China: Half Of All Loans Collateralised By Land, Real Estate

By John Richardson

UShousepricesBEN Bernanke, who as at that time chairman of the Fed, warned in July 2007 that the cost of the US sub-prime crisis would amount to $100bn.

To be honest, we struggled to find a final estimate for the final total cost of the crisis, but these words from Wikipedia give just a flavour of how wildly Bernanke was off the mark:

The five largest US investment banks, with combined liabilities or debts of $4 trillion, either went bankrupt (Lehman Brothers), were taken over by other companies (Bear Stearns and Merrill Lynch), or were bailed-out by the US government (Goldman Sachs and Morgan Stanley) during 2008.

Government-sponsored enterprises Fannie Mae and Freddie Mac either directly owed or guaranteed nearly $5 trillion in mortgage obligations, with a similarly weak capital base, when they were placed into receivership in September 2008.

This, of course, just refers to some of the damage inflicted on the US economy during a crisis which became global.

Nobody has any idea how severe the final fall out will be from China’s real estate problems, but we worry that the consensus view is overly complacent.

Standard & Poor’s and Deutsche Bank, for instance, believe that the scale of the problem is little more than a cooling-off period as the rise in house prices moderate.

We are instead with George Magnus, an independent financial adviser to UBS, who wrote in this Financial Times article:

The Chinese property sector is in a recession. Market optimists insist it is going through an “adjustment” similar to previous property downturns.

A more sober view, however, is that because of unprecedented overbuilding, and leverage nurtured by the eruption of shadow banking, this downturn is both more serious and systemic. China is probably in the first stage of a denouement of the property- and construction investment-led growth model of the past 15 years. Financial markets are having trouble pricing the implications.

Property accounts for about 25% of capital investment, and roughly 13% gross domestic product. Incorporating associated industries, such as steel, cement, and construction machinery and materials, would raise the investment share of GDP to about 16%.

The intricate connections between residential and commercial property, shadow banking and vigorous credit creation raise financial instability risks. Direct commercial bank property loans form about a fifth of bank assets, but perhaps half of all bank loans are collateralised by property and land.

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