China must avoid mortgage bomb

BUBBLE TROUBLE: If ramped-up mortgage borrowing isn't accompanied by bold and steady progress in modernising the economy, a giant asset bubble will result.


    Nov 25, 2014

    China must avoid mortgage bomb

    THE first Chinese interest-rate cut in more than two years is a stark recognition that the world's second-biggest economy is in trouble.

    After years of piling ever more public debt onto the national balance sheet, it makes sense to have the People's Bank of China take the lead in propping up gross domestic product (GDP).

    Yet, while Friday's benchmark rate cut should help stabilise growth, the move also adds to worries about looser credit that could pose risks to the global economy. Case in point - mortgages.

    Earlier this year, Chinese officials took several stealthy steps aimed at stabilising the property sector and bolstering GDP growth.

    The China Banking Regulatory Commission loosened lending policies. Even before cutting the one-year lending rate to 5.6 per cent and the one-year deposit rate to 2.75 per cent on Friday, the central bank had cut payment ratios and mortgage rates, while prodding loan officers to ease up on their reluctance to approve borrowers without local household registrations.

    Pilot programmes for mortgage-backed securities and real-estate investment trusts got more support. Incentives were rolled out to encourage high-end buyers to upgrade properties.

    There's good news and bad in all this.

    The good: It marks progress for President Xi Jinping's efforts to recalibrate China's growth engines. In highly developed economies like the United States, the quest for home ownership feeds myriad growth ecosystems and offers the masses ways to leverage their equity for other financial pursuits. And China's debt problems are in the public sphere, not among consumers.

    The bad: If ramped-up mortgage borrowing isn't accompanied by bold and steady progress in modernising the economy, China will merely be creating another giant asset bubble.

    "Expanding the underdeveloped mortgage market is not bad news," said Diana Choyleva of Lombard Street Research. "But if China relies on household credit to power the economy and pulls back from much-needed financial reforms, the omens are not good."

    Take the experience of South Korea after the 1997 Asian crisis. With regulatory tweaks and a variety of ill-fated incentives, Seoul effectively shifted the nation's debt burden from government to families. By the early 2000s, fresh headwinds were intensifying; in April 2004, one in 13 Koreans was three months or more behind on debt payments.

    Of South Korea, Ms Choyleva said, "all it has to show for its efforts are the mess left by a burst household-debt bubble and an economy even more dependent on exports".

    For all the grand talk of reining in state-owned enterprises and the shadow banking system, and tolerating a "new normal" of slowing growth, Beijing remains intent on getting as close as possible to this year's 7.5 per cent GDP growth target. With Moody's and Standard & Poor's watching, and prominent economists like Larry Summers arguing that China could soon slow to 4 per cent growth, officialdom is looking for covert stabilisers. Among them - securitisation.

    One of China's few reforms in the mid-2000s was securitisation of loans, which began with a trial programme in 2005. Three years later, Wall Street's crash made the bundling and selling of loans and assets a pariah among financial instruments, and the experiment was shelved.

    Since 2012, though, securitisation has not only returned, but also flourished. According to Ms Choyleva, issuance reached US$28 billion (S$36 billion) in the first nine months of the year, compared with US$16 billion between 2005 and last year.

    While most sales have been of car, corporate and credit-card debt, those of mortgage-based securities are rising. In July, the Postal Savings Bank of China did the first residential mortgage-backed deal in seven years, and the markets are buzzing about more to come. These market rumours fit the housing-as-stimulus narrative.

    Risks abound, not least of which is the danger of helping lenders to hide dodgy investments off the balance sheet. If transparency was a problem on Wall Street, imagine what state-coddled Chinese banks could hide.

    Also, to avoid South Korea's missteps, China would have to complement this nascent mortgage boom with policies to redistribute income towards consumers. That means working to narrow the gap between rich and poor by increasing the average household's share of national income and curbing a savings rate that is reaching excessive proportions.

    While China has surpassed Japan in absolute GDP, its distribution of gross household disposable income in GDP terms is tiny by comparison.

    There's much China could learn from South Korea, including how to beat the "middle-income trap" that befalls many developing nations when they reach the US$10,000-per-capita income level.

    Mr Xi and his lieutenants, though, should pay just as much attention to the country's failures as its successes.