China's Economic Crisis Is About To Get MUCH Worse (Housing Collapse Explained)

Across the past few months, if you've seen a news story about China's economy, you've probably seen pictures like this: pictures of social unrest, people protesting outside of banks after their bank accounts were frozen, or outside the headquarters of major property developers after construction on their new homes was halted. Chinese citizens have had enough. Amidst a major debt crisis among property developers and prolonged COVID lockdowns, recently, Chinese citizens have added extra fuel to China's economic fire, standing together and boycotting payments on over 300 billion dollars' worth of mortgages.

What started as a small local petition has now grown to a massive freeze on mortgage payments on over 300 real estate projects in over 90 cities, and it has the Chinese government very worried. The CCP has desperately tried to suppress the spread of the movement, a move which has only fueled the protests further as footage like this hits the internet. But how has this happened? How has the seemingly unstoppable juggernaut of Chinese real estate now turned into a major economic catastrophe? Well, let's find out.

This is Charles Ponzi. No, he certainly wasn't involved in Chinese real estate. He was an Italian con artist who operated in the US and Canada, and of course, he was known for the Ponzi scheme. This is a scheme where you promise investors a very handsome return, and as you find new investors, you simply use their money to pay the investors who came before them. Then, as people see the returns being made in this scheme, they too sign up as investors, and their investment gives the investor before them the very impressive payout they were expecting. The cycle continues.

As you can probably tell, these sorts of schemes are a disaster waiting to happen. But although being horribly illegal, they do work in a world where you can always find new investors. But why am I telling you this? Well, it's because this is kind of how Chinese property development works. More on that in a second.

You see, throughout the last two decades in China, there has been a very strong trend for those living rurally to move to urban areas. Literally hundreds of millions of people have moved to the cities in that time, and this has caused a monumental boom in urban property development. Being able to own your own home became a huge societal goal for people in China, and that drove huge demand for residential homes, not only to live in but also as investment products. In fact, in China, approximately 70% of household wealth is tied up in property. People will stay for decades, even team up with other families just to put down a deposit on some Chinese real estate.

Due to this insatiable appetite for residential property, it didn't take long before the developers started testing the waters of what was possible. So enter pre-sale homes. And no, it's not what we call buying off the plan; it's worse. In China, developers will sell a pre-sale round where buyers will put down a deposit and start paying back a mortgage before their home is even built. You might say that's insane, but in China, it's just how it goes.

In fact, in 2020, 34.5 percent of developers' funding came from deposits and pre-sales. As you can imagine, for developers, the combination of insatiable appetite, freedom to take on vast quantities of debt, and the now commonplace payment structure of handing over a deposit and paying a mortgage before construction has even started quickly led to a scheme that might have caught the eye of our smooth-talking Italian. Revenue collected from pre-sale rounds would not actually be used to fund the project's development; it would, in fact, be shuffled up the chain and used, along with copious amounts of borrowed money, to fund the completion of last year's development.

Then they drop some new apartment buildings and complete the pre-sale round on those, sign up the excited buyers with a big fat mortgage, and then that fresh money can be shoveled up the chain again to fund the completion of the last wave of apartments. A Chinese economist said recently, “When the economy is good with continuous expansion, most of the properties can be delivered. But when the economy is not good, it becomes a bit like a Ponzi scheme. If there is no follow-up funding, they will not be able to complete construction.”

So just like a Ponzi scheme, it actually does work as long as there's always fresh demand and nothing gets in the way of these projects being completed. Ah, but people are refusing to pay their mortgages. Developers have had less cash to fund construction, incomplete buildings that have no piping and water facilities, many wondering what a messy ending might mean for China's financial system.

Two massive factors we need to talk about next. Firstly, the Chinese government's restrictions on leverage. Sensing that the Chinese property developers were getting way over-levered in 2020, the CCP announced a new rule called the "three red lines." What this meant was that for a Chinese real estate developer to be eligible to take on more debt, they must first show that their liabilities do not exceed 70% of their assets, net debt should not be greater than 100% of equity, and cash reserves must at least be able to cover 100% of their short-term debt.

While all of this is pretty smart, really, the problem was that in 2021, almost half of the Chinese property developers were in breach of at least one of the red lines, causing a sector-wide crisis in finding new funds as old debts came due. This is what we saw boil over with Evergrande about 10 or 11 months ago, and that's still causing them a lot of pain today. Because of these new rules, we've already seen many large residential construction projects brought to their knees, and the Chinese government has even alerted other developers to prepare to take over half-finished projects should they see some of those developers go bankrupt.

So many developers are seeing projects stall as they struggle to find funds to get these projects completed. But beyond this, just to make matters worse, earlier this year, the Chinese government also implemented their zero-COVID policies. So dozens of cities were put under full or partial lockdowns; you know, subway stations and offices were empty, roads, apartment blocks, and parks were all sealed off as people were forced to stay home. This brought economic activity to an absolute standstill, which prolonged the stagnation of these real estate projects.

For a lot of once hopeful home buyers, that was the last straw. As the Japan Times notes, "It started with a 590-word letter penned by angry purchasers of the half-built dynasty mansion project in Jin DeJien, Jiangxi province, whose pleas for China Evergreen Group to complete homes they'd long been paying for had fallen on deaf ears. All home buyers with outstanding mortgage loans will stop paying unless construction resumes before October 20," they threatened.

The ultimatum raced across social media platforms WeChat and Douyin, which is TikTok, becoming a call to action for those caught out by China's rapidly deflating property bubble. Within days, the letter became a template for protests from Shanghai to Beijing and Shenzhen to Zhengzhou, with homeowners cutting and pasting it to draft their own boycott manifestos. Within four weeks, more than 320 projects in about 100 cities were facing similar protests, roiling markets and forcing authorities to corral banks and developers to diffuse the unrest.

Fair to say that blew up pretty fast. Now tens of thousands of people are boycotting their mortgage payments on about 300 billion dollars' worth of loans, and despite that being only a small percentage of the Chinese mortgage market, the Chinese government is definitely concerned that this could start a domino effect of economic pain. With property prices now falling nationwide, skepticism of property developers, mortgage boycotts, and developers already defaulting on loans, it's feared this freeze in the real estate sector could spread throughout the banking sector and genuinely to the Chinese economy.

Because remember, in China, real estate accounts for 30% of GDP. According to Net Interest, real estate investments stood at over 13% of GDP in 2019, of which more than 70% was linked to residential building. Adding the contribution of the construction industry, and the share jumps closer to 29%. Now in 2022, China's top 100 developers have seen their sales halve. Sales plunged 39.7% year over year in July, and new construction starts are down 30.6%. Developers are already in a world of hurt, so that in itself is a worry for China's GDP.

But as I said, the second major fear is that a freeze-up of the real estate sector will cause severe distress on the banking sector. Banks already aren't being paid back from developers; now suppliers to real estate developers aren't paying back their loans. And to put the cherry on top, now Chinese citizens are boycotting their mortgage payments. The banking sector has already showed big signs of distress earlier this year as five Chinese banks froze customer deposits, causing 400,000 citizens to be unable to access their savings. If the banking sector is already showing signs of distress, could the real estate crisis prove to be the last straw?

Well, one thing's for certain: the CCP doesn't really want to wait to find out. They've reportedly set aside 148 billion dollars' worth as a real estate bailout fund to support the acquisition of real estate projects should developers start going under. NBC News notes, "The China Banking and Insurance Regulatory Commission told the official industry newspaper on Sunday that banks should meet developers' financing needs where reasonable."

The regulator hoped these steps would help stabilize the property market by enabling the swift resumption of stalled real estate construction and delivery of homes to buyers early. So the CCP is looking to offer some support to the situation. I guess the question from here will be, you know, is that enough to stop the damage? It might get some projects finished, but you could argue that the damage is already done.

The most crucial ingredient to the success of the Chinese housing market is positive investor sentiment. Now, with a vast reduction in new property sales, you know, mortgage boycotts, and nationwide social unrest, it seems that the golden age of the world's largest asset class is now over. But anyway, guys, that will just about do us for this video.

Thank you very much for watching. Definitely let me know your opinion down in the comment section below. You know, what do you think of the Chinese real estate sector? Definitely drop me a comment, and of course, leave a like on the video if you did enjoy it. Subscribe if you'd like to see more because thanks very much for watching, and I'll see you all in the next video.

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