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CNN and NPR: China’s Economy, Too Hot or Too Cold?

August 25, 2010

Two interviews I did recently, one with CNN and the other with NPR, were broadcast yesterday.  Both focused on China’s real estate market, within the context of the broader Chinese economy, and the reports themselves offer an interesting contrast in perspectives on what’s going on.

The NPR report, which you can read and listen to here, focuses on the recent “slowdown” in China’s economy (from just shy of 12% annualized GDP growth in the first quarter, to a little over 10% in the second quarter).  In particular, it notes that some of China’s property developers are having trouble selling units, due to government efforts to “cool” the country’s red-hot real estate market.  I note that, in many respects, a cool-down in actually welcome, given concerns about overheating and inflation.

The CNN report, which you can watch here, paints a different picture:  housing prices remain quite high, and many Chinese savers are still stockpiling empty units as a store of value.  In a part of the interview that didn’t air, they asked me whether I thought goverment “cooling” measure had defused the danger of a housing bubble.   I said that the steps the government had taken had thrown the market into confusion — people are delaying decisions to buy or sell until they see which way the market is heading — but had not changed the underlying dynamics that cause people in China to channel so much money into real estate, particularly unproductive real estate.

So yes, developers are having trouble selling units — for the moment.  But don’t expect that to last, even if the government does hold firm on its tougher policies.  We’ve seen these kind of dips before.  The troubling conditions in China’s real estate market aren’t just momentary speculative froth, but are based on deep-rooted distortions that have proven remarkably persistent.  The big challenge China faces — to find a more sustainable growth path going forward — remains to be tackled.

7 Comments leave one →
  1. dannytchii permalink
    August 28, 2010 1:45 pm

    Professor, does this means the Chinese, with such a huge population,
    could prolong this long-anticipated bubble, or this speculation might
    never happen ?
    My understanding is many are bought on all cash basis, the American
    scenario, bought with over leverage, could hardly fit. Unless I see
    major loan defaults on the banks by developers and regional governments.

  2. Hua Qiao permalink
    August 29, 2010 10:20 am


    One thing that no one seems to be talking about in the stress test review that the CBRC and the Chinese banks did on their real estate portfolios is whether the assets reviewed included commercial (business) loans that have real estate in the collateral package. I cannot be sure but I bet not.

    In China, many traditional types of collateral that we recognize in the west are ineffective. “Floating Charges” over Accounts Receivable and inventory are new and relatively untried in China (the law has only been around for a few years). Equipment collateral is difficult to perfect with a haphazard local filing system. Consequently, most Chinese commercial loans are either unsecured or secured by a combination of cash and real estate. I think this is a big exposure for the banks.

    If China has a slow down and a significant number of these commercial borrowers were to get into trouble, foreclosing banks may be forced to liquidate their real estate collateral at a time when other lenders are doing the same. If this further happens during a downturn in the primary real estate developer market, then I think there could be a lot of trouble.

    To be a cynic, perhaps this won’t be a problem since Chinese banks “extend and pretend”, rarely foreclosing until the borrower is brain-dead. Further, I don’t think the commercial loan collateral is frequently reappraised or marked to market where there might be an issue forced entirely by collateral devaluation.

    In fact, I see no discussion by any regulator or banks about the derivative effects of a real estate slowdown or the curtailing of infrastructure capital. I am very concerned, for example, about contractors who may be forced to carry receivables on jobs where the owner can no longer pay.

    I cannot say for sure, but I don’t think the CBRC review covered (or the banks reviewed) commercial business loans secured or partially secured by property if the purpose was not for real estate development.

    Do you have any insights on this?

    • prchovanec permalink*
      August 29, 2010 10:40 am

      This is actually a question that I’ve had as well, although I know of no way to investigate it, since the CBRC isn’t disclosing their methodology. But given their conclusions — that Chinese banks, in particular the “big four,” can sustain a 30-50% drop in real estate prices with barely any losses — I can only believe they are focusing narrowly on property loans, not on business loans secured by property. Some people I’ve talked to say it really depends on the safety margin built into the collateral arrangements — if the bank insists on $2 million in real estate collateral to back a $1 million loan, then property values could drop 50% and still be sufficient. But if the banks haven’t been playing it that safe, it’s hard to see how a 30-50% drop wouldn’t result in wide-ranging losses on commercial loans, even if a bank had limited exposure to property lending per se.

      • Hua Qiao permalink
        September 1, 2010 7:56 pm


        Today I spoke with someone that was in a position to know on the stress testing. That person said that the only thing tested was residential property loans. Both commercial property and commercial business purpose loans secured by property were not included in the stress testing.

        I can’t verify that…but this person is someone pretty close to the cbrc stress testing exercise.

      • prchovanec permalink*
        September 1, 2010 8:03 pm

        Well then that’s insane, if it’s true. Everyone knows the residential mortgage market is new and, while growing quickly, still relatively small. Commercial property is what’s scary, in terms of leverage, whether it’s actually labelled real estate lending or not. And the exposure to commercial business loans predicated on property as collateral is what permeates the system. So, if what you say is accurate, the supposed implications of these stress tests (“banks can sustain 30-50% real estate plunge without losses”) is meaningless.

  3. Hua Qiao permalink
    September 2, 2010 10:57 am

    I agree. I will see if I can check some other sources.

  4. Hua Qiao permalink
    September 2, 2010 4:39 pm

    Nice article by Andy Xie at the link below

    I took the liberty of copy an excerpt as it points up what Patrick and I were talking about with regard to land collateral pledged for commercial business loans….

    “Recent manufacturing investment, for example, is partly due to high land price. Local governments have been competing fiercely for manufacturing investment. Many companies have learnt to exact so much benefit from local governments that they put down no equity capital for investment. They often ask for free land and use the land as collateral for bank loan. They then lease equipment from the manufacturers that obtain bank loans for the leases. Essentially, the equity capital is from the land donated by the government. This explains why so many companies have always had negative net cash flow but keep expanding. Indeed, expansion is critical to their survival, as they need new investment to bring in cash to sustain themselves.

    “Profit drives investment that in turn powers employment that then grows consumption. When profit is due to asset appreciation and not sustainable, it could lead to crisis. Large bubble often occurs during prolonged prosperity. People stop paying attention to risk and have excessive demand risk assets. It leads to an asset bubble that prolongs prosperity beyond the normal cycle time length. The more overextended the cycle, the more pain the adjustment would be after the bubble bursts.

    “Possibly half of China’s bank lending is to the property related businesses or local governments that pledge land as collaterals. While the current boom has catapulted China ahead of Japan as the world’s # 2 economy, we must remember the excesses in this cycle and the need for an adjustment as soon as possible. Nothing reveals the vulnerabilities more than the banking system’s exposure to the unsustainable economic activities that depend on land appreciation. China should proactively bring about the needed economic adjustment.”

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