The dog days of late summer sometimes disguise nasty surprises in financial markets that dominate economic news for subsequent months or even years. In August 2007, Bear Sterns, then a huge Wall Street bank, announced it was having some difficulties in an obscure fund dealing with so-called sub-prime loans. Within months, the world economy was in crisis.
In August 1998, Russia defaulted and devalued in chaos. Six months later, as inflation decimated Russian incomes, a political nobody from Leningrad – Vladimir Putin – was coronated interim prime minister to bring a bit of bureaucratic order. Two years later he was president and has never left the Kremlin. In August 1997, the Thai baht collapsed precipitating a contagious continent-wide economic calamity known as the Asian Crisis.
What might this August have in store?
The collapsing Chinese property market has the potential to derail a global economy already reeling from widespread, energy-driven inflation. To the Irish reader, the Chinese property market is almost a carbon-copy of Ireland’s around 15 years ago. Sales in the 12 months up to June fell by 22 per cent compared with last year. Trust in the property market is evaporating as over-extended developers fail to complete developments which people have already bought.
In China, people put down deposits which can in some cases be as much as 100 per cent of the cost of the apartment. In times of rapid house-price inflation, this might even seem prudent. However, the developers use this cash to buy more sites from local government only too happy to take in the revenue from land sales, leading to more and more development. While we had our ghost estates, China has it ghost cities, which it is now demolishing.
In response, China is experiencing a mortgage strike as tens of thousands refuse to pay their mortgages until promised homes are delivered, according to a Financial Times report referring to a crowdsource document online titled “We Need Home”. This strike has spread to nearly 100 cities, and over 320 significant projects, almost mini-cities. Dragon City, Peacock City and Phoenix City are among the cities affected. Henan province is particularly affected, with over 40 of the 320 stalled projects in the province’s capital, Zhengzhou. It is easy to see how this type of industry structure leads to a pyramid or Ponzi scheme. The entire edifice is dependent on final sales remaining healthy to pay for the various stages of the scheme. In order to maximise their market share, Chinese developers, such as the giant Evergrand, have borrowed in the international bond market, promising steady returns for investors.
Once final sales falter, cash flow dries up and there’s less money to finish buildings, there are more desperate buyers left high and dry and, as they panic, fewer still put down deposits, causing cash flow to dry up further. The downward spiral ensues. Like Irish people who in 2005-2006 believed house prices could not go down, Chinese people have similarly bet the house on property – and they’ve done this from almost zero over the past three decades. It was not until the latter half of the 1980s that the State began to encourage private property ownership. Before then, it was illegal to own property in China.
Since the 1990s, China’s real estate market has seen a dramatic upswing, with some estimates suggesting it accounts for about 30 per cent of China’s GDP after factoring in related industries such as construction, estate agents and property management. At the start, the market grew in response to demand as the old communist housing stock was not up to scratch, plus industrialising China experienced the biggest migration of people ever from the countryside to the cities. Increasingly, property was seen as the perfect vehicle for savings. Under Chinese law, most Chinese citizens cannot invest overseas, and domestic financial markets are volatile, leaving real estate as an avenue for investment. We know this story. An axis of government looking to raise tax revenue, banks lending to developers and developers over-extending themselves, foisting and pushing a property craze on the people, leads to a bubble which will burst. This is what is happening in China.
The contagious impact of events in China are likely to be insulated because China, in financial terms, is cut off from the rest of the global economy, but as property and construction accounts for close to 30 per cent of China’s GDP, it will take years for the Chinese economy to recover. More worrying are the intangible effects of a Chinese property slump on global confidence. Talk will switch to the conclusion: “If it can happen in managed China, it can happen anywhere.” China is the second biggest economy in the world and we all know that confidence is everything.
Before the crash, Irish developers were at the same game as the Chinese. They too took deposits, which were then used as collateral for the banks that lent against them for more sites to be bought. Who’s to say the same isn’t happening again?
For example, according to the Banking and Payments Federation Ireland (BPFI), 5,355 mortgages were approved in May 2022, a rise of by 24.4 per cent month-on-month and 14.3 per cent compared with the same period last year. Reflecting higher house prices, the value of mortgage approvals rose by 24.8 per cent month-on-month and by 25.3 per cent year-on-year. Brian Hayes, chief executive of the BPFI, stated: “In fact, May 2022 saw the second-highest recorded value for FTB [first time buyer] approvals (after October 2020) and the seventh highest for mover purchase.”
In terms of actual amounts, latest figures show that the value of FTB mortgage approvals increased by 14 per cent year-on-year to €732 million, while the value of mover purchase approvals increased by 6.3 per cent year-on-year to €346 million. The country’s wealth remains property-driven and thus reliant on house price trends. The value of privately owned real estate grew by €95 billion year-on-year in the first quarter, the highest annual revaluations on record, despite the pandemic. Even today, with energy and food prices rising, property prices are rising by more than 14 per cent nationally. As we are seeing with the Robert Troy saga, the age-old nexus of politicians, banks, developers and the land lobby is still firmly in place, over a decade after the crash. Politicians as landlords means they are not objective or impartial when it comes to the housing market.
The warning from China is that property goes bad and when it does, the entire economic edifice is threatened because so many are vested. We’ve seen this movie. We are at the same game as the Chinese, although at a different stage of the credit cycle. People think that because there’s a shortage of property, we will not have a property slump. We can because it’s all about price and today Irish property prices are way out of whack with incomes and are sustained only by panic and its better sounding counterpart, confidence.