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Chinese Real Estate Is a Bubble, Not a Disaster

The Tier-2 cities, generally speaking the provincial capitals and the remaining central-government-direct-report cities (Tianjin, Chongqin), are more or less in balance in my opinion. Again, my main rationale is the supply of demand in each city's lower rungs on the sociopolitical ladder.

The Tier-3 and lower cities, or at least with tremendous over-building problems, are where the trouble lies. These would be the ghost cities many western reports have been obsessing with, meaning that the bubbles there have already burst. Some of the over-building goes way beyond the realm of plausibility. This is due to the combination of the local governments' obsession with nominal GDP numbers and the moral hazard, the blind belief by developers, investors, and local banks that whatever the government supports will never fail. I'm not sure if more ghost cities would surface.

But even if they do, who cares? It wouldn't matter to anyone except the investors and local banks, and hopefully a few local government heads. If anything, it would mean cheap good housing for the locals, and might even provide some incentive for people to move into these under-developed regions, therefore helping balancing out the economic structure that's been overly tilted toward the eastern region. Good riddance.

China's development has been, and continues to be, very un-balanced, both geographically and in terms of income disparity in any given region. The real estate market, in comparison, has lagged the growing geographic imbalance as prices shot up in absurd places as some investors went bargain hunting. Rebalancing is inevitable; but it will be in the form of the peripheral crashing, not the core.

But the issue of Chinese debt, especially that of local governments, has also caught attention abroad. Could the real estate bubble, even if just in the peripheral, cause a contagion similar to the subprime crisis in 2007? To that my answer is a very clear no.

Yes, most, if not all, local governments in China have been guilty of over-building capacity in pretty much all aspects of the economy except R&D, food safety and pollution control. And their debt can only be much larger than official stats, as by way of The Wall Street Journal , since there are untold amount of implicit liabilities based on the governments' habit of assuming authority and responsibility on everything, along with the ensuing, above-mentioned blind faith in such implicit "guarantee."

Real estate is a critical pillar of any credit-based economy, of which China is one despite the fact that the financial system works on a very different set of assumptions and rules (mostly the former). They know this, of course. And equally of course, they will try to prop it up with all they've got. And again of course, they will fail, eventually -- and not quite in the sense that, eventually, we all fail.

But when they do fail, it will not be a systemic disaster as subprime of 2007. The reason is very simple: there's neither a panic button nor a chain reaction mechanism -- no securitization, high equity ratio (30% down is still the norm), a culture that values property ownership to totally irrational heights, a culture that still attaches tremendous shame to personal bankruptcy, and a culture that calls all generations of the extended family to band together to avoid such shame.

Sorry, fellas, it's a different country.

China will have its baby-boomer moment as Japan and the west have. But that's 10 to 20 years later. Not today.

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