China’s Real Estate Bubble — The Next Threat to The Global Economy?

(jurvetson)

While the U.S. struggles to recover from a housing bust, China is currently in the midst of a housing bubble. Yet, few inside or outside of China seem very happy about it.

In light of America’s own recent housing boom and bust, analysts are worried about what skyrocketing Chinese property values could ultimately mean for the world economy. A November 2009 TIME article warned of “bubble trouble” and cautioned that real estate is “China’s biggest headache.”

Real estate may be the driving force behind China’s recovery, but some fear that the current boom could create an “unstable and dangerous” economic climate for years or decades to come.

The Buildup to the Bubble

Signs of a bubble in Chinese real estate began to emerge in late 2009. As TIME explains, government data showed property prices in 70 cities rising 3.9% in October 2009 over what they were in October 2008. It was the largest such increase in 14 months, and in 20 of those cities, property prices jumped 1% or more from just one month earlier.

Nor was this an isolated bubble confined to China’s wealthy coast cities. Nanjing, Chonging and Kunming are among the other towns which also saw property price hikes.

On the heels of these findings, Bank of America Merril Lynch Global Research economists declared that “rapidly rising property prices now becomes a top issue for policy makers in China.” The fear is not simply that the bubble will eventually burst (although that is a real concern), but that it is muddying the issue of when to end China’s sweeping economic stimulus efforts.

Delaying The End of Stimulus Measures

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Like most developed countries, China enacted a sweeping stimulus package in response to the financial meltdown of 2008. Forbes revealed in November 2008 that the “massive” stimulus effort spanned four trillion yuan ($586 billion) to be spent on upgrading roads, railways, airports and the national power grid, as well as “raising incomes via land reform” and social welfare projects like environmental protection and, yes, affordable housing.

Several interest rate cuts and the relaxing of lending limits on commercial banks were also central to the Chinese stimulus plan. The United States, by contrast, pumped “only” $100 million into the economy during summer 2008 with tax rebate checks (although it did spend considerably more on later stimulus projects.)

At any rate, TIME finds that the rapid escalation of property values is “complicating Beijing’s decisions on when and how to unwind the drastic stimulus measures” and get back to economic normalcy.

Soaring Increases in Lending

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The stimulus, in fact, arguably helped create the real estate bubble. According to MSN Money, investment in the real estate property market from developers and speculators increased 38.2% during the first five months of 2010, compared with the same period in 2009.

Shedding some light on how this came to be, TIME adds that the “amount of new loans granted by Chinese banks in the first 10 months of 2009 surged an eye-popping 144%, to $1.3 trillion, from the same period in 2008.” All of this increased activity is good – up to a point.

Policymakers are worried that many of these rising home prices in China’s major cities are putting homes out of affordable reach. To the extent that occurs, the result could be diminished consumption – the very thing China’s gigantic stimulus bill sought to stop and prevent from happening again. After all, a higher share of one’s income devoted to housing, by definition, means less is available to buy other consumer goods.

Parallels to America’s Housing Bust

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Perhaps most worrisome are the striking parallels China’s bubble has with America’s most recent one. While Chinese buyers aren’t nearly as leveraged as American borrowers were (Chinese buyers are typically putting down 30% of the purchase price), as MSN Money points out, the cheap money flooding the market is largely financing second homes and third homes. Borrowers are less likely to be as diligent in repaying these loans as they would loans on their primary residences.

Loans are also reportedly being made to buyers with inadequate incomes and, in some cases, without the requisite credit checks. “China is clearly in an asset bubble”, IHS Global Insight chief economist Nariman Behravesh told CNN Money in April 2010. “It’s almost like it didn’t learn its lesson.”

What’s Next

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To its credit, the Chinese government is attempting to prevent the situation from escalating to a bust. A separate TIME article found that the central government in Beijing has sought to tighten credit growth and property loans since the beginning of 2010. The debt being incurred by local governments to finance the above mentioned infrastructure projects has only heightened fears of the turmoil a housing bust might create.

To address the problem, the government eliminated a first-time property buyer perk that made fixed, 5% 20-year mortgages available for about 4% back in March. Lending standards have also been tightened somewhat in connection with second and third homes and investment properties. It remains to be seen whether these efforts will contain the bubble.