A Ponzi scheme by any other name: the bursting of China’s real estate bubble | Chinese economy

a A little over a year ago, a Chinese property developer largely unknown to the outside world said its cash flow was under “enormous pressure” and might not be able to repay some of its horrific $300 billion (£275 billion) debt.

Today, this company, China Evergrande Group, is well known as the poster child for the country’s economic problems. Home prices fell in China every 12 months Since Evergrande now prophetic warningThe government of Xi Jinping is now preparing to dump billions of dollars into a property market that experts say is increasingly similar to a giant Ponzi scheme.

New home prices in 70 Chinese cities fell worse-than-expected 1.3% year-on-year in August, According to the official numberswhich reflects the turbulent 12 months during which China’s housing sector has transformed from an unstoppable engine of growth and prosperity to the main threat to the world’s power economy.

Nearly a third of all mortgages are now rated as bad debt – 29.1%, up from 24.3% at the end of last year, According to research conducted by Citigroup this week – With once-secure state-owned property developers driving the increase.

House prices in China falling fee

crisis in EvergrandeChina’s second-largest property developer at the time, spread across the industry to the point that this week’s government pledge of 200 billion yuan (£26 billion) to start investing was seen by analysts as far less than needed.

Rating agency S&P said at least 800 billion yuan – or even 10 times that amount in a worst-case scenario – would be needed to rescue a property market where prices have fallen, sales are down, developers are bankrupt and buyers are taking off. The unprecedented and widening mortgage boycott Protesting large upfront payments for unfinished homes.

Analysts say the market is witnessing a complete collapse in confidence, and only government intervention can save the situation.

Unfinished development by China Evergrande Group under demolition order in Danzhou, Hainan Province.
Unfinished development by China Evergrande Group under demolition order in Danzhou, Hainan Province. Photo: Ali Song/Reuters

About two million homes on the map are still unfinished around China, according to a rough estimate of S&P. This number will increase if sales continue to decline and developers continue to run out of money to complete projects.

“The real estate slump in China has turned into a crisis of confidence that only the government can solve,” Standard & Poor’s said. “If lower sales push more developers into the distressed area, things will get worse. Troubled companies will halt construction on more pre-sold homes, hurting buyers’ confidence even more. Our rough estimate is that around 2 million unfinished homes were previously sold by developers. The Chinese are now in limbo. This has shattered confidence in this market.”

For years, selling homes – mainly apartments in large blocks and newly designed urban villages – kept developers cashing in, and along with borrowing on an epic scale, they could buy more land and keep building. In 2021, about 90% of off-plan homes were sold in China.

But Xi’s decision two years ago to crack down on loan-hungry developers hungry for funding, and when the music stopped, it turned out they couldn’t finish the homes they had already taken money for because they spent it on buying the next package of land or a project.

People walk past a map in Beijing showing China's Evergrande development projects.
People walk past a map in Beijing showing China’s Evergrande development projects. Photo: Andy Wong/Associated Press

In short, it’s like a Ponzi scheme where money taken from new investors is used to repay existing clients in an ever-decreasing spiral of collapse. It’s even how Sober pages of The Economist see it.

George Magnus, a fellow at Oxford University’s China Center, said the Chinese market wasn’t quite the classic Ponzi scheme in style. The notorious Bernie Madoff scam which were revealed after the global financial crisis, but they were very similar.

“The developers are raising huge sums from clients to basically fund the purchase of the following construction projects. This goes on over and over before it gets to the size it used to be,” Magnus said. “It’s not strictly Ponzi in terms of asset management, Madoff style, but they are using Client money is basically to fund the next project, so yeah, it’s the standard definition of what that means.”

The real estate market accounts for anywhere between 20% and 30% of China’s GDP. This is a significant proportion compared to other large economies, thanks in part to the country’s investment-based economic model that has prioritized construction. As a result, it has spawned hitherto a blind belief in property values, which have more or less uniformly risen over the past two decades or more.

But with frequent shutdowns also frustrating the market, the long-held belief that prices can only go up is starting to wane. This could result in Chinese households moving 127 trillion yuan of real estate in the next nine years to other investments such as stocks, bonds and wealth management products, according to brokerage and investment group CLSA, Bloomberg mentioned last week.

“People lose faith in the pre-sale model,” Magnus said. “It’s a restart of the Chinese mortgage market…the sacred assets of property. China’s legendary rising middle class isn’t in great shape along with lockdowns either.”

Chinese President Xi Jinping poses with delegates during the closing ceremony of the 19th Party Congress in Beijing.
Chinese President Xi Jinping poses with delegates during the closing ceremony of the 19th Party Congress in Beijing. Photo: Andy Wong/Associated Press

The situation presents a major challenge for Xi’s government, especially with the all-important party congress taking place in October when the president is striving to become as long as he wants.

But while his government is pushing to restructure failed developers like Evergrande and hoping to spread the debt burden to state-owned companies, banks and local governments, the pain will likely fall on ordinary Chinese — just as it does on ordinary investors. When a Ponzi scheme finally collapses.

Anne Stephenson Yang, co-founder of US-based J Capital Research and a China expert, said the regime in Beijing was more interested in protecting corporations, state-owned enterprises and corporate billionaires than homeowners – and that should tell us about its response to the crisis.

“There is something they can do and there is something they will do,” she said. “What they can do is transfer money to families, like give apartments, let people live in places where mortgages aren’t paid, and increase pensions so people can trust and spend again.

But this is not of course what will happen. The Chinese political system is not built on individuals, it is built on corporations, they are the components. The political system runs through them.

“The real estate market was not designed to be a Ponzi scheme – a Ponzi scheme needs design. But it is an investment bubble. And the bubble is gone.”

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