An American Commentary
By Richard Wottrich
CHICAGO: March 30, 2010: China should heed the lesson of the American real estate recession – what goes up must come down. The worldwide recession was triggered by the unholy trinity of the US Federal Reserve Bank (FED) low interest rate monetary policy, political class influence to make homeownership available regardless of ability to pay, and the moral risk of the federal government backing the mortgage giants Fannie Mae and Freddie Mac. You reap what you sow.
The US FED supplied cheap money. The politicians provided an implicit guarantee to back Fannie Mae and Freddie Mac, enabling them to write billions in risky mortgages. Fannie Mae and Freddie Mac executives made substantial contributions to the politicians overseeing their companies, while these mortgage giants took over half the US mortgage market. Wall Street packaged these mortgages into complex opaque securities and sold them globally, reaping hefty fees.
Americans took advantage of this “free” money by buying and refinancing properties in a spiral of escalating debt. Real estate prices exploded. They took capital out of their “suddenly valuable” properties and went on a spending binge. The American stock markets soared.
This bubble burst in the most human of ways. Somewhere in America a middle class schoolteacher discovered that she couldn’t sell her home to pay the accelerating interest payments on the big mortgage she had been romanced into. Her home that cost $100,000 to build, that she bought for $175,000, and then mortgaged several times to the tune of $250,000, had reached the limit of what could be financed. She was told she could not refinance again. Multiply this story by several million and you understand how the recession started. It was a giant game of musical chairs and the music stopped. It was a Black Swan moment.
At every step in the process so-called professionals benefited mightily through fees. The banks, mortgage brokers, mortgage property managers, real estate brokers, appraisers, title companies, politicians, the FED, the rating agencies and Wall Street all had a professional responsibility to behave responsibly. They did not. They took the money.
China is at a similar crossroads in its history. Real estate prices are soaring. In 2009, a record $560 billion of residential property was sold in China, an increase of 80 percent over 2008. As a result prices are exploding, developers are in a building frenzy, and speculators have moved into many markets. By any standard business measure, such as rental yield, this is a real estate bubble. At some point the music will stop.
Mitigating this risk is the urbanization of China. This huge population shift helps it sustain the real estate boom, along with favorable government policies. Government infrastructure stimulus spending of over $586 billion aids real estate developers. China’s GDP is roughly $4 trillion compared to about $14 trillion for the U.S.; hence GDP China’s $586 billion stimulus is three times as large as America’s $787 billion stimulus, or about 15% of their GDP, compared to America’s 6% of GDP.
The country’s high growth rate of roughly 10% supplies the cash that feeds the real estate price spiral. Chinese government policies and tight control of the banking industry influence its currency to stay relatively low in exchange markets, which assists in keeping Chinese exports competitive.
Local governments in China also profit in real estate development because they sell land leases to developers. According to Chinese economists, up to half of all local government revenue comes from selling state-owned land to private developers.
These symbiotic relationships among favorable governmental monetary policies, government infrastructure stimulus spending, land sales by local governments, high growth in manufacturing exports, real estate values and the booming Chinese stock markets (SSE, SZSE, HKEx, SEHK) helps to promote a certain “gambling” mentality on the part of the emerging Chinese middle class. To assume that these favorable factors will not change is unwise.
While the factors influencing the real estate bubble in China have different labels than in the US, in reality they are the same. Cheap money, political influence, speculators, government policies and plain human greed are part of human nature. The trick is to tell the difference between what is real and what is hyperbole.