Chinese officials used to claim they had studied and learned lessons from the Japanese Bubble period. They clearly learned little from the U.S. mortgage crisis. To be sure, mortgage Credit is seductive and too easily manipulated by government officials. It appears sound so long as housing prices are inflating. And the greater housing inflation, the greater the growth of self-reinforcing Credit. Risk, while growing exponentially, remains largely hidden.
In years past, it received a decent amount of attention. Yet few analysts these days even bother to mention the Chinese housing Bubble, despite its historic inflation. The problem didn’t go away; it instead got much bigger than anyone could have imagined. Indeed, Bubble risk has inflated to the point of risking peril for China as well as the world – financially and economically.
The Shanghai Composite traded as high as 3,587 intraday on Monday, January 29th, a more than two-year high. This followed the S&P500’s all-time closing high (2,873) on the previous Friday. On February 9th, the Shanghai Composite traded as low as 3,063, a 14.6% decline from trading highs just nine sessions earlier. In U.S. trading on February 9th, the S&P500 posted an intraday low of 2,533, a 10.7% drop from January 26th highs. Based on Friday’s closing prices, the Shanghai Composite had recovered 43% of recent declines and the S&P500 70%.
Global equities markets demonstrated notably strong correlations during the recent selloff. Few markets, however, tracked U.S. trading closer than Chinese shares. From the Bubble analysis perspective, tight market correlations provide confirmation of the global Bubble thesis. It’s also not surprising that Chinese markets were keenly sensitive to the abrupt drop in U.S. stocks. The U.S. and China are dual linchpins to increasingly vulnerable global Bubble Dynamics. Moreover, intensifying fragilities in Chinese Credit – and finance more generally – ensure China is keenly sensitive to any indication of a faltering U.S. Bubble.
February 21 – Bloomberg: “China stopped updating its homegrown version of the VIX Index, taking another step to discourage speculation in equity-linked options after authorities tightened trading restrictions last week. State-run China Securities Index Co. didn’t publish a value for the SSE 50 ETF Volatility Index on its website Thursday. An employee who answered CSI’s inquiry line said the company stopped updating the measure to work on an upgrade. The move was designed to curb activity in the options market, said people familiar with the matter… It’s unclear when the index will resume.”
Derivatives rule the world. Of course, Chinese authorities had few issues with booming options trading when markets were posting gains. Here in the U.S., regulators will supposedly now keep a more watchful eye on VIX-related products. In China, “the VIX goes dark,” as regulators place various restrictions on options trading. It’s not clear to me why international investors at this point would be drawn to Chinese markets. As Bubble fragilities turn more acute, Chinese officials will assume an even more heavy-handed approach.
February 23 – Wall Street Journal (James T. Areddy): “When Anbang Insurance Group Co. paid about $2 billion to buy New York City’s Waldorf Astoria Hotel three years ago, the deal seemed to define an era for China Inc. President Xi Jinping shortly afterward dropped in to stay at the Park Avenue landmark. China’s business priorities have since changed, turning real-estate trophies into symbols of risk. Regulators in Beijing on Friday said they seized control of Anbang to keep the privately held insurer from collapsing, while prosecutors in Shanghai said they indicted Wu Xiaohui, Anbang’s swashbuckling ex-chairman, for alleged fraudulent fundraising and abuse of power. China’s government makes no secret of its penchant to guide commerce, even with private companies, but the boardroom takeover still rattled analysts used to Beijing’s applying its influence more quietly. ‘This is an unprecedented step, putting into receivership a Chinese company in such a public direct way,’ said Scott Kennedy at the… Center for Strategic and International Studies. ‘They are so worried about risks that they will stop at nothing to avoid them.’”
Wu Xiaohui, Anbang’s former chairman, disappeared (was detained) this past June. Married to the granddaughter of Deng Xiaoping, Wu for years operated as if protected by the Chinese establishment. As the WSJ article noted, Chinese President Xi stayed at the Waldorf Astoria hotel shortly after it was purchased by Anbang in 2015. At breakneck speed, Wu built a financial (“insurance”) empire with assets surpassing $300 billion, largely financed through high-yield wealth management/“shadow” deposits. Anbang’s ownership structure was opaque, which didn’t matter so long as Wu was in good graces with Beijing.
How quickly the world changes. Wu has been charged with fraud and embezzlement – “illegal business operations which may seriously endanger the company’s solvency”. It would appear the game of freewheeling – and well-connected – billionaire Chinese dealmakers tapping the shadow “money” spigot to buy prized international real estate assets has come to an end. The immediate impact on global trophy property values is unclear. Yet the government takeover and charges against Wu certainly send a strong message to the Chinese business community. Beijing is exerting control and pursuing President Xi’s priority to rein in financial risks.
February 23 – Bloomberg Gadfly (Nisha Gopalan): “Beijing’s interventions in the economy don’t always merit applause, but the government’s unprecedented seizure of Anbang Insurance Group Co. deserves a round. Anbang was a toxic threat to China’s financial system after a debt-fueled global acquisition spree — including trophy assets such as New York’s Waldorf Astoria hotel — that was funded by the sale of high-yield insurance policies. Those risky products propelled the company from obscurity into the ranks of the country’s biggest insurers in the space of a few years. The government will take temporary control of Anbang for a year starting Friday… Markets reacted calmly to the announcement, underpinning the sense that regulators have acted in time to head off potentially bigger problems down the road.”
Anbang has been considered “too big to fail,” so the government takeover had little general market impact. And I suppose we can applaud Beijing for actions against one of the more conspicuously egregious high-risk financial operators. But in terms of an effect on overall systemic risk, this move barely registers on the risk-o-meter. Analysts have noted that Anbang’s assets have ballooned to a hefty 3% of Chinese GDP. But as a percentage of banking system assets, Anbang is less than 1%. With unrelenting rapid growth in Credit of deteriorating quality, systemic risk continues its parabolic ascent.
February 12 – Reuters (Kevin Yao, Fang Cheng): “China’s banks extended a record 2.9 trillion yuan ($458.3bn) in new yuan loans in January, blowing past expectations and nearly five times the previous month as policymakers aim to sustain solid economic growth while reining in debt risks. While Chinese banks tend to front-load loans early in the year to get higher-quality customers and win market share, the lofty figure was even higher than the most bullish forecast… Net new loans surpassed the previous record of 2.51 trillion yuan in January 2016, which is likely to support growth not only in China but may underpin liquidity globally as major Western central banks begin to withdraw stimulus… Corporate loans surged to 1.78 trillion yuan from 243.2 billion yuan in December, while household loans rose to 901.6 billion yuan in January from 329.4 billion yuan in December…”
The crackdown in shadow finance was surely a factor in January’s record-setting bank lending. The first month of 2018 saw major slowdowns in trust loans, entrusted loans and bankers’ acceptance lending, all key shadow instruments. Overall, Total Social Financing increased $483 billion in January, seasonally the strongest month of lending annually. This was gargantuan Credit growth, but actually 17% below January 2017. And looking at the most recent four-month period, growth in Total Social Financing was actually down 15% from the comparable year ago period.
Notably, household debt jumped $145 billion during January. This was easily a record and 21% above what at the time were record monthly household borrowings back in January 2017. For perspective, Chinese household debt growth averaged about $90 billion monthly in 2017, $80 billion in 2016, $50 billion in 2015 and $40 billion in 2014.
China faces major Credit issues from years of excessive corporate and local government borrowings. Chinese officials have moved somewhat to rein in these sectors. Meanwhile, household debt growth continues to accelerate. Apartment mortgages represent the largest component of China’s household borrowings, and I would argue that the Chinese mortgage finance Bubble is operating in the perilous “Terminal Phase.” It’s worth noting that the trajectory of China household borrowings is similar to mortgage Credit growth during the U.S. Bubble period.
Chinese officials used to claim they had studied and learned lessons from the Japanese Bubble period. They clearly learned little from the U.S. mortgage crisis. To be sure, mortgage Credit is seductive and too easily manipulated by government officials. It appears sound so long as housing prices are inflating. And the greater housing inflation, the greater the growth of self-reinforcing Credit. Risk, while growing exponentially, remains largely hidden.
Mortgage Credit is prone to rapid acceleration, as housing inflation spurs both rising prices and increasing quantities of transactions. Especially during the boom period, mortgage Credit becomes a major – and unrecognized – source of system liquidity, both in the financial system and throughout the real economy. As was certainly the case in the U.S., boom-time mortgage finance spurs consumption excesses along with mal-investment. A prolonged mortgage finance Bubble inflation fosters deep structural maladjustment.
China’s crackdown is no doubt having a major disciplining effect on the Chinese billionaire business community. Meanwhile, the Chinese mortgage and apartment Bubble runs mostly unchecked. Literally hundreds of millions of Chinese aspire to rising wealth and social mobility through the purchase of apartments that only go up in price. Virtually everyone believes Beijing will never tolerate a housing bust. This unwieldy episode of borrowing and speculation will continue to prove quite difficult for Beijing to control. The bust will be brutal.
I understand why Beijing would choose to crackdown on the likes of Anbang, HNA and Wanda. They’re conspicuous risk-takers outside of the core of the banking system (paying top renminbi for international non-essential assets). They can be easily and publicly disciplined, providing a stark warning to the business community without risking a systemic shock. I also assume it is somewhat of an opening act to what will evolve into broadening measures to rein in total system Credit growth and accompanying excesses. Such a strategy makes some sense, except for the reality that mortgage Credit is in the throes of dangerous “Terminal Phase” excess. Household debt expanded 21% in 2017, after 23% growth in 2016. And if January borrowings are any indication, 2018 could see Chinese household debt growth surpassing $1.3 TN, about three times the level from 2015.
Mortgage finance Bubbles don’t function well in reverse. At some point, lending tightens and the marginal buyers lose the capacity to bid up home/apartment prices. In China, a lot of serious problems are being masked by ever-rising apartment prices. It is said that in many markets up to one in four apartments remain vacant, purchased purely to speculate on higher prices. Deflating prices would likely see tens of millions of empty units transferred to lenders. Credit losses will no doubt be enormous, compounded by widespread fraud and shoddy construction.
A case can be made that household debt is rapidly becoming the greatest threat to China’s banking system and economy. They’ve clearly waited much too long to get mortgage Credit under control. At this point, the boom is an expedient to meet GDP targets. A burst apartment Bubble would now pose great systemic risk. Of course, the Beijing meritocracy believes they can adeptly manage through any circumstance. Their dilemma is that this type of Bubble becomes only more perilous over time, though mounting latent risks remain unappreciated. Chinese officials would prefer that new Credit finances productive endeavors. But at this late stage of the cycle, reliance on productive Credit would leave the system with woefully insufficient finance to keep the the Bubble levitated.
In years past, it received a decent amount of attention. Yet few analysts these days even bother to mention the Chinese housing Bubble, despite its historic inflation. The problem didn’t go away; it instead got much bigger than anyone could have imagined. Indeed, Bubble risk has inflated to the point of risking peril for China as well as the world – financially and economically. And while January’s lending data evidenced a boom replete with momentum, I would caution that there may be more near-term risk than is generally perceived.
The shadow banking crackdown will likely have a significant impact on higher-risk lending generally, including mortgage Credit. Moreover, regulators are demanding bankers slow loan growth, this after household lending expanded to a significant proportion of overall system Credit expansion. Total system Credit has already slowed. There are indications of tighter lending conditions and even an incipient slowdown in housing transactions. And let’s not forget rising global yields, one more factor to weigh on inflated Chinese apartment prices. Anbang, HNA and their ilk make for interesting reading, full of nuance and intrigue as Beijing plots a financial crackdown. The real story, however, might be unfolding in Chinese household and mortgage finance.
Original Post 24 February 2018
Categories: Doug Noland, Perspectives