China Strings Up the Safety Nets

There is much evidence of a property bubble in China. For example, developers are paying $1,000 to $1,500 per sf for undeveloped land in Bejing and Shanghai. Further, as a centrally managed economy there is likely to be a significant mis-allocation of resources and corruption.

That said, it is far easier to overcome bad economic decisions in a rapidly growing economy. Time and growth are your friends.

Further, China’s leaders appear to be reasonably astute in managing nascent bubbles before they turn into economic catastrophes. They have raised bank reserve requirements, down payment requirements and mortgage interest rates particularly on properties acquired for investment purposes. While these actions may not forestall a bubble collapse, they will provide a cushion to protect the system in the event one occurs. It will be far easier to work out of bad property transactions when 40% of the purchase price was upfront cash, the initial mortgage term was 10 – 15 years and banks are holding $1 of capital in reserve for every $6 to $7 in loans. (Compare this to our scenario of 100%+ debt financing, 30 year mortgages, 30 to 1 reserve ratios, off balance sheet accounting mechanisms and derivative bets that can serve to magnify rather than cushion the effects of a bubble collapse.)

Does China have bubble worries? Yes. Will the collapse in the real estate bubble devastate China’s economy? Who really knows, but at least the Chinese government recognizes the risks and is stringing up the safety nets to cushion a fall if one comes.