“Self-fulfilling expectations of falling house prices, financial difficulties among developers on the back of a highly leveraged economy with huge local government debt, and a fragile financial system with a large shadow banking sector, suggest the risks of a disorderly adjustment in the Chinese economy are real and rising,”
This is what Jian Chang, Barclays’ chief China economist, said in a recent report covering the Chinese housing sector and specifically the danger of a hard landing (we will have a full post on the report shortly), and judging by the most recent housing data reported by China overnight, the likelihood that the Chinese housing sector, whose problems have been extensively covered here for the past 4 years, is finally coming unglued is higher than at any time since the Lehman collapse.
Here is what China reported overnight via SocGen: New starts contracted 15% yoy (vs. -21.9% yoy in March); property sales fell 14.3% yoy (vs. -7.5% yoy); and land sales (by area) plunged 20.5% yoy (vs. -16.9% yoy previously).
It doesn't take an Econ PhD to conclude that "the housing market situation has undoubtedly turned quite gloomy. There has been a constant news stream of falling property prices everywhere, even in the 1-tier cities. A number of local governments, as we expected, have started to ease policy locally, especially relaxation of the home-purchase restrictions."
But nowhere is the contraction in this all important sector for China's credit-driven bubble more visible than the following chart showing a very distinct, if somewhat mutated, head and shoulder formation in the average 70-city property price index. If and when the blue line intersects the X-axis for only the third time in history, watch out below.
SocGen's take is less than rosy:
Since 2008, there have been two periods of falling housing prices across the board: H2 2008 and late 2011. Even tier 1 cities were not spared. However, the downturns were brief and shallow. In the midst of the Great Recession, price declines lasted for about six months and 14 out of the 70 cities tracked by the statistic bureau recorded cumulative price declines of over 5%. During the previous downturn between Q2 2011 and Q3 2012, property prices in most cities fell consecutively for no more than 10 months, and only 4 cities saw prices falling by more than 5%. The turning points in both cases coincided with the beginning of credit easing. The logic is simple: most Chinese households, especially first time buyers, still need to borrow to buy, despite the high savings ratio on average. And down-payments and mortgages account for 40% of developers’ investment capital.
Which brings us to the key issue - credit, and rather its sudden lack of availability.
The housing sector is very important to the Chinese economy. Its share in total output is easily 20%, if its pull on related upstream and downstream sectors in included. And its significance to the financial system is far beyond banks’ mortgages and direct lending to developers, which account for 14% (CNY 10.5tn) and 6.5% (CNY 4.9tn) of the loan book respectively. Developers’ borrowing from the shadow banking system could potentially amount to another CNY 5-7tn. Moreover, we estimate that over CNY 10tn of other types of corporate borrowing is collateralised on real estate and another CNY4-6tn borrowing by local governments for infrastructure investment is collateralised on future revenue from sales of land-use rights. Adding everything together, the aggregate exposure of China’s financial system to the property market is likely to be as much as 80% of GDP. Hence, this is not a sector that can go terribly wrong if China wants to avoid a hard landing.
Unfortunately, housing is one of the few sectors that the Chinese government has not mastered its control over. Although policymakers have used many sector-specific means to try to mitigate the cycles of this sector over the past 10 years, it has not been very effective. Even the harshest administrative controls – home-purchase restrictions – are subject to loopholes and implementation issues. Our observation is that the short-term cycles of China’s housing market, like housing markets in many other countries, are first and foremost a credit phenomenon.
And since it is a credit phenomenon, should China continue with its recent initiative to tighten lending and purge credit market pathways, housing is first and foremost in line for a collapse.
So what is China, suddenly facing the all too real prospect of yet another housing downturn to do? Why turn on the credit spigots again, of course. At least according to SocGen:
... we think the only effective measure to ease the housing downturn is to reaccelerate, or at least stabilise, credit growth. Reportedly, the central bank has asked commercial banks to quicken mortgage lending despite the series of defaults and near-defaults of developers. Clearly, policymakers know which lever to pull, but the question is to what extent.
We agree that many Chinese cities are already suffering from over-supply issues. Although further urbanisation will continue to support demand growth, the pace of urban population growth in the next decade will still slow and there is a big affordability gap for rural migrants. Hence, if the authorities decide to use another credit binge to inflate the sector again, they will merely make the structural imbalance between supply and demand worse. There could be a middle ground. Measured and targeted credit easing might avoid a nation-wide crash, but some overly stretched cities – in terms of over-supply and leverage – will still experience severe pain, just likely Wenzhou where property prices have declined non-stop for more than two years by over 20% cumulatively.
Ah yes, being caught between the proverbial rock and a hard place.
For now the market is convinced that the worse the housing data, the more likely that the PBOC will engage in yet another massive stimulus and do what western central banks are so happy to do virtually constantly - kick the can once more.
But what if it doesn't? What happens to not only China but the suppliers of its raw materials? The FT reported overnight that "In just two years, from 2011 to 2012, China produced more cement than the US did in the entire 20th century, according to historical data from the US Geological Survey and China’s National Bureau of Statistics." We showed this two years ago - little did we know that two years later the situation would be completely out of control.
Surely the suppliers of cement were happy. But should the credit, and thus housing, bubble continue to deflate, what happens then? Already we know that steel rebar prices in Shanghai crashed to record lows just last week "as Chinese mills churn out record amounts of steel while growth in the economy and the property market ease."
What happens if instead of kicking the can as the market is convined it will, China decides to bite the bullet and do what the Politburo thinks will be a controlled bubble burst?
We don't know, but if recent images of Shenzhen riot police preparing for a "working-class insurrection" are any hints, we would not be absolutely convinced that China will simply kick the can once more. Because the next time the bubble bursts, the shock will be so much worse that not even throwing countless amounts of credit money at the problem will make it go away...