China Is Heading Toward A Housing Crisis That Could Be Far Worse Than Japan In 1980s and Banking Crisis Bigger Than US In 2008

Japanese asset price bubble

The Japanese asset price bubble (????? baburu keiki?, lit. “bubble economy”) was an economic bubble in Japan from 1986 to 1991, in which real estate and stock prices were greatly inflated.[1] The bubble’s subsequent collapse lasted for more than a decade with stock prices initially bottoming in 2003, although they would descend even further amidst the global crisis in 2008.[2] Lacking appropriate action by monetary policy makers to arrest the dangers of escalating asset prices, fueled by uncontrolled credit expansion resulted in subsequent damage to the economy.[3] Such Japanese asset price bubble contributed to what some refer to as the Lost Decade.[4]Some economists, such asPaul Krugman, have argued that Japan fell into a liquidity trap during these years.[5]

China: Massive Credit Bubble Fueled By Shadow Banking And Securitization Could Collapse Banks

The unprecedented level of credit expansion in China has gotten to the point where it dwarfs anything we’ve seen before with overall credit now at about $23 trillion, making a severe banking crisis a very real possibility.

With a shadow banking system that is becoming increasingly prominent, the rise of bundling of assets and securitization, and an acceleration of policy tightening, over-indebted local governments and institutions will feel the pain of a rising cost of capital, prompting Fitch Ratings to raise red flags about the future growth prospects of the Chinese economy.  At Nomura, where they noted that liquidity tightening is dangerous in a highly leveraged economy, they increased their probability that a risk scenario could push GDP growth below 7% this year, threatening social stability.

Why The China Bubble Could Be Far Worse Than Japan In The 1980s

I am back from San Francisco, where I had the great pleasure of attending and speaking at FAME Symposium, diligently put together by students at San Francisco University.  One of the other speakers was a famous international investor, Charles De Vaulx.  During a break Charles and I were discussing the Chinese bubble today vs. the Japanese bubble of the  late ’80s.  This conversation got me thinking.  In Japan the bubble was the most prominent in commercial real estate and to a lesser degree in residential real estate.

The house-price-to-income ratio (just take the average house price and divide by average income) in Tokyo at the height of the bubble was 9, while in China in 2010, in the big cities this number was much greater (Beijing 15, Shanghai 13), and in fact the ratio for the whole of China was over 8.  The commercial real estate bubble might have been greater in Japan; it is hard to tell.  I remember reading that at the peak of the Japanese bubble the Imperial Palace was worth more than a state of California.  But from different reports I’ve seen, China has plenty of empty skyscrapers.

But China also has a couple more bubbles, in industrial overcapacity and overinvestment in infrastructure.  Japan did not have an infrastructure bubble, for several reasons: first, it was a more developed country than China.  Second, the government played a much smaller role in the economy – Japan did not have a command-control economy, and it did not try to build for social/political stability reasons.  Japan had your garden variety real estate bubble: easy credit, inadequate banking laws, etc…

Also, and this point is hard to quantify, but the quality of Japanese construction is better than in China.  There are many reasons for that: less corruption, no five-year plans (i.e., output-per-capita targets), and the Japanese put a higher value on human life….

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China is now heading toward Japan-style economic paralysis if it doesnt change course

Subprime mortgage crisis

The U.S. subprime mortgage crisis was a set of events and conditions that led to a financial crisis and subsequent recession that began in 2008. It was characterized by a rise in subprimemortgage delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages. Several major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.

There were many causes of the crisis, with commentators assigning different levels of blame to financial institutions, regulators, credit agencies, government housing policies, and consumers, among others.[1] A proximate cause was the rise in subprime lending. The percentage of lower-quality subprime mortgages originated during a given year rose from the historical 8% or lower range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S.[2][3] A high percentage of these subprime mortgages, over 90% in 2006 for example, were adjustable-rate mortgages.[4] These two changes were part of a broader trend of lowered lending standards and higher-risk mortgage products.[4][5] Further, U.S. households had become increasingly indebted, with the ratio of debt to disposable personal income rising from 77% in 1990 to 127% at the end of 2007, much of this increase mortgage-related.[6]

As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralized debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased.[7] Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses.[27]

Falling prices also resulted in homes worth less than the mortgage loan, providing a financial incentive to enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S. continues to drain wealth from consumers and erodes the financial strength of banking institutions. Defaults and losses on other loan types also increased significantly as the crisis expanded from the housing market to other parts of the economy. Total losses are estimated in the trillions of U.S. dollars globally.[27]

Share in GDP of U.S. financial sector since 1860[28]

While the housing and credit bubbles were building, a series of factors caused the financial system to both expand and become increasingly fragile, a process calledfinancialization. U.S. Government policy from the 1970s onward has emphasized deregulation to encourage business, which resulted in less oversight of activities and less disclosure of information about new activities undertaken by banks and other evolving financial institutions. Thus, policymakers did not immediately recognize the increasingly important role played by financial institutions such as investment banks and hedge funds, also known as the shadow banking system. Some experts believe these institutions had become as important as commercial (depository) banks in providing credit to the U.S. economy, but they were not subject to the same regulations.[29]

The Rise Of Shadow Banking In China [CHART]

This Great Graphic was posted on the Financial Times’ new news delivery service called fastFT.  It in turn picked it up from BofA Merrill Lynch, who drew on data from the China’s central bank.
The orange-ish line are the yuan loans made by China’s banks.  The blue line a broader measure.  It depicts what China officials call “social financing”, which, in addition to bank loans, it includes the fund raising of other financial and non-financial firms, as well as households.   The measure was introduced by the PBOC in 2011, so the economists that put the chart together must of projected the social financing prior for the earlier period.


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Mark Mobius: China’s Problems as Big as US Subprime

While China’s housing market problems are similar in scale to those faced during the U.S. subprime mortgage bubble and its banks are rife with bad loans, it won’t lead to another Lehman-style crash, Franklin Templeton’s Mark Mobius told CNBC on Monday.

Mobius said the similarities could not be denied but since Chinese banks are owned by the government, they will not be allowed to fail.

Investor fears have been heightened after a credit crunch last week led to a spike in yields on inter-bank loans. Some analysts have pointed out the credit crunch was spiked by China’s central bank tightening liquidity, rather than a loss in confidence among banks.

China Crashing: Is It Finally Going To Happen?

China crash would dwarf subprime crisis

Scott Jagow: Today, China’s stock market hit 5,000 for the first time. While other stock markets around the world have floundered, China’s just keeps steamrolling along. While other central banks have poured money into their banking systems, China is doing the opposite. It’s tightening. It just raised interest rates for the fourth time this year. Our economics correspondent Chris Farrell is here. Chris, why is there such a disparity between China and everybody else?

Chris Farrell: The Chinese central bank is facing a floodgate of liquidity; much of it is pouring into the stock market. The Chinese Shanghai Index is up 147 percent so far this year.

Fitch says China credit bubble unprecedented in modern world history

China’s shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.

The agency said the scale of credit was so extreme that the country would find it very hard to grow its way out of the excesses as in past episodes, implying tougher times ahead.

“The credit-driven growth model is clearly falling apart. This could feed into a massive over-capacity problem, and potentially into a Japanese-style deflation,” said Charlene Chu, the agency’s senior director in Beijing.

“There is no transparency in the shadow banking system, and systemic risk is rising. We have no idea who the borrowers are, who the lenders are, and what the quality of assets is, and this undermines signalling,” she told The Daily Telegraph.

While the non-performing loan rate of the banks may look benign at just 1pc, this has become irrelevant as trusts, wealth-management funds, offshore vehicles and other forms of irregular lending make up over half of all new credit. “It means nothing if you can off-load any bad asset you want. A lot of the banking exposure to property is not booked as property,” she said.

Concerns are rising after a string of upsets in Quingdao, Ordos, Jilin and elsewhere, in so-called trust products, a $1.4 trillion (£0.9 trillion) segment of the shadow banking system.

Wen Warns on China Tensions in Final Speech as Premier: Economy

Chinese Premier Wen Jiabao said the nation lacks a sustainable growth model and faces mounting “social problems,” as he ends a decade in power that saw the economy grow fourfold to be the world’s second largest.

“We are keenly aware that we still face many difficulties and problems,” Wen told almost 3,000 delegates in his final report to the National People’s Congress in Beijing today. He set an economic growth target of 7.5 percent for this year, unchanged from 2012, and an inflation goal of 3.5 percent.


06-29-13 Macro Analytics – The Coming CHINA Crisis – w/ Bert Dohmen & Ty Andros