Jul302014
The Chinese housing bubble deniers are wrong
The housing bubble deniers in China use poor reasoning and macroeconomic arguments to ignore their massive Ponzi scheme.
Here in America, the bubble deniers — and Never forget the bulls and bubble deniers were completely and totally wrong — the bubble deniers succumb to their optimism bias and comforted themselves with fallacies and wishful thinking, even past the point where denying the obvious was no longer operative.
The same is true in China.
China’s Property Market Is No Bubble
A correction is coming, but not a crash.
By YUKON HUANG, July 24, 2014 12:44 p.m. ET
Will China’s property bubble trigger a financial crisis? Concern is high this year thanks to deteriorating sales figures and reports of large price cuts.
(See: The deflating Chinese real estate bubble could destabilize the world economy)
But China really is different.
ROFLMAO! He really wrote that!
Though a correction is coming, the consequences will be more manageable than common sense might suggest.
I’ll go with common sense on this one. A deflating housing bubble in China could destabilize their entire financial system and disrupt the world economy.
No real property market existed in China until housing was privatized more than a decade ago. Then came the 2008 global financial crisis and Beijing’s credit expansion, after which Chinese land prices surged five-fold, triggering commensurate increases in property prices and other asset values. In other words, the market was trying to establish appropriate prices for an asset whose value was previously hidden by socialist fiat (a pattern also seen a decade ago in Russia).
No, the market was inflated five-fold by a massive lending Ponzi scheme that completely detached values from any basis in cashflow.
Instead of a bubble, therefore, China’s sharp property-price increases could represent the real value of land in a densely populated country.
It could also represent a massive Ponzi scheme allowed to go unchecked by a country with no experience in capitalism’s dark side.
If so, they would signal the Chinese economy’s financial deepening, not the imminent onset of a financial collapse.
A main concern is that China has allowed housing construction to outpace requirements, especially in second- and third-tier cities, so prices will fall.
China has inflated a bubble 12 times as large as the bubble in the United States, a bubble resulting in a 30% to 50% decline in real estate values before endless and unprecedented market manipulation stopped what should have been an even deeper correction.
But the correction may not be destabilizing because long-term trends in Chinese property prices don’t fit the typical pattern of a bubble.
It fits every typical pattern of a bubble: excessive debt creation with no relation to cashflow, an unfounded faith in ever-increasing prices, frenzied buying by investors who keep properties empty, and constant denials from people who should know better (“But China really is different.” — Yukon Huang).
China’s property market has seen cyclical downturns followed by rebounds, most recently when housing prices started falling in late 2011 and then turned upward again in the second half of 2012. It is hard to find past bubbles that experienced such significant and persistent price declines before reversing and continuing to inflate.
Great Britain has reflated four housing bubbles, and California has reflated three of them.
When prices start falling in a bubble situation, investors typically rush for the door and cause a collapse.
That China’s property market saw no such collapse in 2012 suggests that its high prices were supported by more than “irrational exuberance” and may be a reasonable floor—
Investors in China felt there was nowhere else to put their money, and the correction didn’t cause lenders to call their bad loans; in fact, they extended even more credit to further their Ponzi scheme.
implying, in turn, that today’s prices may fall by about 20% over the coming year but not more than 30%.
Thirty percent is still a large correction. Prices need to fall 95% in order to reach values supported by cashflow.
These kind of minimal-damage predictions are also characteristic of a bubble. At first, everyone claims prices can only go up. When they don’t, they retreat to prices may soften slightly. When prices crash, the market apologists claim the crash won’t be so bad. At every step along the way, they underestimate the final impact.
The China Household Finance Survey (published by Chengdu’s Southwestern University of Finance and Economics) indicates that even after a 30% decline in prices, only 3% of households would be underwater thanks to high down payments and accumulated equity. The strength of household balance sheets has led the Bank of China to estimate that a 30% drop would have a negligible impact on bank ratios of non-performing loans and thus would have only modest spillover effects.
Wiping out that much equity — assuming we believe their numbers — would certainly cause more than modest spillover effects, particularly in the US where Chinese investors support pockets of our housing market. I speculate it could turn Chinese buyers into desperate sellers.
Still, scaling back property construction will have a negative impact on growth. Construction and real estate have been gradually rising as a share of economic activity for three decades and today account for 13% of GDP. Contraction there will slow growth and have ripple effects on related industries.
The US economy has been weak for 7 years now because our construction industry, which accounts for a smaller percentage of GDP, has been sidelined.
But China’s construction and real-estate boom, like its property market, does not fit the pattern common to bubble countries. As the nearby chart shows, the 1997 Asian financial crisis saw construction and real-estate activity in other Asian counries collapse after sharply increasing in previous years.
Estimates of China’s excess property stock suggest that construction volume will fall by roughly 10%, subtracting two to three percentage points from GDP growth. Yet the full impact of the correction on GDP growth is likely to be spread out over several years. If uncompensated by other infrastructure investments, it could cause growth to fall toward 6% in the next year or two—but darker scenarios, in which growth collapses to 5% or less, are highly improbable.
Given the impact on the US economy, I think the darker scenarios are very likely.
Many China bears are nevertheless convinced that the only thing that has kept China’s growth so high in recent years is the even faster growth of credit, and that eventually a credit curb will cause a sharp economic contraction.
Yes, it’s called a Ponzi scheme, and eventually, they all collapse.
That pessimism isn’t warranted given the link between credit expansion, property-price increases and GDP growth.
This is where he really jumps the shark. The link between credit expansion, property-price increases and GDP growth is only sustained by Ponzi lending. This analyst’s macroeconomic models overlook this basic feature of unregulated capitalist markets.
The credit expansion that has supported increases in property prices doesn’t contribute to GDP growth but is reflected in China’s increased fixed asset investment—which is why China’s debt-to-GDP ratio has surged in recent years.
This is compelling evidence of a building Ponzi scheme.
But this increase is only a problem if rising asset values aren’t sustainable.
Since these values are completely unsupported by the cashflow on these properties, it is clearly unsustainable.
Rising debt-to-GDP isn’t a problem if, despite whatever credit was wasted, the bulk of it was used productively and unlocked real value in land-related assets.
Take a moment and look over the post showing entire cities that are completely unoccupied, and ask yourself if you believe any value was created.
As such, most of the surge in Chinese credit since the global financial crisis can be considered healthy financial progress toward more market-based asset values.
Complete and utter bullshit.
China’s debt-to-GDP ratio is about what one should expect—lower than that of most developed countries but higher than that of most developing countries. In this context, China’s property-related debt problem needs to be managed, but it isn’t the catastrophe that some are warning about.
Sorry, Mr. Huang, it is the disaster people are warning about.
Mr. Huang is a senior associate at the Carnegie Endowment for International Peace and a former country director for the World Bank in China.
Apparently, Mr. Huang was a former director for the World Bank in China, one of the architects of the Ponzi scheme. Is anyone surprised to see him deny the problem?
This is going to end badly. I am more convinced than ever that the Chinese real estate market is going to implode into one of the most devastating financial disasters ever recorded.
[listing mls=”OC14160592″]
Purchase Index down 12% from last year
Continuing the long-term trend this year, mortgage applications decreased 2.2% from one week earlier, according to data from the Mortgage Bankers Association’s Weekly Mortgage Applications Survey for the week ending July 25, 2014.
The Market Composite Index, a measure of mortgage loan application volume, decreased 2.2% on a seasonally adjusted basis from one week earlier. On an unadjusted basis, the Index decreased 2% compared with the previous week.
“Despite mortgage backed security issuance being up 38 percent from the first quarter average, the MBA index continues to show declines. This suggests that there are fundamental shifts occurring in the market where big players (reporting to the MBA) may be giving up market share or perhaps not holding as many loans in portfolio, thereby pushing up the bond issuance,” said Quicken Loans Vice President Bill Banfield. “In either case, the current level of activity for purchases and refinances has been directional stronger in recent months based on actual security issuance. With home prices stabilizing from a rapid level of appreciation and interest rates either falling or holding steady recently, I expect to see continued improvements in the purchase arena.”
The Refinance Index decreased 4% from the previous week. The seasonally adjusted Purchase Index increased 0.2% from one week earlier.
The unadjusted Purchase Index increased 1% compared with the previous week and was 12% lower than the same week one year ago.
Refinances declined. Oh my!
Purchase applications increased 1%. The rally is back on!
No surprise: HAMP defaults still running high
HAMP faces a significant challenge of borrowers redefaulting out of HAMP.
So far, 398,222 homeowners have not been able to keep up with their mortgage payments even though payments were lowered by HAMP, with 29% of homeowners in HAMP already falling out of the program.
Meanwhile, the future does not look too much brighter for HAMP.
Freddie Mac reminded mortgage servicers in April that interest rates on some HAMP rescues are about to start to tick higher.
After five years, the rate on HAMP loans began to tick up 1% until reaching its previous rate before modification.
“If it was reset to 2%, it will go up 100 basis points this year to 3%, and to 4% next year,” said Robert Kimble, senior director of mortgage servicing policy at Freddie Mac.
“Hopefully the borrowers are aware of the reset,” he added. “Though, the fear is there will be some recidivism.”
When HAMP first started, the ratings agencies were predicting 70% re-defaults, so if the rate of default is only at 29%, then the program has wildly exceeded all expectations. Well, not all because I was predicting re-defaults of 25% after 12 months seasoning all along. People on other blogs laughed when I would make this prediction, but when you work in the trenches and see that people are getting payments much lower than comparable rent, it sort of gives you an edge.
So if you lower expectations enough, that makes a 29% redefault rate good?
Considering the default rate on conventional mortgages is generally about 1.5%, and the redefault rate is near zero, only a wildly distorted perception says a 29% redefault rate is good.
You have a point about the lower payment. If the payment is much less than a comparable rental, the borrower has every incentive to keep paying. Their alternative is to rent something they can afford and endure a huge loss of lifestyle. But that just underscores how many people can’t begin to afford their homes or their current standard of living. A great many people are going to take a huge step down the property ladder, particularly when you consider many of these loan modifications face increasing payments over the next several years.
The loans in the program were 100% in default or imminently headed to default prior to receiving a modification, so the cure rate has been 71%, a monumental feat when you consider how much negative equity these loans have. Comparing conventional mortgages to this group is like comparing Irvine home prices to Detroit. You’re not comparing apples to oranges.
I like bold economic predictions, but I believe this one will be an epic fail. Other than wishful thinking and the desire to attract attention, I don’t see what drives their analysis.
Altos: Critics wrong about housing, it’s going to soar
With so many fists beating on the housing-is-facing-ruin door, Altos Research is set to release data that claims all that pounding is in vain.
Clients will begin receiving a report Wednesday afternoon, but HousingWire was able to get a sneak peek, and the results say that housing recovery critics are wrong about housing. According to Altos, it’s going to soar in 2015.
“While we see signs of demand easing, we are significantly more bullish on housing than many of the recent headlines seem to suggest,” said Altos CEO Michael Simonsen. “Based on our models, we’re forecasting another year of home price appreciation, with a 7% home price increase for the year of 2015.”
Single-digit appreciation is a remarkable prediction. Many other experts anticipate depreciation in the nation’s housing market, so the Altos call is relatively noteworthy.
What’s driving the negative stand most of the market holds? The media is partially to blame, the report states.
Bearish Headlines, Bullish Reality
In the section titled, “Bearish Headlines, Bullish Reality,” the researchers state their case this way:
“In our view, these attitudes reflect a myopic view of actual market conditions and conflate concerns over the mortgage industry, the otherwise-constrained new construction market, and more broadly, the long-term financial stability of the U.S. consumer with specific current housing market supply and demand dynamics. While these are valid long-run concerns, the variables impacting home prices have proven to be driven by low available supply and growing household formation.”
So what is the main driver for the Altos view that prices will rise 7%? Altos expects inventory to climb another 10%.
“As inventory and transactions rise along with pricing, participants in the housing market stand to benefit broadly,” they write. Furthermore, the number of days on market remains low compared to before the housing bust, indicating a seller’s market.
In a seller’s market, sellers can list homes at a higher value, hoping a buyer takes the bait. If not, they can also bring down the price closer to market value, while appearing to offer a sales compromise to the buyer.
Altos estimates that approximately 35% of properties will take such a price cut. Altos sees this as an indicator of strong competition, despite weaker demand overall.
The nation’s housing market, they note, continues to require a more nuanced view of its future.
“Home prices across the U.S. are poised for a fifth consecutive year of recovery. The market is still faced with low inventory and demand, buoyed by an expanding economy, which, among other factors, remains healthy,” the report concludes. “Both supply and demand conditions are moving from extreme bullish conditions to healthy condition.”
Prices are dropping in the middle of Summer, in spite of steady rates. The MSM has recently begun reporting lower sales volumes – lets see what happens when they acknowledge lower selling prices as well.
“…Altos CEO Michael Simonsen.”
“MS”… You sure his last name doesn’t start with an “R”? It would fit. 😀
He would likely be a lot smarter if those were his initials.
“Bearish Fundamentals, Bullish Reality” a dissertation by M. Ruse.
Powered by ZIRP-aid.
Single-digit appreciation is a remarkable prediction. Many other experts anticipate depreciation in the nation’s housing market, so the Altos call is relatively noteworthy.
Who are these many other experts they reference? The only so-called expert that I remember saying prices had peaked was Christopher Whalen, but with the most recent Case Shiller showing 9% price growth that prediction has proven to be disastrously wrong.
I haven’t seen anyone predicting actual declines in pricing either, but this level of bullishness is hard to find. They are betting on a huge surge in economic activity that most don’t see coming.
The economy is definitely picking up from the start of the year. The question is whether or not it’s sustainable. The 2Q14 +4.0% GDP growth explains some of the 200k+ job growth over the last few months. If 3Q14 and 4Q14 follow up with strong GDP growth and hiring, salaries will begin to rise next year.
There is a lot of talk about inventory accounting for a third of the GDP growth. But, given the fact that consumer spending grew at the strongest pace in the last five years, I view inventory as future sales produced at lower costs (as do many businesses that expanded their inventories).
All of the stimulus that drove up housing prices and stock prices had to hit main street eventually. Is now the time? Millions of households have refinanced over the last few years. This extra money initially went to shore up savings and/or pay down debt. Discretionary spending is picking up as personal balance sheets improve. Why is this shocking?
http://www.businessweek.com/news/2014-07-30/economy-in-u-dot-s-dot-grows-more-than-forecast-after-smaller-drop
I think the first quarter slump had more to do with Obamacare than the weather. Healthcare spending dropped as people switched over to new plans (at a much higher cost in many cases). A lot of this spending was delayed from Q1 to Q2, since Obamacare deadline was March 31st. Also, major purchases were delayed until households figured out what their new budget would look like with higher healthcare premiums.
it is inherently unsustainable.
How?
1 in 3 Americans being chased by debt collectors
A new report form the Urban Institute shows how weak the U.S. economy is, and offers at least one reason for the housing doldrums – one in three Americans is so far behind in paying their bills that they are in collections.
An estimated 1 in 3 adults with a credit history — or 77 million people — are so far behind on some of their debt payments that their account has been put “in collections.”
That’s a key finding from a new Urban Institute study.
It examined non-mortgage debt, including credit card bills, car loans, medical bills, child support payments and even parking tickets.
The debt in collections ranged from as little as $25 to a whopping $125,000. But the average amount owed was $5,200.
Geographically, no area of the country is untouched.
Among the states, Nevada had the highest percentage of residents with debt in collections — 47% — as well as the highest average amount owed —7,198. That was helped in part by the Las Vegas metro area, where 49% of residents had debt in collections.
Where is the connection between the economy and the number of people in collections? How does the author conclude that a weak economy is causing people to not pay their bills? He is assuming that under normal circumstances, people always pay their bills in full and on time. If this were true, why do we have credit scores?
Are we just seeing the result of moral hazard playing out? Or is this the economy?
A lot of these debts are no doubt medical, and being grossly inflated, they are being disputed and negotiated down. I have a friend that got injured without insurance (shame on him) and the hospital bill was over $100k. He negotiated it down to $40k. Who would pay the initial bill when everyone knows that hospitals can’t even explain their costs?
The fact that Lost Wages is the epicenter of debt collection is fascinating. I can’t believe that gamblers would not pay their debts. Shocking!
Home Ownership Rate Dips to Lowest Level in Almost Two Decades
Homeownership in the United States lost a little more ground last quarter, declining to a new 19-year low as consumers—particularly young adults—continue to grapple with debt and difficulties obtaining credit.
According to an estimate from the Census Bureau, the U.S. homeownership rate was 64.7 percent in the second quarter, a decrease of 0.1 percentage point from the first quarter’s previous low and 0.3 percentage points from the same time last year. It was the lowest rate since 1995.
Homeownership continued to slide among the millennial age group, who find themselves more burdened than other groups by high debt, tight credit conditions, and limited job prospects. The percentage of young adults who own their homes was 35.9 percent last quarter, down nearly a full point from last year.
As housing trends move in a healthier direction, one of the biggest headwinds has been a lack of activity among first-time homebuyers, who historically account for 40 percent of sales activity, according to the National Association of Realtors (NAR). Through this year, that share has hovered around 28 percent.
While today’s young adults have so far been inactive compared to historical norms, a recent report from NAR suggests a number of markets, particularly those in the Midwest and West, are likely to see more activity from millennials as labor market conditions and home prices create a more favorable market for buyers.
As millennials age and start to hit their own life milestones, the group expects to see a resurgence in younger homebuyers.
“Millennials will eventually settle down, trade their roommates for spouses and want to raise a family,” commented NAR President Steve Brown on the study. “As long as median income continues to support purchasing power in most areas, the demand and opportunity will be there for Millennials to purchase their first home with guidance and insights from a Realtor.”
Let’s home Millennials are wise enough NOT to get manipulated by a realtor.
No greater story of false hope than the one written for housing bulls…
in that the very elements of the current price model… QE, financial churn, debasement, straw buyers, fraudulent accounting practices, other frauds, money laundering, inflation, capital controls, and subsidies… are unending.
China takes it to a level exponentially larger than what we’ve done.
“Mr. Huang was a former director for the World Bank in China…”
After reading all of that dismissive rhetoric, I intended to Google the dude to see what branch of their government he came from. Your last paragraph saved me the trouble lol.
If there are repercussions here from their inevitable correction there, Irvine could be ground zero. At least we’ll have good seats. 😉
Let’s check Trey’s prediction from yesterday:
http://www.housingwire.com/blogs/1-rewired/post/30813-heres-why-the-week-ahead-will-make-or-break-housing-and-the-economy
“Anyway, back to this week – Wednesday we’ll see if the Federal Reserve Open Market Committee has its act together, and we’ll see what the initial second quarter GDP is.
Current estimates are for the number to come in at between 2.4%-4%. This is highly doubtful. All the numbers that brought us to -2.9% haven’t changed that much.
I’m not saying it’s going to be a contraction, but it’s not going to be anywhere near the middle ground of the expectations. If it breaks 2%, I’ll eat 50 boiled eggs.”
Well, the report is out and the initial estimate puts GDP at 4% for 2Q. That means the most bullish of mainstream economists got it right and everybody else got it wrong, with Trey Garrison being the worst. You would think he would man up and admit how badly he missed on this prediction, right? Wrong. Today he changes the conversation to how the initial estimate is likely to get revised down. LOL…
Sadly, people like Irvine Renter believe his reporting is “closer to reality” than the mainstream, even though he continually misses on every prediction and changes the subject after every failure. Come to think of it… Isn’t that what mainstream economists do too? Well, at least he’s funny…
I wonder if he will eat 50 boiled eggs.
Uh…. this is the initial estimate which typically comes in hot so the
pro’sinsiders can sell the highs to the dumb-money crowd. LOL!btw, mellow ruse calling-out others for not manning-up, missing predictions, changing the subject after every failure, and changing conversations. POT.MEET.KETTLE.deluxe
…and hilarity ensues.
This would certainly be the time to sell the highs. I was urging you to invest in stocks 5 years ago and you didn’t listen. You also ignored my warnings about gold in 2011. I guess that’s what you mean by not manning-up, missing predictions, and changing the subject. Actual results are what matter.
Gee, this somehow all too familiar to us over here in “Too Big To Fail Land”:
http://blogs.wsj.com/economics/2014/07/29/chinas-banks-pose-worlds-largest-systemic-risk/
“It may come as no surprise that China’s biggest banks top the list of the riskiest to the system — the bigger the come, the harder they fall and the more money it would take to prop them back up. Bank of China tops the chart, followed by the Agricultural Bank of China, China Construction Bank and the Industrial & Commercial Bank of China.”
If there exists a Bank of , then maybe this is the part where we run like hell folks.
Well, China may have more success than others at debasing their currency if they have to print money to paper over this problem. How many trillions of dollars or Yuan does it take to make those banks solvent again? Printing money on that magnitude can’t help their currency out any.
Here’s a plausible reason why Watt isn’t interested in principal reductions:
http://www.housingwire.com/blogs/1-rewired/post/30824-the-real-reason-fannie-and-freddie-dont-do-principal-modifications
Great explanation.
It also brings up another level of unfairness: if the GSEs start forgiving principal, what about the borrowers whose loans aren’t owned or insured by the GSEs. Principal forgiveness is a lottery ticket for the loanowners whose loans happen to be owned or controlled by the right entity. Everyone else gets coal in their stocking.
I think we should only mod mortgages that are owned by the homeowners own pension funds.
Remind me why we need to reduce principal again? Distressed sales are less than 10% of the market. We didn’t reduce principal when it was 70%. Why change now? House prices are rising, so the market is “forgiving” principal on a daily basis. Why should taxpayers or pensioners have to pay when the homeowner doesn’t? How is this fair, or even the right thing to do?
LOL Holy crap man. That is an awesome article. Thanks for posting.
Maybe affordable housing advocates want to double-check their own investment portfolios before they continue the diatribe on principal mods. An announcement of principal mods would certainly create undesirable behavior in the market.
it’s cold hearted and doesn’t seem necessary to put a joke caption on the picture of a woman that lost everything in the 9.0 earthquake+tsunami in japan. maybe i’m overly sensitive because i was there when it happened…
http://www.gettyimages.com/detail/news-photo/woman-sheds-tears-among-debris-after-a-9-0-magnitude-strong-news-photo/110106496
First off, I really appreciate the info contained in this blog and regularly check up on postings. I like Irvine renters perspective and find myself often agreeing. Having said that, I think the lead in picture was done in poor taste. I know that the pictures here are tongue in cheek, which I completely get, but that man obviously just suffered a great loss. To put his picture up with some sarcastic comment seems to be pretty insensitive. Imagine if you just suffered a lost home due to an earthquake an someone on the internet used your pic in a joke. Feel free to tell me to lighten up, etc. but I felt I at least had to say it
What if the Chinese property bubble is bursting because funds are now allowed to flow out of China, and not the other way around? Everyone assumes that Chinese real estate investors are pulling their money out of China because the bubble is bursting. What if the bubble is bursting because they are now allowed to diversify abroad?
This has bad implications for Chinese property values, but conversely, this is good for non-chinese housing prices. China has been selling goods to the US for a couple of decades and unable to move the profits off-shore. This money has to be invested in a closed system, which naturally increases prices in that system. Once investment is opened up to include the global real estate market, prices in China fall and the rest of the global prices rise.
http://www.vancouversun.com/business/economy/Secret+path+revealed+China+billions+buying+foreign+real/10029551/story.html
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