If the Chinese property market doesn’t scare you, it’s because you aren’t paying attention. Charts via Citi https://t.co/YZPbOp937j
This is astonishing. The level of borrowing to buy homes with high vacancy rates in second tier cities can not end well?
Would it impact Western banks outside of Asia? How exposed to China would they be?
I’m working on a post for the “Canadian Recession†thread right now but I’ll add my thoughts here quickly and then return to add some color.
We’ll go in reverse and start with Western banks. Could a Chinese credit implosion affect them? Hell yes. I think it would be very naieve at this point to simply assume that China’s financial system is somehow firewalled from the rest of the world. Onshore Chinese companies own a lot of offshore companies (Ironman/Wanda is a good example). The ownership and financial structures could take on all sorts of forms but let’s just throw out something hypothetical: a company like Wanda borrows money from a U.S. bank to build an 80-story luxury high rise in Chicago (something they’re actually doing). The bank underwrites the deal conservatively and the LTV is such that if things go south they’ll be made relatively whole. What the bank doesn’t realize is that Wanda set up shell companies in the U.S. through which they buy Chinese made supplies (steel before the tariffs, nails, plumbing, cabinets, etc. etc.) so a bunch of the cash leaves rather quickly (there are some controls) but there’s no guarantee the supplies make it back to the U.S. and the building gets built.
…a U.S. bank could lend to a U.S. company ordering a large amount of inventory from a Chinese company. The Chinese company might not have the dollars to buy the commodities to manufacture the inventory and thus not deliver forcing the U.S. company to default (a risk sometimes mitigated through escrows). The lack of dollars in China I’ll address later as it is a key point.
…the Chinese had become large incremental buyers for U.S. (and Canadian) real estate. A good example is NYC. One of my best friends works for Inverland development. They broke ground on two projects in NYC in 2014 and completed them in early 2018 which was just in time for both the rental and sale markets to sputter. The model for developers like that is to “build at 8†and “sell at 4†where the numbers reflect IRR and the cap rate. Well between the lack of demand for rental units and new condos and the skyrocketing property taxes their IRR is now zero if not slightly negative and the bid side has completely collapsed. Inverland operates on all cash so they can wait it out but most developers are leveraged so the clock is ticking for them. If they can’t lease/sell units and sell the project they’ll default… indirectly a result of artificially high demand in the past as a result of China.
…still, this is me just thinking up transmission mechanisms in 30 seconds. Suffice it to say the transmission mechanisms are legion. That said, U.S. banks are aware of the risk and I know for a fact that JP Morgan routinely tests for “China going dark†when they do counter party risk assessments. European banks? I honestly don’t know.
China’s financial system is a house of cards at this point. In January total “social financing†totaled something like $620 billion. At this point, a lot (if not most) of the credit created in China is being used to pay for loans that otherwise would have soured.
The majority of China’s financing is Renminbi denominated and China certainly isn’t short on political will so they can keep that bubble inflated for a looooong time. What China cannot remedy, though, is the on-shore dollar funding crisis. That’s where their real crisis is (besides demographics, natural resources, etc.) I’ll elaborate on that in a later post.