How China’s bubble began
For a moment, as Chinese real estate giant Evergrande teetered on the edge of bankruptcy, it looked as though President Xi Jinping might do the unthinkable: prick the greatest real estate bubble in history.
He’s right about the problem—property speculators have hijacked the world’s second largest economy. Homes are “for living in, not for speculation,” is Xi’s mantr
But those speculators are responding to a set of incentives unique to the Chinese model of development. In fact, Chinese land and housing markets are set up in a way that not only encourages but virtually demands the speculative purchase of apartment
If Xi really wants to put speculators out of business, he’ll have to alter a critical component of the Chinese “state capitalist” system in which the central government sets a growth target and local governments deliver by pumping up their real estate market
Property developers like Evergrande are merely cogs in this growth-generating machine.s.s.a.
Of course, the entire system depends on buyers of apartments believing their values will keep rising. Absent that faith, the market craters, taking with it GDP growth while gutting the finances of local governments and destroying middle class family wealth.
Speculators have always bet that Beijing will never let that happen, given that real estate drives more than one-quarter of economic output and 90% of families own their own home.
They’re probably correct. Right on cue, Evergrande this week staved off default by paying a bond coupon ahead of a Saturday deadline. Speculators appear to have won another round.
Indeed, it’s becoming clear that Beijing has no intention of allowing Evergrande to collapse altogether under the weight of its $300 billion in debt. Rather, Chinese authorities want to punish the world’s most indebted developer as a warning to others about the dangers of out-of-control borrowing.
Their normal playbook is to squeeze demand. Hence, in larger cities speculators are held in check by a thicket of restrictions on property purchases. In Beijing, for instance, married couples are only allowed to own two homes.
Now, Chinese authorities are also squeezing supply, placing limits on the borrowing of real estate developers—the so-called three “red lines” introduced last year. Still, they’re just dealing with the speculative excesses of the system, not changing the system itself.
The idea that real estate will deliver unearned windfalls, guaranteed by the government, is as old as the Chinese housing market. Prior to 1988, all Chinese workers lived in state-owned welfare housing. Then, Premier Zhu Rongji sold off the government’s entire stock of urban housing at bargain-basement prices, and almost overnight China became a nation of homeowners.
China’s former Premier Zhu Rongji gives his farewell address during the National People’s Congress in Beijing in 2003.
Those homes have appreciated year after year. In fact, it’s arguably not speculation at all when property prices can only go up. Most investors think of apartment purchases as a one-way bet, which is why so many buy two or three —or ten, for that matter, if they can get a mortgage.
Meanwhile, city governments have every incentive to support ever-rising prices: land sales account for 46% of total government fiscal revenue.
A number of smaller cities are so desperate to keep prices trending up that they’re forcing rural residents to sell their village homes and move into more expensive urban high-rise housing blocks. In other words, they’re manufacturing demand.
Beijing is now trapped in a speculative marketof its own making. An obvious exit, as Matthew Brooker notes in Bloomberg Opinion, would be to institute a property tax. At a stroke of the pen, this would discourage the purchase of multiple homes by raising their so-called “carrying costs” while offering local governments a stable source of revenue.
But Beijing seems to have balked at this solution. The risks of antagonizing local governments and middle-class homeowners are apparently too high.
It may be that Xi, in going after indebted property developers, has altered the psychology of property speculation if not the policy underpinnings. With real estate prices falling for the first time in six years, said Ting Lu, chief China economist at Nomura, households “may not believe their home price will rise forever. That’s very, very important.”
Ting Lu Photographer: Jerome Favre
In any event, the Evergrande fiasco has exposed a popular myth about the Chinese economy—the notion that it’s guided by technocrats who gaze far into the future, in contrast to their counterparts in Western democracies who struggle to think beyond the next electoral cycle. It turns out that China may be locked into the worst kind of economic short-termism.
“State capitalism” as practiced in the all-important property sector is largely a speculative enterprise. The longer it lasts, the more painful the adjustment when it finally comes crashing down.