Thursday, July 7, 2011

Crash and Burn

Blog at Forbes fails to mince words.

It's been a busy week in China. Yet another rate hike. Moody's sniffing around 1/2 trillion $ in off-balance-sheet, poorly documented, local-government lending . . . Every round of this, you'd think the fat lady would finally find her breath mints and take her spot in the wings.

How China will Crash and Burn
I often hear the argument that China will not have a real estate crisis of U.S. proportions because home and condo owners have to put 30-40% down when they buy. So where do people get the money to buy a house that costs, on average, 8 times their annual income (a figure several times higher than in the U.S.)? Some of it comes from savings, and some comes from borrowing from relatives.

Let’s pause for a second. In the 1990s, the Chinese banking system basically collapsed. To revive it, the Chinese government took bad loans from banks’ balance sheets and put them into off-balance-sheet vehicles (Enron would be proud of that financial ingenuity). Banks started to function as though nothing had happened. To finance the off-balance-sheet assets, the government set deposit interest rates at very low levels: 1% or so. In a country with a very high savings rate and 5% inflation, this resulted in a 4% annual loss of purchasing power.

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