“China’s Empty Apartments II”

In their follow-up to the piece they posted yesterday, ChinaBeat goes into what could happen to the real estate market in the future:

“If real estate prices keep rising, then you’re using all of your money, all of your parents’ money to buy an apartment for you and your spouse,” Shih said. “You don’t have any money to buy anything else. How can you expect people to spend more in the future when every major policy in China actually leans against that?”

But Shih said he believes that the bubble in real estate threatens to have more wide-ranging effects in the long term. For if land values are currently overpriced and therefore fall in the future, the value of all loans backed with land as collateral would be called into question, and many, extended hastily in the wake of the financial crisis to prop up the economy, would not be repaid. After a year’s research, Shih concluded that excessive lending had led to 11 trillion RMB in debts assumed not only by local governments, but also by the local investment companies established by them.

“If the land value plummets, many local governments will not be able to repay these loans, and the banking system is in big trouble,” he said.

The effects of a failure to repay this debt could include a loss in foreign confidence in the Chinese financial system and a need for the government to spend billions to re-capitalize the banks, according to Shih.

“It looks bad for a lot of bad local government loans to suddenly appear on these banks’ balance sheets,” Shih said. “Foreign investors may sell off their holding of Chinese bank shares. This would force the government to plow even more money into Chinese banks, which basically would be a re-nationalization of the Chinese banks.”

Despite a similarly rapid increase in housing prices, Chovanec cautioned against thinking that the effect of decline in Chinese housing prices would be the same as it was in the U.S. in 2008. Instead, he used Japan in the 1990s as an example of what could happen: large amounts of unacknowledged debts slowly crippling future lending and growth.

“I’m not sure that the bottom falls out,” he said. “It’s not like Japan suddenly imploded. There was lot of growth years on, and banks that looked healthy were in fact sitting on top of a mountain of debt. Given the state run system in China, I doubt like this ends up being some kind of market meltdown.”

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