Is Chinese Mortgage Data Waaaay To Low? (No, seriously)

So recently a lot of ink has been spilled on the rapid growth in Chinese mortgages.  On the face of it the increase is certainly worrying.  New mortgage lending in 2016 is up 111% and the total stock of mortgages is up 31%.  Even if we take a broader measure of household lending that likely captures a not insignificant amount of real estate related debt, medium and long term loans to households is up 31%.  The numbers on their face appear large with medium and long term loans to household registering 22 trillion RMB and personal mortgages clocking in at 16.5 trillion RMB.

These sound like big number and in some ways they are, but in reality these numbers are if anything suspiciously too low.  Most get caught up on the size of the numbers but never place these total numbers in any type of context.  In fact, if you place these numbers in context, these numbers are absurdly low.  Let me explain.

For conservatism, data, and simplicity sake, I am going to limit the analysis to urban housing units.  In other words, let us assume that all mortgage and medium to long term household debt is owed only by urban households.  This does not change the outcome in anyway and if anything make it much more conservative than it would be otherwise.

The primary thing we want to do is adjust for the number of households in urban China.  Without going into all the underlying calculations, which come from all official data, there are approximately 272 million urban households in China and according to official data, only a very small number of households do not own their housing.  Again, this is all relying and strictly using official data.

If we then estimate urban residential real estate wealth using the 100 City Index price per square meter as our high value and the Third Tier City Price per square meter as our low value, we have both a high and low value for our estimate of urban residential real estate wealth.  This gives us an estimated upper bound of 330 trillion RMB and a lower range of 189 trillion RMB.

Here is where it gets interesting.  If we translate this into a broad loan to value number, this means that urban China has an estimate loan to value ratio on its real estate holdings of 5-9%.  In other words, almost all of urban Chinese real estate is owned almost entirely free and clear according to official statistics.

If we apply this analysis backwards, the numbers are even more nonsensical.  In 2011, the urban loan to value ratio ranged from 3.3-4.5%.  If we use absolute numbers, the appear even more absurd.  When the average housing unit in 2011 cost 665,000 RMB using the third tier city price and 910,067 using the the 100 City National Index, mortgage debt totaled only 29,675 RMB per urban housing unit.

If we focus just on the new mortgages and new urban units, the numbers look decidedly problematic.  For instance, if we use the 100 City Index housing price, this would give us an implied equity share for new housing units from new mortgages of 71%.  In other words, if we assume that only newly constructed units are purchased with new mortgage debt, owners would be providing a down payment equal to about 71%.

Now while I use the slightly more restrictive mortgage debt, even if we include the broader label of medium and long term this would barely dent the number.  If we use the medium and long term household debt number instead which is only about 4-5 trillion RMB more, again using only urban households, this would still barely move the per unit or value debt number.   To bring Chinese urban housing wealth up to a 20% LTV, would require about a 41 trillion RMB increase in mortgage debt.  Put another way, outstanding mortgage debt would need to go from about 16.5 trillion RMB to 58 trillion RMB. Including the obvious candidates that some have nominated simply does not come close to making these numbers plausible.

We are left with a conundrum: either believe the data at these levels or find a better candidate when no good obvious source of debt under counting exists.  I’ll be honest in saying I’m not sure whether to accept them as vaguely reasonable representation or believe that they are not even close.

If we consider the possibility that these debt numbers are relatively accurate, while there are positives, there are also very real risks.  First, it raises the scope that Beijing could further increase urbanization and home ownership rates by loosening credit.  However, there is evidence that rural households migrating to urban areas are already debt budget constrained and that Beijing is uncomfortable with the level of debt even at these levels.  Additionally, this raises the possibility that real estate prices have a long way further to appreciate which seems implausible given already elevated price to income levels.

Second, this would imply that households have put very high level of savings into their homes and may have less liquidity available than understood.  By some recent estimates, Chinese households had 70% of their wealth in real estate.  Liquidity constraints may exacerbate any real estate or broader economic down turn placing additional pressure on prices.

Third, this would seem to place enormous pressure on public officials to maintain housing prices at elevated levels.  If Chinese households have placed the vast majority of their wealth into their home, though lack of leverage will not magnify the financial returns, it will place enormous pressure on the government to prevent price declines.

There is one possible scenario, though we do not have the data to say for sure this happening that would explain the discrepancies we see.  Given the mismatch of the mortgage data and required down payment this raises the possibility of the leverage upon leverage scenario.  For instance, a home is owned with no mortgage debt.  The owner then pledges the real estate as collateral to borrow money for the equity share and borrows money in the form of a mortgage to purchase additional real estate.  In this instance, only one mortgage appears outstanding where, if we assume the second property is financed with a 50/50 debt/equity split at the same value of the first property, then we have a mortgage per unit value of 25%.  However, in reality the risk level is much higher as both properties have debt against them and depend on stretched cash flow valuations or capital appreciation.

There are many possibilities but the only thing we can say for sure at the moment, once we break down mortgage data into per housing unit basis, the numbers seem implausibly low.


Hong Kong: The Game Behind the Game

Lost in all the hand wringing about Hong Kong is a larger more important issue: Chinese GDP is in all likelihood zero. China is not just on track to miss, though officially meet, its growth target but miss badly.

Steel and electricity consumption are falling.  Real estate prices have begun falling causing riots among consumers who feel defrauded or that apartments selling at almost $1,000 a square foot were a one-way bet.  Despite these falling indicators the People’s Bank of China continues to pump money into an already saturated market.  In the middle of September, the PBOC injected 500 billion rmb into major state owned Chinese banks.  All the while, Beijing continues to release additional stimulus measures while continuing to insist it will not release a major stimulus package as it did in 2008-2009.

Nothing here bears the hallmark of a healthy economy much less one growing at 7.5%. One source indicated that 7.5% was internally believed to be the number which would maintain enough cash flow to keep the Chinese economy from tipping into a crisis given the poor state of finances.

This matters for one very simple reason.  The implicit agreement between the Chinese populace and the government has always been an acceptance of political repression if the economy was growing rapidly.  If you want to see protests on the streets of every major city in China announce that housing prices have fallen by 50%.  Riots break out over smaller changes to prices and a significant slow down in Chinese growth would break the acceptance of political repression.

Beiing views taking a hard line with Hong Kong as a dress rehearsal for the serious economic problems festering just beneath the surface inside China.  Breaking their part of the agreement of rapid economic growth means needing to enforce the other side of the agreement, even if the Chinese population decides they want to opt out.

Standing up to the student protesters organizing recycling has always had nothing to do with Hong Kong and everything to do with the Mainland.  The self admitted fall in steel, electricity, and real estate prices, are prompting Beijing to see Hong Kong as nothing but the opening act.

Chinese New Year News

Apparently, I am not the only one coming up with better estimates for the reality of Chinese data.  One Chinese academic says that if a more representative methodology is used to record home prices in China it may increase “housing market appreciation by more than 100%!”  It is also worth noting this is from the China Daily not a foreign publication.  These data discrepancies have caused one research firm to estimate Chinese GDP at 6.1% in the 4th quarter rather than the officially report 7.7%. More some other time on why China needs to maintain such rapid growth but it is interesting just how many people are pointing out the Dragon Emperor has no clothes.

From departing Fitch Chinese shadow banking expert Charlene Chu comes this beautiful tidbit regarding asset management and bad loans:

The fundamental question with these asset-management companies is where are they getting the money to do their business. We can see on the asset-management-company balance sheets that much of their funding is coming from banks, so they are borrowing from banks to buy bad debt from banks. In that scenario, there isn’t any true risk transfer the way there was in the previous bank bailout when the financing for the nonperforming loan carve-outs came from the government. Instead, what we have is bad loans moving from banks’ loan portfolios into their interbank portfolios as a claim on an asset-management company. Over the short term, this disguises the bad debt situation. But over the longer term, if asset-management companies can’t repay their borrowing from banks, then bank capital is still at risk of loss….Fundamentally there needs to be a deeper recognition that most of the challenges facing the financial sector, including the liquidity issues we see at the moment, are related to asset quality problems. That’s regardless of what the nonperforming loan data say. The market recognizes that; that’s why the banks are trading at such low valuations.”

While credit problems loom in China, there are also larger underlying pressures to the real economy.  One of the biggest is wage pressures.  According to this Financial Times article Chinese “factories made clothes at half the cost of its facilities in Malaysia and Thailand but that gap has since disappeared.”

China wants to start policy think tanks which invites the obvious question: don’t you need to be able to think to have a think tank?  Jailing professors for pushing the government to require officials to disclose their personal wealth isn’t radical stuff, unless you have something to hide.

Update:  According to Goldman Sachs the Chinese banking regulator has issued a warning on all loans made to coal miners.  Remember, it is a Shaanxi coal miner that triggered the first wealth management product that defaulted which is currently under negotiations with investors.


What Investment Banks are Saying About China

According to JP Morgan report on housing in China from late November, “we think homes are still broadly affordable to the general public and policy risk should be contained in 2014.”  Wonder if they interviewed anyone in China or looked at any measure of home prices for this piece of crack research?

Credit Suisse has even better crack research, which albeit defies the laws of mathematics, but offers hope for those who failed statistics.  According to CS, “all of them (Chinese real estate developers) expect their own company’s growth to be higher than the market’s – even though some of them have been underperforming the overall market in terms of contracted sales growth over the past few years.”  Let’s break this down real slow.  First, it is mathematically impossible for everyone to “be higher than the market”.  If you believe this is possible, no wonder you are optimistic on Chinese developers.  Second, if you ignore the fact that sales growth is contracting then yes, you can continue to remain upbeat on Chinese developers.  Amazing that you need an MBA to come up with research like that.

Credit Suisse which appears to be able to state the obvious writes of the recently finished government audit PR campaign of public debt that “Local government debt (LGD) almost quadrupled from Rmb4.5 tn in 2007 to Rmb17.9 tn by 1H13 (or +67% since 2010)…we view fast LGD growth in the past few years as not sustainable.”.  That bit of profound financial insight just might be the understatement of the year by the same people that believe all companies will outperform the market.

According to another JP Morgan report from earlier this month on Chinese financials, “we believe that 2014 is going to be a tougher year for banks, compared to 2013, as the liquidity situation is going to be tight and asset quality deterioration will continue.” Just to be clear, the year when at least one Chinese bank has acknowledged being in technical default is going to be the easy year?



The Enormity of the Fire Breathing Debt Dragon

There is some skepticism of just how large the approaching debt crisis is by China-Dragons.  The argument goes that just as China did a little over 10 years ago, Beijing will simply create a bad loan  management firm to take those assets of the banks balance sheets.  The simple problem is this: the sheer size of the financial stress dwarves what even the Beijing puppet master can muster.

The South China Morning Post who has probably the best China coverage in the world puts the sheer size of the debt dragon into perspective and the role Beijing played in creating it:

“While many small and medium-sized enterprises, hobbled by a slump in exports, cried foul at missing out on their share of stimulus cash, steel traders were among the biggest beneficiaries of the state-backed loans.  In 2009, Shao and other steel traders were approached by banks which were actively seeking to extend loans to the private entrepreneurs. “They simplified loan approval procedures, gave us discounts to interest rates and encouraged us to take advantage of regulatory loopholes to borrow the money,” Shao said. “We are strong believers in the saying that cash is the king; therefore, we were more than happy to take the money.”

In other words, the banks were chasing down favored industries and companies pleading with them to take more loans at discounted rates.  But wait, it gets better:

“Shao says loan assessment officers told him he could move the same batch of steel products he had already borrowed against to a different warehouse, and use it as collateral against another loan. “Steel products worth several million yuan could be collateralised several times to obtain credit that amounted to scores of millions,” said Shao. “Nobody cared about our repayment capabilities at that time.” Some of the money went back into the steel trading business, with newly bought products being used as collateral to secure yet more easy credit. A steel trader with a personal net worth of 100 million yuan could eventually have about 10 billion yuan of cash on hand via the aggressive borrowing, people with knowledge of the situation said.”

Read that again in case you missed it: by using the same product as collateral to obtain many different loans, you could turn 100 million into 10 billion!  Needless to say the cash from this borrowing orgy was not exactly well used:

“And the abundant cash, combined with the credit lockdown many SMEs were suffering, presented yet another opportunity for steel traders.  Billions of yuan flew into the underground banking system in Zhejiang province, heartland of the shadow banking industry, to chase the high interest returns offered by illegal lenders. “I didn’t even bother to ask them how they would use the money,” Shao said of people he lent cash to. “The borrowers promised to pay higher interest than the banks’ lending rates and I just agreed on the spur of the moment. Now I don’t even know where some of the cash has gone.”

Nor was this baiju fueled lending binge limited to steel traders.  The credit crisis is spreading to smaller cities throughout China with the predictable consequences of collapsing sales, bankruptcies, and falling real estate prices. According to this New York Times article of one mid-size Chinese town, apartment prices rose from $20,000 to $330,000 in a city where the average per capita GDP was $4,000.  That translates to a home price to income ratio of 80.  Considering the United States peaked in San Francisco around 11, this would imply one of the biggest housing price corrections in the history of mankind.

It should come as no surprise that steel traders cash and real estate prices went hand in hand.  Between the incentives to turn out low price steel for large apartment blocks and lending to fuel their purchase, this completes two sides of the same coin.

Think I’m exaggerating the magnitude of this and the coming correction of asset prices?  Watch this 60 Minutes piece touring cities built for hundreds of thousands where no one lives.

The coming correction to asset prices will be one of the largest and most painful we have ever seen.

The Ongoing Data Discrepancy in Chinese Inflation and GDP

A question I have answered frequently in recent history is why I decided to write my working paper How Badly Flawed is Chinese Economic Data? and the answer is simple.  I was astounded that smart people would so readily believe the economic propaganda being announced by Beijing.  Apparently, other people have been just as skeptical and and heartfelt thank you to CNBC for broadcasting this:

Now whether you agree with everything that I have said, how I calculated it, or the final conclusions I reached let me give you some new information.  According to new official data (as I stress about Chinese data: do not actually believe it) in 70 major cities the price of new homes rose 7.5%.  Nor was this increase limited to new homes as existing home prices jumped also.  According to Bloomberg: “Existing home prices rose 15 percent in Beijing last month from a year earlier and increased 11 percent in Shanghai and Guangzhou each, according to the data”

Now to put these numbers in perspective you must bear in mind that according to the same people that released these statistics, from 2000-2011 urban areas saw housing price inflation of 8% total.  It must be emphasized that the real estate asset price and the consumer price change are two very different things but they are also very related.  The real estate component of CPI is not going to increase in perfect correlation with the change in real estate prices, especially when there is a bubble.  However, nor are the housing CPI and real estate asset price independent and unrelated.  To think that real estate asset prices go up by 7.5% annually but the housing CPI goes up by only 8% in 12 years in ludicrous.

The reason this matters is that banks are enormously stressed and continuing to lend to developers to buy land, consumers to buy apartments, and related industries to stay in business.  Think the banks aren’t stressed?  Chinese interbank rates are already spiking in anticipation of the end of the month capital adequacy ratio tests and the market is pushing for additional PBOC liquidity.

There are a couple of problems here.  First, it should serve as a warning sign that every time there is a capital adequacy test, Chinese banks go into panic mode.  That is not a good sign.  Second, banks should not be this dependent on on the central for bank for ongoing liquidity.  This smacks of an ongoing quiet bailout.  In normal times, banks should be able to lend to each other with minimal central bank intervention to ensure smooth financial market operation.

Given the line of rights issues that have already started are continuing by banks, this sounds a lot like a government engineered bailout except under quasi-Communist Authoritarianism, you get try to dupe the private investors into putting up the capital.  (Am I the only one that finds it odd that the quasi-capitalist US does a public bailout while the quasi-Communists conduct a private bailout?).  Point being, the PBOC and string of new rights issues are telling you just how stressed Chinese banks are.

You definitely can’t believe the macroeconomic data any more than you can believe a set of public Chinese books.

My New Working Paper on Bogus Chinese Economic Data

So after getting a bunch of questions about a blog post I did about bogus Chinese economic data, some challenging what I wrote and some just wanting to know more, I decided to give it a bit more formal treatment.  I put together a working paper entitled How Badly Flawed is Chinese Economic Data? The Opening Bid is $1 Trillion available here.

I plan on covering some of the major findings periodically over the next couple of weeks but Chinese is so fraudulently manipulated as to be Alice in Wonderland absurd.  Let me give you one simple example below in this table.

According to the official National Bureau of Statistics China (NBSC), the price of private housing in urban areas between 2000 and 2011 rose by a grand total of 6% with rural area prices grew slightly faster registering a 20% increase.  It needs to be emphasized that these are not annual numbers but rather the total increase in China in 12 years.  To anyone who is alive and has heard of China, these numbers are not simply questionable but downright comical and fraudulent.

It is also worth noting that according to the NBSC, approximately 70% of Chinese households are considered “private housing” occupants.  This means that the NBSC is saying about 70% of Chinese households have faced housing price inflation of between 6-20%.  More about this break down in a future post which is very interesting in itself.

The primary point of the paper is not simply to reveal more discrepancies in the Chinese economic data, which it does, but also to measure the impact of these fraudulent statistics on real economic activity.

If you don’t want to read the paper or hit the highlights, don’t worry I will be posting the greatest hits here over the next couple of weeks.

Enjoy and cross your fingers.