china real estateImagine that your local city and county controlled all land rights, and the only ownership a private builder or developer could secure was a long-term lease. Now imagine that 40% of the city and county's revenues come from the lease fees paid by developers. Next, imagine a giant real estate bubble has priced most residents out of the market, and that the local governments are reaping huge gains as the development rights and leases they sell are skyrocketing.

Can you say conflict of interest?

That's the Chinese real estate dynamic in a nutshell. Local governments have every incentive to push lease prices higher, further fueling China's real estate bubble, and zero incentive to build low-cost housing for the average citizen.

Who Benefits

Minxin Pei, professor of government at Claremont McKenna College and a senior associate at the Carnegie Endowment for International Peace, recently described who benefits from what he termed China's "irrationally exuberant" property market: Local government and its officials, and state-owned enterprises (SEOs), which have exploited their ties to government-controlled banks to enter the speculative real estate market with a vengeance.

"With access to almost unlimited no-cost credit from the state-controlled banking system," he wrote, "these behemoths have abused their financial clout and plunged headlong into the real estate market, snapping up high-priced land and investing in high-end residential housing units that now sit empty across the country."

Once you understand this dynamic, it's not difficult to see why China's housing bubble will end badly. Local governments are so heavily dependent on development fees and taxes for their revenues that any fallback in new development will spell catastrophe for city and regional government budgets.

Who Pays for the Bailout

Who will lose when the bubble inevitably deflates?

Residents will suffer because government services will have to be slashed as revenues from development fees collapse.

The Chinese investors who overpaid for grossly inflated luxury condos will suffer massive losses, developers dependent on a fast-rising bubble market will go bust, and somebody will end up covering the losses as bankrupt developers renege on their loans.

Since most of the loans came from government-owned banks, then that "somebody" will be the Chinese taxpayer. Sound familiar?

"China's taxpayers will twice be made the victims by the housing bubble," Professor Pei noted. "In the bubble years, they're priced out of the market for affordable housing. When the bubble bursts, they'll pay for the cleanup. When Chinese state-owned banks write off their bad loans, they don't do so with money growing on trees. Instead, the Ministry of Finance will issue bonds to recapitalize the banks -- and fund the bailout with future tax receipts."

How Big a Bubble?


Recent reports estimate there are 64.5 million vacant "investment" flats in China. Analyst Andy Xie recently laid out the risks this giant speculative bubble poses to China's local governments and banks.

"Local governments in China depend on real-estate deals for revenue and could default if the market falls too far," he wrote. "Notice the bind China is in. It has to keep the bubble going to preserve local government finances. They've become a classic Minsky Ponzi unit."

If the Chinese central government keeps the bubble inflated with easy money, Xie concluded, the resulting crash and bailout will only be that much more painful.

Local Officials Benefit Personally from Bubble

While contributions from property developers tend to have outsized political influence in much of the world, local government officials in China are brazenly pocketing the proceeds from development. For example, the majority of homes in a newly launched subsidized housing project in Shaanxi Province have been handed to local government officials.

Add up these factors -- widespread corruption, a real estate bubble that's priced average citizens out of the market, local governments dependent on new development for their revenues and a government-run banking sector that will turn to taxpayers to fund the inevitable bailout -- and there's plenty of fuel for taxpayer resentment and anger once the bubble pops.

Sound familiar?

Based on the accounts of these analysts, Chinese taxpayers will soon have common ground with their American counterparts: They, too, will be stuck paying for the bailout of private developers and government-controlled banks (which in the U.S. are called Fannie Mae and Freddie Mac).

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Willie

WHO EFFING GIVES A CRAP ? MAYBE SOME OF OUR JOBS WILL COME BACK

August 18 2010 at 1:55 PM Report abuse -1 rate up rate down Reply
joyce

I agree,dont buy anything made in China not only do you risk getting sick but you risk the idea of empowering them! The gov't treats their people horrible,the human rights are horrible,never mind what they do to animals.Look we need to start making our own goods again and KEEP AMERICANS working,stop buying foreign!

August 18 2010 at 10:41 AM Report abuse +1 rate up rate down Reply
Larry

Awww----Poor China-----screw 'em-----They are trying to kill us! Lead paint on baby toys, poisonous drywall, defective appliances that burn people's houses to the ground (and don't stand downwind of one that has Chinese drywall!), defective tires that fly apart AT SPEED, Poison Pet Food, poorly made cribs that kill babies, undermining the US Manufacturing base to the point that we're damn near helpless, the list goes on and on. DON'T BUY CHINESE! READ the boxes when you are shopping! Better to do without than buy Chinese garbage (it will end up in the garbage anyway). There is a very good reason Chinese ships are called JUNKS------it's not the ship, it's the CARGO!

August 18 2010 at 10:30 AM Report abuse +1 rate up rate down Reply
phil

"...For example, the majority of homes in a newly launched subsidized housing project in Shaanxi Province have been handed to local government officials." Is this classic...or what? "All animals are equal, but some animals are more equal than others." (Animal Farm) Human nature is universal and transcends borders and language. The only weapon China has that will stop this greed, is that they can (and do) promptly execute offenders of the people.

August 18 2010 at 10:25 AM Report abuse +2 rate up rate down Reply
garyrjas

If the Chinese worker is squeezed too far, they will overrun the communist government. The only reason the communists are in power thus far is they have been able to improve the standard of living for their people. The people there will not look back, if the government fails them, you will see a coop. You can't stop 1.3 billion people from rebelling. So much for the prognasticators who see China as the #1 economy in ten years. Mark my words, no way, no how.

August 18 2010 at 10:06 AM Report abuse +2 rate up rate down Reply
jcfstf

Assuming this article on China's building market is correct and knowing that a large amount of America's debt is covered by China - a Chinese collapse could result in a demand for payment that we could not meet. Economics is an elusive science does it cover this kind of a senario?

August 18 2010 at 9:55 AM Report abuse +1 rate up rate down Reply
1 reply to jcfstf's comment
Larry

Right----The USA will have to pay

August 18 2010 at 10:32 AM Report abuse +1 rate up rate down Reply
wbhanna

Greed and politics are generic characteristics. The Chinese are no different than the rest of the world. This is not the time to invest in Chinese banks. Rather, invest in the companies that manufacture the firewords. The show is about to begin.

August 18 2010 at 9:53 AM Report abuse +6 rate up rate down Reply
ruthsgardens

There are a lot of things going on in China that most of you don't know about.Their housing bubble bursting isn't the only thing the world needs to worry about.And while I am thinking about it,for the people who like to compare the parties here to the parties in other countries,they are just the opposite in almost all the countries.The dems here are the republicans over there.The republicans here are the dems over there.There are a few exceptions but not many.But anyway the world and China has to worry about China's steel producing.America has 23 blast furnaces to make iron which is converted to steel.Not all of them are running.In fact most mills have shut down.As of 2005, China has over 3,000 blast furnaces at full production.They are illegally dumping their crap steel on world markets by violating the trade agreements.In other words,we are buying their steel while they have never bought one pound from America.Or any country.China has tried to corner the world market on iron ore which is the main ingredient in making iron.And the world's largest exporter of it is Australia.Thank God they are one of our strongest allies.China has threatened to boycott them unless Australia sells all of the iron ore to them first.Australia politely declines.China is one of the 143 countries on a list that threatens every new president in America with boycotts if our president attempts to get legislation passed saying "Buy American".U.S.Steel Corporation, America's largest steel producer stands alone against China in world courts for violating the trade agreements.And they do so without the backing of both parties in congress or any president which is pathetic.Our steel mills marched on washington in 2005.They asked for a 2% tariff increase on imported cheap crap chinese steel.Both parties in congress told them to consolidate,cut wages and do whatever they have to do to compete with China.Kind of hard to do when a chinese steelworker makes 4 dollars a week.Our autogroups stand behind our steelmills the best they can.Yes it is more expensive,but by God it is steel made in america by americans, it is the best steel in the world and it keeps our jobs here.China has gone from a defensive military buildup to an offensive military buildup as of 2005.Their rate of buildup is almost equal to America's rate during ww2.Building ships,planes and tanks etc.The only good thing is they are building them with their own cheap crap steel.With no emissions or safety standards,their skies are dark and the air is polluted and 1,000s of workers and civilians are dying each day.Workers are asking for more money and they are being given it to.That is country wide.China continues to promise America that it will begin to abide by the trade agreements.Until this day they still haven't.Obama stated in his first weeks that he will not touch the agreements.Not one president or person in congress has the balls to back our american workers.Utterly pathetic.There are a lot of bubbles that are going to burst.When China's pops,they are going to want their money back from America.Get the picture?

August 18 2010 at 9:46 AM Report abuse +11 rate up rate down Reply
1 reply to ruthsgardens's comment
phil

All this is part and parcel of "The New World Order." You cannot buy an American made car in America. Many of the parts are foreign made and shipped here for assembly. It's not that our workers are less productive, or less motivated, or less educated, or less talented. The deck has been stacked against Americas' workers by both political parties for some time. No one can compete against $4 per week. American consumers are not to blame either. We cannot buy an American made television. (there is no such animal.) The shirt on your back is very probably made in Vietnam. Ditto for the rest of your wardrobe. As our manufacturing base shrinks, our children will find much difficulty in securing permanent employment. Reminds me of The Philippines where many households are filled with relatives with upper level, professional degrees. There are very few jobs. This will ultimately lead to a government revolution. I pray for the future of America and for the future of my children and grandchildren. Never in American history has a generation expected a lower standard of living for their offspring. This is the result of social tinkering by the ruling class that has thumbed its collective noses at our constitution and almost openly expresses its disdain for the people that made this country work. It is up to us to give the ballot box one last try this November, and in 2012. If we do not take back America, our children will lose their liberty and freedoms that made this country the envy of the world. Vote, and hold fire to the feet of those you elect. The stakes are too high to sit idle.

August 18 2010 at 10:53 AM Report abuse +1 rate up rate down Reply
Scott

Actually, a long-term government lease IS what we have here, too - with regularly increased payments! Try not paying your lease (called PROPERTY TAXES!) and see how long you 'own' your property.

August 18 2010 at 9:40 AM Report abuse +6 rate up rate down Reply
1 reply to Scott's comment
Larry

Exactly------and stop allowing non-citizens from buying property----lease only. Just TRY to BUY a house in France or Italy----not gonna happen.

August 18 2010 at 10:35 AM Report abuse +1 rate up rate down Reply
Tommy

Fannie Mae and Freddie Mac are still in big trouble and losing more everyday. But since the guys running them ar Obama contributors and friends, nothing will be done until after it's too late. Well, its been too late for a long time, so expect the "O" to bail them out soon with more of your money.

August 18 2010 at 9:06 AM Report abuse +4 rate up rate down Reply
1 reply to Tommy's comment
trmnatr2

TOMMY,Obama didnt sign TARP into law,The trade centers werent attacked under Obamas watch,Obama didnt start the war in Iraq,The stock market didnt crash under Obamas watch .Just facts tommyboy.

August 18 2010 at 10:16 AM Report abuse -1 rate up rate down Reply