Chinese Real Estate Ponzi Scheme

From the israelfinancialexpert blog comes a fascinating expose of the ponzi scheme that the Chinese real estate bubble has become. I'll let the following excerpt speak for itself.

So many ordinary households pledge their inflated house and get a loan from the bank, then lend the money to a shark loan operator with 20-150% annual interest rate, this shark loan operator then lends this aggregated loan to real estate developers, speculator, or some SME which have to pay back the bank. ( China’s banking system operates at a roll over loan base on a year on year base, so many Chinese SME will borrow at shark loan market rates to pay back the bank, then days later, use the approved new bank loan to pay back. And it is very common practice, given the dire situation for many SME exporters due to razor thin profit margin combined with rising labor costs, in reality. Furthermore, in recent years, many SME’s totally stopped old business of exporting , since the high return of real estate flip flop drove more and more capital into this historical bubble, thus further inflating the housing market.

The parallels with liar loans, ARMs, subprime mortgage lending, and using houses as ATMs are unmistakable. This kind of ponzi scheme cannot last without ever increasing supplies of money and credit from the central bank. If the blog is correct that 85-90% of some cities are participating in the lending schemes, then the saturation point is close at hand. Even so, the government could extend the bubble further. However, they will have to worry about general price inflation at some point. Then the people who have been left out of the real estate lottery will become restless.  Recently, the government is acting as if they are concerned about a hard landing. They should be. Nothing makes people angry and desperate like being cheated out of their house for a few interest payments.

The details of the scheme are telling. In 2008, the government kept property development companies in business by preventing the lowering of property prices. If this strategy is applied again, it means that markets could disappear overnight. The loan shark ponzi schemes are very troubling. In simplest terms this means that massive increases in credit are issued from state run banks to homeowners who then lend to development companies to build more homes. I can not think of a more self-defeating process in the long run.

So, now I have to figure out how to play this. The report also says that inflation is much higher than the government's official numbers. So that means that renewed tightening is much more likely. And higher interest rates are usually very bearish for equities. So I will watch FXI. But that's not a sure thing, as the government's solution might be to blow a new bubble in equities to replace real estate. A hard landing a China could also depress commodity prices, but inflation in China might increase demand short-term if inflation gets out of control. All these ideas bear careful watching, but it seems pretty clear to me that the real estate bubble is on its last legs. The time is ripe for a big pop.