Chinese Real Estate Boom

Chinese down-payment requirements help protect home buyers to some extent. So, when their real estate bubble pops, the Chinese economy will fall onto the floor, instead of into a pit, like the American economy did. Nevertheless, it can hurt bad to fall on the floor:

When the global marketplace went into meltdown mode two years ago and Chinese exports dropped off, Beijing mounted a stimulus several times bigger relative to the size of its economy than in this country. It announced a four trillion yuan ($586 billion) stimulus for infrastructure projects and housing developments.

...Beijing also lowered capital reserve requirements for its state-owned banks ordering them to dole out loans to "support growth." Though official data are unreliable, in 2009 Beijing apparently handed out somewhere close to 10 trillion yuan in new loans—more than twice the year before—and expanded the country's total loan portfolio and money supply by one-third, according to Patrick Chovanec, associate professor at Tsinghua University's School of Economics and Management in Beijing.

...Fueled in part by this massive injection of liquidity, housing prices that had started dropping due to the recession began to soar again. Over the past year they increased nearly 12 percent, according to the latest figures from China's National Bureau of Statistics. So many middle-class Chinese (especially young couples wishing to move out of their parents' home) are being priced out of the market that their travails became the subject of a popular TV series called Dwelling Narrowness. Beijing banned the show, fearing it would cause unrest.

The problem is that government money is going to build homes not for occupancy but for ownership. Speculation, if you will. Andy Xie, a Shanghai-based economist formerly with Morgan Stanley, believes almost 25 percent to 30 percent of private commercial and housing stock in China is vacant. Entire cities, such as Ordos in inner-Mongolia, erected literally from scratch, stand empty.

"Chinese treat homes like gold bars buying multiple units as a store of value," notes Chovanec. Chinese avoid the stock market because it is still volatile and risky, and banks and bonds offer a low yield. Hence, Chinese are content to buy homes and let them sit because, thanks to the absence of property taxes, holding costs are negligible. Having never experienced a housing slump since China privatized its housing market in the 1990s, they believe that home prices only rise.

This can't last, but backers of China's stimulus believe there won't be any serious economic downside when the bubble bursts. Homeowners won't be thrown on the street because Chinese buy their first homes outright through their savings—not loans. And when house prices drop, the excess stock will quickly get scooped up—not boarded up.

While Chinese homeowners are not generally leveraged, those who buy second homes do finance them. And developers, including local governments and state-owned companies, are massively leveraged. This poses a big problem—Shen Minggao, Citigroup's Hong Kong-based China economist, estimates in Bloomberg Businessweek that at least 2.4 trillion yuan of the stimulus is already in nonperforming loans.

China's autocrats understand that they have a bubble on their hands. They've mandated minimum down payments of 50 percent on second homes and are considering property taxes to rein in speculative purchases. However, this will mean that the houses put on the market will find fewer buyers.

Beijing is in a dilemma. It can cut spending and rein in its monetary expansion, releasing over time capital for more productive endeavors (especially if it opens up hitherto closed investment options) and putting the economy on a healthier footing. However, that would mean slower growth, lower home values, rising unemployment and potential political unrest. Alternatively, it can buy a few more years of faux-growth and stability by propping up the real-estate market—and risk making the day of reckoning far worse when it arrives.