Two weeks ago, I offered an argument for why there is a good chance a residential housing bubble is fully formed in China and is frighteningly large in scope. There are, however, plenty of critics of this view. I want to address some of those concerns.
To start with, it is important to understand the Chinese bubble is a different kind of bubble than in the U.S. or Europe. And when it comes apart it will look different than recent experience has shown.
Leverage
Analysts who shrug off fears of a China bust first point to the limited leverage in the Chinese housing market. One reason the U.S. economic crisis was so intense was that balance sheets-in homes and businesses-were leveraged to the hilt. Debt relative to disposable income was well over 125 percent (according to the SF Fed) in 2007 when the crisis started to become acute. In fact, most of the housing bubbles that popped over the past few years in industrialized nations were highly leveraged bubbles. The bursting effect caused debt crises of literally global proportions as property values plunged and left millions without a chair once the music stopped.
In China, however, most of the housing investments have been made with cash according to cultural traditions. While there are plenty of mortgages outstanding, most of the debt in the country is government debt. Families instead hold five apartments, living in one and leaving the others vacant. But this lack of leverage doesn’t preclude a bubble. The dot-com bubble at the end of the 1990s was purely speculative bubble that had little leverage at all. When that bubble came apart investors were wiped out, even though there wasn’t a debt crisis. The Chinese real estate bubble is a similar story.
Prices are higher than they otherwise would be without government monetary supports. Families are excessively invested in housing instead of traditional savings. So there doesn’t need to be leverage in the system for a housing bubble bursting to sweep across the China and wipe out the nest egg of the millions with their live savings in housing. It will be a family balance sheet crisis instead of debt crisis. It won’t just be speculators and wealth investors hit hard.
Demand Mismatch
In order for the bubble to burst there will have to be wide spread loss of confidence in the housing market, causing a glut of supply to flood the market driving down prices. Some analysts say this is unlikely, given the huge demand for housing in China. In fact, it is estimated that some 300 million people will move into China’s cities-where the bulk of empty housing sits-over the next twenty years. They will need places to live, and with the abundant housing available being timed with a coming wave of retirements, the demand should keep prices high and help families cash in on their investments.
The problem with this view is that it fails to account for the mismatch in demand for low-income housing with the supply of luxury housing available. Developers have long focused on high-rises built for the upper income level citizens and luxury housing complexes out of financial reach for most because they can make a bigger profit margin there. In 2009, 90 percent of the massive spike in housing starts funded by the monetary stimulus was targeted at the luxury market. As a result, most of those looking for housing even now are priced out of the market.
A famous 2009 TV drama in China, “Dwelling Narrowness,” featured two educated sisters unable to find any affordable housing in Shanghai with a mortgage payment that was less than two-thirds their collective salary. The government eventually banned the TV series for its accurate depiction of corruption, but the show remains popular in the minds of many Chinese today who identify with the struggle. According to Peter Cohen, in Beijing a typical 1,000 square foot apartment is priced about 80 times the average annual salary of citizens.
Top China-policy commentators Pat Chovanec and James Chanos both point to the mismatch in supply and demand as a problem that will only become more acute over the years. Without demand for the housing available, eventually there will be wide spread property value depreciation. The real question isn’t whether there is a bubble but when will it pop and what will be the consequences. It may not wind up destroying the Chinese economy, but it will destroy the wealth of millions just as the U.S. bubble bursting has done to Americans.