Doug Noland: The Latest on China’s Mortgage Finance Bubble

It’s been a full seven days since a CBB focused on China… Important – confirmation of the thesis – data again this week.

October 21 – Reuters (Yawen Chen and Nicholas Heath): “China’s new home prices rose in September at the fastest rate on record as buyers rushed to close contracts before new restrictive measures took effect in October. The boom in sales and prices was evident in mortgage lending, with new housing loans to individuals totaling 475.9 billion yuan in September alone, some 76% higher than the same month last year… Prices in China’s 70 major cities rose 11.2% in September from a year earlier, accelerating from a 9.2% increase in August, as 64 of them saw year-on-year price gains…”

Year-on-year prices were up 34.1% in Shenzhen, 32.7% in Shanghai, and 27.8% y-o-y in Beijing.

Also from Reuters: “The house-prices-to-household-disposable-income ratio in first-tier cities has risen to be around 18 to 20 times in this year’s housing fever, putting housing affordability close to Hong Kong’s and making it less affordable than London, UBS wrote…”

October 19 – Wall Street Journal (Lingling Wei): “Xiong Meifang was about $30,000 short two months ago for a 30% down payment on an $895,000 apartment in the southern part of China’s capital. To make up the difference, the 31-year-old graphic designer took out a line of credit from a national bank. She said the bank told her she could use the loan however she wanted. China bans borrowing for down payments. A surge in such financing offered by nonbank lenders earlier this year led to a regulatory clampdown. But as banks increasingly turn to mortgage lending, there are new signs of risky practices. In some instances, banks offer credit lines to borrowers buying apartments with few questions asked. In others, banks work with independent loan brokers or property agents to funnel money into down-payment financing… Data released Tuesday showed medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The above noted WSJ article, China’s Property Frenzy Spurs Risky Business (Lingling Wei), included some insightful data and a particularly interesting chart. While briefly dipping below 10% in 2012, new mortgage loans as a share of the value of total new loans averaged around 20% for much of the period 2010 through 2015 – before spiking over recent quarters. “…medium- and long-term household loans, almost all of which are mortgages, made up 60% of all new loans created in the third quarter, up from 47% in the second quarter and 23% in the first.”

The article also included a graphic, “Number of years of median household income needed to buy a property of median value.” Here, Chinese cities are compared to some of the more notoriously expensive markets in the world: London 29 years, Tokyo 23, New York 15 and Sydney 12. With China’s Credit Bubble now spurring rampant housing inflation, Shenzhen has shot to the top of the list at 41 years, followed by Beijing (34) and Shanghai (32). Guangzhou made the list at 25 years, followed by Nanjing (22) and Hangzhou (17).

Not a big surprise, China’s September loan growth was reported at a level double forecasts.

October 18 – AFP: “New loans by Chinese banks in September surged nearly 30% from the previous month…, deepening concern about risky credit expansion in the world’s second largest economy. New loans extended by banks jumped to 1.22 trillion yuan ($181.3bn) last month from 948.7 billion yuan in August… Beijing has relied on stimulus measures such as loose credit to boost the economy, which faces a tough structural transition and sluggish global demand. But the rapid rise in borrowing has sparked alarm.”

Fueled by a surge in housing-related finance, September Total Social Finance (total Credit excluding govt bonds) surged to almost $250 billion, almost a third larger than forecast. This was the strongest Credit expansion since (“off the charts”) March ($360bn).

October 18 – Bloomberg: “The value of China’s new home sales rose 61% in September from a year earlier, defying policymakers’ moves earlier this year to cool the property market. The value of homes sold rose to 1.2 trillion yuan ($178bn) last month from a year earlier… The increase compares with a 33% gain the previous month.”

“CTV.” During the mortgage finance Bubble heyday period, I regularly highlighted a “Calculated Transaction Value” that I pulled from my spreadsheet of National Association of Realtors data (sales volumes by average prices). A Bubble’s manic phase sees a powerful surge in the number of transactions – at rapidly inflating prices. This explains how the value of China’s September home sales inflated 61% from September 2015, with “new housing loans to individuals” up 76% y-o-y.

I viewed CTV as the leading indicator of systemic risk associated with mortgage Bubble excesses. For one, it provided a timely barometer of the general tenor of Credit growth. It was clearly the best gauge of the “inflationary bias” at work throughout housing. Parabolic growth in CTV also accurately reflected the commencement of “Terminal Phase” excess. The historic surge of (borrowed) “money” into housing was indicative of destabilizing speculative excess, loose Credit conditions and, more generally, the degree to which financial stimulus was fueling economic imbalances.

It’s my view that the world is at the critical late-stage of a historic multi-decade Credit Bubble. China has become integral to the global Bubble – the marginal source of Credit and global finance. And in the face of a faltering Bubble Economy and increasingly vulnerable Chinese financial system, China’s mortgage finance Bubble has evolved into the predominant source of stimulus. Record Chinese Credit growth is the biggest global financial and economic story of 2016.

There’s a fundamental problem with speculative melt-ups and Credit Bubble “Terminal Phases:” They are invariably unsustainable. A torrent of Credit-driven liquidity inflates prices to unsustainable levels. Mortgage finance Bubbles are especially dangerous. They tend to be powerfully self-reinforcing, with Credit expanding exponentially during the precarious “Terminal Phase.” Fear and panic, as we’ve witnessed, can rather quickly see massive Credit expansion transformed into collapse.

It’s now been years of Chinese officials tinkering with an increasingly impervious Credit Bubble. They remain too timid, and I’d be surprised if current measures to slow housing markets have a dramatic impact. More likely, Chinese Credit continues to grow rapidly over the coming months. The much higher interest rates needed to slow rampant mortgage Credit excess are viewed as completely incompatible with a struggling general economy. Instead, it appears China will tolerate booming mortgage Credit as it systematically devalues its currency.

According to Zerohedge, a Goldman analyst (MK Tang) estimated that flows out of China surged to $78 billion during September, up from August’s estimated $32 billion. This would be the highest outflows since January. The Chinese currency weakened another 60 bps versus the dollar this week, putting the year-to-date devaluation to a not insignificant 4.2%.

Perhaps booming Chinese Credit and strong financial outflows are behind a growing inflationary bias taking hold in global markets. Crude traded near 15-month highs this week. In the currencies, the South African rand jumped 2.3%, the Mexican peso 2.2%, the Brazilian real 1.6% and the Russian ruble 0.9%. Brazilian stocks surged 3.8%, and Mexican stocks jumped 1.5%.

Along with EM, markets are looking at bank stocks through more rose-colored glasses. European banks jumped 5.1%, with Italian bank surging 7.3%. U.S. bank stocks rose 3.5%. The European periphery also rallied strongly this week, with Spanish and Italian stocks up 3.8% and 3.5%.

And while global yields have risen over the past month, bonds don’t seem all that fearful of an inflation resurgence. Recall 2007, and how the bond market had smelled out the loaming mortgage bust. Yields dropped, basically ignoring stocks (and crude) as equities went to all-time highs. What I remember most from that period was how monetary disorder created heightened instability across the markets right up until the crisis.

Original Post 22 October 2016

Categories: Doug Noland, Perspectives