Vocabulary

 

 
 
 
 
 
 
 
 

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Transcript

Across the past few months, if you’ve seen a news story about China’s economy, you’ve probably seen pictures like this pictures of social unrest; people protesting outside of banks after their bank accounts were frozen; or outside the headquarters of major property developers after construction on their new homes was halted.

Chinese citizens have had enough amidst a major debt crisis among property developers and prolonged covert lockdowns. Recently Chinese citizens have added extra fuel to China’s economic fire, standing together and boycotting payments on over 300 billion dollars worth of mortgages.

What started as a small local petition has now grown to a massive freeze on mortgage payments on over 300 real estate projects in over 90 cities.

And it has the Chinese government very worried: the CCP has desperately tried to suppress the spread of the movement, a move which has only fueled the protest further as footage like this hits the internet.

But how has this happened? How is the seemingly unstoppable juggernaut of Chinese real estate, now turned into a major economic catastrophe?

Well let’s find out.

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This is Charles Ponzi.

No he certainly wasn’t involved in Chinese real estate; he was an Italian con artist who operated in the US and Canada — and of course he was known for the ponzi scheme.

This is a scheme where you promise investors a very handsome return; and as you find new investors you simply use their money to pay the investors who came before them.

Then as people see the returns being made in this scheme, they too sign up as investors and their investment gives the investor before them the very impressive payout they were expecting. And the cycle continues.

As you can probably tell, these sort of schemes are a disaster waiting to happen. But although being horribly illegal, they do work in a world where you can always find new investors.

But why am I telling you this?

Well it’s because this is kind of how Chinese property development works. More on that in a second.

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You see, throughout the last two decades in China, there has been a very strong trend for those living rurally to move to urban areas. Literally hundreds of millions of people have moved to the cities in that time.

And this has caused a monumental boom in urban property development. Being able to own your own home became a huge societal goal for people in China . . . and that drove huge demand for residential homes — not only to live in but also as investment products.

In fact in China approximately 70% of household wealth is tied up in property. People will save for decades, even team up with other families, just to put down a deposit on some Chinese real estate.

And due to this insatiable appetite for residential property, it didn’t take long before the developers started testing the waters of what was possible.

So enter pre-sale homes. And no it’s not what we call buying off the plan — it’s worse. In China developers will sell a pre-sale round where buyers will put down a deposit — and start paying back a mortgage before their home is even built.

You might say that’s insane. But in China it’s just how it goes; in fact in 2020, 34.5 percent of developers funding came from deposits and pre-sales.

And as you can imagine, for developers, the combination of insatiable appetite, freedom to take on vast quantities of debt and the now commonplace payment structure of handing over a deposit and paying a mortgage before construction has even started, quickly led to a scheme that might have caught the eye of our smooth talking Italian.

Revenue collected from pre-sale rounds would not actually be used to fund the project’s development; it would in fact be shuffled up the chain and used — along with copious amounts of borrowed money — to fund the completion of last year’s development.

Then they drop some new apartment buildings and complete the pre-sale round on those, sign up the excited buyers with a big fat mortgage. And then that fresh money can be shoveled up the chain again to fund the completion of the last wave of apartments.

A Chinese economist said recently when the economy is good with continuous expansion most of the properties can be delivered . . . But when the economy is not good it becomes a bit like a ponzi scheme. If there is no follow-up funding, they will not be able to complete construction.

So just like a ponzi scheme it actually does work as long as there’s always fresh demand and nothing gets in the way of these projects being completed.

Ah!

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Two massive factors we need to talk about next.

Firstly the Chinese government’s restrictions on leverage.

So sensing that the Chinese property developers were getting way over levered in 2020 the CCP announced a new rule called the “three red lines”.

And what this meant was that for Chinese real estate developer to be eligible to take on more debt, they must first show that their liabilities do not exceed 70 of their assets.

Net debt should not be greater than 100 of equity, and cash reserves must at least be able to cover 100 of their short-term debt.

And while all this is pretty smart, really the problem was that in 2021 almost half of the Chinese property developers were in breach of at least one of the red lines causing a sector-wide crisis in finding new funds as old debts came due.

This is what we saw boil over with Evergrande about 10 or 11 months ago, and that’s still causing them a lot of pain today.

And because of these new rules, we’ve already seen many large residential construction projects brought to their knees. And the Chinese government has even alerted other developers to prepare to take over half-finished projects should they see some of those developers go bankrupt.

So many developers are seeing projects stall as they struggle to find funds to get these projects completed.

But beyond this just to make matters worse earlier this year the Chinese government also implemented their zero-covid policies, so dozens of cities were put under full or partial lockdowns: you know subway stations and offices were empty roads apartment blocks and parks were all sealed off as people were forced to stay home.

This brought economic activity to an absolute standstill which prolonged the stagnation of these real estate projects.

And for a lot of once hopeful home buyers, that was the last straw.

As the Japan Times notes, quote,

“It started with a 590-word letter penned by angry purchasers of the half-built Dynasty Mansion Project in Jingdezhen, Jiangxi Province whose pleas for China Evergrande Group to complete homes they’d long been paying for had fallen on deaf ears.

All home buyers with outstanding mortgage loans will stop paying unless construction resumes before October 20, they threatened.

The ultimatum raced across social media platforms Wechat and Do-In (which is Tik-Tok) becoming a call to action for those caught out by China’s rapidly deflating property bubble.

Within days the letter became a template for protests from Shanghai to Beijing and Shenzhen to Zhengzhou, with homeowners cutting and pacing it to draft their own boycott manifestos.

Within four weeks, more than 320 projects in about 100 cities were facing similar protests, roiling markets and forcing authorities to corral banks and developers to diffuse the unrest.”

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Fair to say, that blew up pretty fast.

Now tens of thousands of people are boycotting their mortgage payments on about 300 billion dollars worth of loans.

And despite that being only a small percentage of the Chinese mortgage market, the Chinese government is definitely concerned that this could start a domino effect of economic pain.

With property prices now falling, nationwide skepticism of property developers, mortgage boycotts and developers already defaulting on loans it’s feared this freeze in the real estate sector could spread throughout the banking sector and genuinely the Chinese economy.

Because remember in China real estate accounts for 30 percent of GDP according to net interest real estate investments stood at over 13 of GDP in 2019 of which more than 70% was linked to residential building adding the contribution of the construction industry and the share jumps closer to 29%

Now in 2022, China’s top 100 developers have seen their sales halve: sales plunged 39.7% year over year in July, and new construction starts at down 30.6%

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Developers are already in a world of hurt, so that in itself is a worry for China’s GDP.

But as I said, the second major fear is that a freeze-up of the real estate sector will cause severe distress on the banking sector. Banks already aren’t being paid back from developers. Now suppliers to real estate developers aren’t paying back their loans.

And to put the cherry on top, now Chinese citizens are boycotting their mortgage payments; the banking sector has already showed big signs of distress — earlier this year as five Chinese banks froze customer deposits, causing 400,000 citizens to be unable to access their savings.

If the banking sector is already showing signs of distress, could the real estate crisis prove to be the last straw?

Well one thing’s for certain: the CCP doesn’t really want to wait to find out; they’ve reportedly set aside 148 billion dollars worth as a real estate bailout fund to support the acquisition of real estate projects, should developers start going under.

NBC News notes, quote:

“The China banking and insurance regulatory commission told the official industry newspaper on Sunday that banks should meet developers financing needs where reasonable.

The regulator hoped these steps would help stabilize the property market by enabling the swift resumption of stored real estate construction and delivery of homes to buyers early.”

So the CCP is looking to offer some support to the situation.

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I guess the question from here will be, is that enough to stop the damage?

It might get some projects finished, but you could argue that the damage is already done.

The most crucial ingredient to the success of the Chinese housing market is positive investor sentiment.

Now with a vast reduction in new property sales you know mortgage boycotts and nationwide social unrest, it seems that the golden age of the world’s largest asset class is now over.

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Questions

Real Estate, Property. In China in the summer 2020, there is complete order, peace and stability. True or false?

Loan, Mortgage. Is the issue over abortion, marijuana or gay marriages?

House, Home. Mr. Ponzi was a Chinese official. Is this right or wrong? How did Charles Ponzi become notorious? Why is he notorious?

Interest, Debt. Has real estate (property) become a huge industry? Why did the property sector become so huge?

Construction. How did the Chinese property sector or real estate market operate?

Materials, Supplies. Was the government oblivious to the situation, or did it try to regulate it? Was it effective?

Construction Worker, Builder. The developers are busy constructing and finishing new apartment complexes. Is this correct or incorrect?

Architect, Engineer. Have all home buyers continued to diligently and faithfully continues their mortgage payments?

Bank, Lender. The problems of the property sector will be contained there. Do you agree?

Borrower, Home Owner. Why do you think the property and banking sector are in serious trouble? What is the solution?
 
 
 
Regulations. Are houses cheap, medium-priced, expensive or very expensive in your city, region and country, or does it depend?

Inflation. Everyone wants to buy and own their own home. Yes or no?

Appreciation, Depreciation. Is property, housing and real estate a good investment? Do many people buy houses and property?

Housing Bubble, Overpriced. What might happen in the future?

Collapse, Bubble Burst. Is there a housing problem? What is the solution?