparked an economic boom by sharply reducing transportation costs, and the final value to the economy was much greater than the initial losses on the railroad assets.
The worst case, by this thinking, is if assets that are not viable at current prices are effectively taken off the market because the owners are not forced to liquidate, in which case they become a pure deadweight for the economy.
The counterargument, of course, is the Fischer argument – that forced liquidation is inherently less stable because it causes a self-reinforcing cycle of price collapses.
This sounds as much like a political argument as an economic one, but it is worth considering what might happen in China.
The consensus is that the government is far more concerned about avoiding short term instability than about promoting long term viability, and so will make every effort to force banks to stretch out the restructuring process, avoid panic liquidations, and take assets off the market.
With the mainland economy tanking to its slowest growth rate in seven years and banks wary of lending as defaults rise, small business operators are hocking belongings and company assets for loans from pawnshops.
‘Banks are reluctant to lend,’ says Huang Jing, deputy business manager at Shanghai Oriental, the city’s second-biggest pawnshop. ‘But we have a lower threshold and can provide loans much more quickly and with shorter terms.’
The front page of People’s Daily has an article with the large headline ‘Communist Party leadership warns of ‘austere’ year for China.’ It goes on to say:
‘The ruling Communist Party of China (CPC) said the country will launch a comprehensive economic package to tackle an ‘austere and complicated’ year ahead.
‘We will increase large-scale government investment, implement and readjust a plan to revive industries, make great efforts to boost innovations, and greatly enhance the level of social security,’ said a press release issued after a meeting of the Political Bureau of the CPC Central Committee. The meeting was presided over Hu Jintao, general secretary of the CPC Central Committee.
Seeking Alpha reported that Xinhua wrote of PBoC concerns about deflation:
China’s central bank on Monday warned of deflation in the near term caused by continuing downward pressure on prices. Commodities prices were low and weak external demand could exacerbate domestic over-capacity, the People’s Bank of China (PBOC) said in an assessment of fourth-quarter monetary policy. ‘Against the backdrop of shrinking general demand, the power to push up prices is weak and that to drive down prices is strong,’ the PBOC said. ‘There exists a big risk of deflation.’
While assuring us that it would ensure ample liquidity in the banking system and promote the reasonable and stable growth of credit, the PBoC, along with the CBRC, also stated three days ago that it was planning to investigate the lending spike.
According to an article in the current Caijing:
A dramatic increase in bank lending in January has attracted attention from investigators with China’s central bank and regulatory agencies, Caijing has learned.
The China Banking Regulatory Commission plans to investigate the huge cash flow after banks issued 1.62 trillion yuan in loans during the month. Notes trading represented 38% of the total credit. Some analysts have claimed companies may be using government-encouraged bank loans to invest in the Chinese stock market, which has rallied since the start of the year.
Until today the stock market had continued its upward surge – although the SSE Composite suffered a dizzying 7.5% drop last Tuesday and Wednesday on concerns that the PBoC investigation, if it determines that a primary cause of the recent market surge was bank lending to stock speculators, may pull the rug out from under the market.
The overall surge, largely on speculation about which sectors are going to receive bailout packages from the government, has made China the top performer among global stock markets this year, with the SSE Composite rising about 20% year to date.
A lot of my Chinese financial market friends are very worried that small investors are rushing in too quickly and are likely eventually to get hurt, since what is driving the markets — as always — is not changes in fundamentals but rather rumors of government intervention.
The game seems to be to guess which sector will receive the next set of rumors about government bailouts and to buy accordingly.
Even if the rumors are true, I think the market is ignoring how difficult it will be for profitability to revive and how even more difficult it will be for asset prices to stabilize.
Even real estate companies have seen stock prices benefit from rumors, although the sector is in serious trouble and it is only because they are in such trouble that the government would consider supporting them.
Still, this is always how the stock markets work here — it ain’t about fundamentals, its all about government rumors.