Speaker 1: Hello, and welcome to another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Alloway and I'm Joe. So Joe, it feels
Speaker 1: like it's another day, another default by a Chinese property developer,
Speaker 1: and so just today, I should say we're recording this.
Speaker 1: On January, we saw a company called Oian I'm probably
Speaker 1: not pronouncing that right, saying that it won't make payments
Speaker 1: on four bonds that I think add up to almost
Speaker 1: seven hundred million dollars. But here's the weird thing. For
Speaker 1: a brief moment this week, it seemed like people investors
Speaker 1: were getting more optimistic about the Chinese real estate space.
Speaker 1: We actually saw a pretty dramatic rally in dollar bonds
Speaker 1: from junk rated property developers because there were some reports
Speaker 1: that China would make it easier for property companies to
Speaker 1: get cash from pre sales of developments. And then of
Speaker 1: course we saw China lower its interest rates earlier this week,
Speaker 1: which you know, obviously monetary easing is going to be
Speaker 1: good for housing. So there seemed to be these really
Speaker 1: opposite push pull factors at the moment, and no one
Speaker 1: seems to know quite what is going on in the space.
Speaker 1: I have to say, I kind of missed, you know,
Speaker 1: in all the my scanning of the news, I actually
Speaker 1: kind of missed the optimism period you were talking about
Speaker 1: because every time, I mean it was only a day. Okay,
Speaker 1: we're back to pessimism already, because I have to say,
Speaker 1: like every time I read like you know, obviously look
Speaker 1: at uh sort of like Q four of last year,
Speaker 1: we're talking a lot about ever Ground and the trouble
Speaker 1: they were getting into, and it feels like since then
Speaker 1: things have metaestasized, more developers getting into trouble, more fears
Speaker 1: of default, maybe companies that were perceived as a safer
Speaker 1: credit risks than ever Grand was getting into trouble. So
Speaker 1: it really feels that the big story, or at least
Speaker 1: every time I look into it, it's like this situation
Speaker 1: is getting worse. Yeah, So we haven't really seen an
Speaker 1: extreme financial crisis like a Lehman moment that some people
Speaker 1: were talking about, you know, late last year. But we
Speaker 1: have seen contagion in the sense that we have seen
Speaker 1: spreads on other junk rated dollar bonds go up quite
Speaker 1: a bit. But really, I think the question no one
Speaker 1: quite knows yet is what exactly is the end game here?
Speaker 1: Like what exactly is China trying to achieve. Are they
Speaker 1: going to provide policy support for property developers or are
Speaker 1: they going to reform the market and let the weaker
Speaker 1: players fail. So today I'm very pleased to say that
Speaker 1: we have the perfect person to come on and give
Speaker 1: us an update on what's really going on in Chinese
Speaker 1: real estate. We're going to be speaking with Travis Lundie.
Speaker 1: He's an independent analyst who publishes on the smart Karmat platform,
Speaker 1: and of course we had him on the show last
Speaker 1: year to talk about China Evergrand, which has since then
Speaker 1: finally and officially defaulted on its debt. So, Travis, thank
Speaker 1: you so much for coming back on the show. Thank
Speaker 1: you for having me. I'm trying to think where to
Speaker 1: begin because there has been so much going on in
Speaker 1: the space, But maybe just to start, you can give
Speaker 1: us an update on I guess, the current situation around
Speaker 1: Chinese property developers. What have we seen since we last
Speaker 1: spoke to you and since Evergrand actually defaulted. Okay, if
Speaker 1: we take it back a little bit further back to
Speaker 1: when we last spoke, and I can I think we
Speaker 1: can use ever Grand as a kind of case study
Speaker 1: for the way other developers have also seen deterioration, and
Speaker 1: because ever Grand is so large, it effectively encompasses the
Speaker 1: size of several other smaller developers who might default. The
Speaker 1: loan interest payments were not made on domestic bank loans.
Speaker 1: It appears trust loan repayments were not made. Wealth management
Speaker 1: products have not been repaid at their maturity. At some
Speaker 1: point in late Q three to early q four, something
Speaker 1: like half of the projects that ever Grand was working
Speaker 1: on had been at sea work suspended. At that point,
Speaker 1: we've seen a certain amount of positioning. People are positioning
Speaker 1: for the fall. Local governments started looking at taking back land.
Speaker 1: Ever Grant was trying to reduce its its debt by
Speaker 1: delivering assets, selling assets to other developers, selling assets to
Speaker 1: local government affiliated s o ees. Basically none of that worked. Eventually,
Speaker 1: ever Grand ran into problems paying its coupons on its
Speaker 1: offshore debt, paid a bunch of them late. It got
Speaker 1: an extension on a guarantee on a private debt which
Speaker 1: people did not know existed. That extension required delivery of
Speaker 1: certain documentation from a municipal government. That documentation didn't derive.
Speaker 1: The bond holders demanded repayment. That came with the great
Speaker 1: end of a grace period of another coupon, and you know,
Speaker 1: Evergrhanad just tossed in the towel and said, you know,
Speaker 1: we're not paying. That triggered an event of default on
Speaker 1: the on the offshore notes, all of them. Uh. And
Speaker 1: since that time it hasn't made any sense to pay
Speaker 1: any of the other coupons or redemptions on the offshore notes.
Speaker 1: And so you know, people are looking at these and saying, woo,
Speaker 1: they didn't pay that coupon, or maybe they're not going
Speaker 1: to pay that redemption at the end of this month.
Speaker 1: Well they're not going to. They can't simply decide to
Speaker 1: start repaying these things without paying back the other ones.
Speaker 1: In the meantime, the onshore bonds are seeing pressure. There
Speaker 1: was an effort to extend the repayment on some onshore
Speaker 1: bonds last week that was successful, but it's not sure
Speaker 1: how much of that was effectively prodded by local authorities.
Speaker 1: You either extend or you get nothing. When the Jumble
Speaker 1: Fortune redemption missed, that triggered you know, considerable upset in
Speaker 1: local circles, and a working group was dispatched and they
Speaker 1: set up a new risk management committee. That work group
Speaker 1: is very similar to the way H and A group
Speaker 1: was resolved in February two after years of debt issues
Speaker 1: and over investment which had gone sour and some you know,
Speaker 1: likelihood of missed payments in Q one two, the high
Speaker 1: non government sent in a working group. And this is
Speaker 1: you know H and A says, we will request you
Speaker 1: to send in the working group, and that's the official story.
Speaker 1: What really happens is, you know, the local government says,
Speaker 1: we would like you to request us to send in
Speaker 1: a working group, and they say yes, sir, So they
Speaker 1: send in a working group, and that working group chairman
Speaker 1: became the new chairman of the company. And the goal
Speaker 1: was quote to diffuse risks and safeguard the interests of
Speaker 1: all parties. And so that's the risk management part. And
Speaker 1: given that the local government in every grand's case has
Speaker 1: been tasked with sorting out all of the claims, financial
Speaker 1: and otherwise, its involvement is key to safeguard the interests
Speaker 1: of all the parties. And so if we look at
Speaker 1: the H n A process, we can look and we
Speaker 1: can see that there's a possibility that EVERGRAND turns out
Speaker 1: roughly the same way. H and A basically went into
Speaker 1: a kind of suspended animation. Bond holders didn't know what
Speaker 1: was going on. Non strategic assets which could be sold
Speaker 1: were sold to non local parties that raised a little
Speaker 1: bit of cash. The local operating businesses continued running and
Speaker 1: you know, at a negative earnings rate. The working groups
Speaker 1: spent basically a year figuring out where all the bodies
Speaker 1: were buried and what needed to be done. And in
Speaker 1: February two thousand twenty one, the company filed for bankruptcy.
Speaker 1: That got the court officially involved in the working group.
Speaker 1: Managed company could then solicit sponsors to take over the
Speaker 1: businesses and the assets, and they took all three hundred
Speaker 1: assets and and companies bunched them into a group of
Speaker 1: four and then said please bid. And it was the
Speaker 1: bids which were presented which proposed breakdowns of how much
Speaker 1: each of the creditor classes got. And that meant that
Speaker 1: you know, people who were who didn't have money, they
Speaker 1: were waiting to get repaid. It took them a long
Speaker 1: time to get repaid. And I think that ever Grand
Speaker 1: is going to be in much the same situation. Instead
Speaker 1: of three units, it has you know, a thousand units.
Speaker 1: Right now, everyone is quote unquote cooperating U and the
Speaker 1: highest goal here is to just keep on working, building,
Speaker 1: finishing projects and delivering them. The home buyers, you know,
Speaker 1: homebuyers and local governments are the protected classes here. Importantly,
Speaker 1: they're also the way that cash eventually gets back to
Speaker 1: the Onshore Real Estate parent company. So without these projects continuing,
Speaker 1: there's no resolution on the other end. That progress rate
Speaker 1: is now up into the nineties, and there will be
Speaker 1: positive news because every grand will say, you know, we're
Speaker 1: doing this, we're doing that, and the negative news simply
Speaker 1: doesn't come out. So Tracy said something interesting in the beginning,
Speaker 1: and it's something to the extent of like, well, what
Speaker 1: is the Chinese government attempting to achieve here? What is
Speaker 1: the endgame? Which to me raising the question of like, okay,
Speaker 1: how much of what we've seen over the last several
Speaker 1: months is the result of some policy aim versus some
Speaker 1: sort of unintended consequence of something that was not the
Speaker 1: aim at all. And so when you look at what's transpired,
Speaker 1: and you know, as we haven't had anything like Lehman,
Speaker 1: but it's certainly been messy. There's certainly been a lot
Speaker 1: of pressure on the protected groups of homebuyers and local governments.
Speaker 1: How much was this a goal versus how much was
Speaker 1: this a unfortunate side effect of aiming to achieve something else.
Speaker 1: That's a really good question. I'm not sure I have
Speaker 1: a good answer for that one, and if I did,
Speaker 1: I'm not sure I could say it. It's pretty clear
Speaker 1: this was not a policy or a group of policies
Speaker 1: which happened out of the blue. The p POC started
Speaker 1: cracking down on excessive debt at financialized developers, which included
Speaker 1: every grand at that time, in two thousand eighteen, they
Speaker 1: warned them. At the beginning of two thousand eighteen, they
Speaker 1: labeled them in a report. At the end of two
Speaker 1: thousand eighteen, the Chairman Hua went on the tape saying
Speaker 1: we will reduce debt. He went on the tape again
Speaker 1: in early two thousand twenties saying he would reduce debt
Speaker 1: drastically in the next three years. This was a plan,
Speaker 1: and it only came to the August two thousand twenty
Speaker 1: when the p POC, the Housing and Urban Development Ministry
Speaker 1: came out and said you twelve, we need you to
Speaker 1: abide by these new rules. These are the three red lines.
Speaker 1: And it never became official policy as far as I
Speaker 1: can tell, but everyone knows what they are. And it
Speaker 1: meant that, you know, those who were triggering two to
Speaker 1: three of those red lines, and ever grand triggered all three,
Speaker 1: there was simply nothing to do other than shrink. If
Speaker 1: you're running a business and you're growing top line and
Speaker 1: you have a hundred and you're financing at ten, that
Speaker 1: means in order to roll your financing next year, you
Speaker 1: need to roll a hundred and ten. Well, if you've
Speaker 1: got new new assets and new obligations because you bought
Speaker 1: some land bank last year and you've got an increased
Speaker 1: number of projects this year, well, you know, to start
Speaker 1: a project, you pay off the government with the local
Speaker 1: government with your payment for the land. You have to
Speaker 1: go get debt to do that. So you go get
Speaker 1: some debt, you pay the land, you start pre selling,
Speaker 1: You get some cash in the door. Some of that
Speaker 1: has to stay in escrow, but that debt to pay
Speaker 1: off the land at the start of a building is
Speaker 1: a kind of a bridge. You have to increase the
Speaker 1: capacity for that bridge. If you can't have any ability
Speaker 1: to increase interest bearing debt, then you have to sell stuff.
Speaker 1: It's not as much as you know buying land bank,
Speaker 1: you actually have to sell stuff. And I think that
Speaker 1: the problem is that if you do that for the
Speaker 1: twelve largest developers, well that's going to trickle down. It's
Speaker 1: going to hurt everybody. This was not something which was
Speaker 1: an accident. There was a real design to reduce over
Speaker 1: leverage at developers. There has been efforts to reduce upward
Speaker 1: price pressure in a bunch of markets. There have been
Speaker 1: efforts to reduce excessive lending against property. They've put pressure
Speaker 1: on the banks for years to keep the cap at
Speaker 1: the allocated level or below. They get really nasty when
Speaker 1: a bank goes anywhere near that level. So they've been
Speaker 1: reducing the leverage available in all of the domains until
Speaker 1: they got to developers. Then they finally pushed it on
Speaker 1: developers too. This was not a coincidence. Now, you know,
Speaker 1: the common prosperity theme became very popular in two thousand
Speaker 1: twenty one. It existed before that. I think most of
Speaker 1: us didn't pay quite enough attention to it. But the
Speaker 1: houses are for living in, not for speculation. That was
Speaker 1: around for even more and we you know, we didn't
Speaker 1: pay attention to that either. I think that the the
Speaker 1: government has spent a great deal of effort to try
Speaker 1: and close off avenues of rescue. You know, the banks
Speaker 1: may find it tough to increase lending because they are
Speaker 1: at their limits. The central government made it us a
Speaker 1: part of the fifty five year Plan to increase development
Speaker 1: and financing for local and regional rejuvenation and urbanization. And
Speaker 1: this was basically, you know, them putting money into the
Speaker 1: pot for growing the equality of of real estate access
Speaker 1: to people who didn't have that access before. However, that's
Speaker 1: a very small part of the country. It's not small
Speaker 1: in terms of people. But the land price starts lower,
Speaker 1: the aspirations are lower, the total nominal amount spent is
Speaker 1: lower um if you increase that by but you decrease
Speaker 1: the the major urban centers by is a very large
Speaker 1: net drop. Now, the other thing is that this is
Speaker 1: this is a big part of the economy, right so
Speaker 1: it's it's some odd percent of the economy residential real
Speaker 1: estate is and that means that if you dampen its growth,
Speaker 1: you dampen the growth of the overall economy. And another
Speaker 1: part pivot of the five year Plan was they were
Speaker 1: going to increase quality growth and decrease quantity of growth
Speaker 1: or emphasize quality versus quantity. That means that they were
Speaker 1: telling you very clearly, the stuff that we did before
Speaker 1: to get a high growth rate, we're not going to
Speaker 1: do it anymore. That's a policy decision. So I think
Speaker 1: there's there's a fair bit of effort put into changing
Speaker 1: the direction here. I think also that it's important to
Speaker 1: notice that real estate is considered to be like the
Speaker 1: driver of inequality. So if you want to decrease inequality,
Speaker 1: you've got to decrease the inequality embedded in real estate.
Speaker 1: So I want to get into how real estate actually
Speaker 1: impacts all the various parts of the economy, including things
Speaker 1: like local government financing. But before we do, you know,
Speaker 1: you just described the response to the redlines policy, which
Speaker 1: was basically I mean, it wasn't nothing. But the only
Speaker 1: thing that developers could really do is try to shrink
Speaker 1: sell off assets. I'm wondering, you know, even if they
Speaker 1: sell off assets, they still have these massive liabilities that
Speaker 1: they need to fund somehow. And given all the uncertainty
Speaker 1: in the market, it seems very unlikely that a lot
Speaker 1: of foreign investors are going to step into buy those
Speaker 1: dollar bonds. So I'm curious, how are real estate developers
Speaker 1: actually funding themselves right now. I ever, Grant spent much
Speaker 1: of two thousand one extending the terms on its non
Speaker 1: interest bearing liabilities. So if you look at the interest
Speaker 1: bearing liabilities, they actually shrunk from December two thousand twenty
Speaker 1: to June two one. If you look at the the
Speaker 1: commercial bills or the trade payables, those increased. So the
Speaker 1: debt numbers, which was the intersparing liabilities portion, that actually shrunk,
Speaker 1: and they made their target of shrinking debt by a
Speaker 1: hundred and fifty billion RMB. But that's that's doesn't help anything.
Speaker 1: If you put more suppliers on the hook and they
Speaker 1: stopped working for you, then you can't finish your project,
Speaker 1: and that's what happened in the second half of two
Speaker 1: If we ask ourselves what can replace the foreign funding,
Speaker 1: that's a good question so far. I think in this
Speaker 1: year there's something like thirty six billion dollars of redemptions
Speaker 1: of the US dollar debt for Chinese developers. That's a
Speaker 1: fair bit. That means that that money has got to
Speaker 1: come from someplace else. It's not clear to me that
Speaker 1: banks will want to increase there lending in order to
Speaker 1: repay they're already under pressure to not increase. If you
Speaker 1: look at what the n d r C said as
Speaker 1: a side note to the four five year plan last year,
Speaker 1: it was very clear they were going to crack down
Speaker 1: on the unconstrained growth of local government debt and hidden debt,
Speaker 1: and they were going to emphasize prudent fiscal rotation rather
Speaker 1: than monetary easing in the sector and in the growth
Speaker 1: mix of the economy. And Lika Shine came out and
Speaker 1: said six people have been expecting a higher number, had
Speaker 1: always been a higher number, and he came out with
Speaker 1: a lower GDP target for two thow it ends up
Speaker 1: higher than that according to the stats, but the willingness
Speaker 1: to accept a lower target was seen as proof that
Speaker 1: there was a goal to to crack down on on
Speaker 1: the excesses of the quantity of growth versus quality of
Speaker 1: growth problem. In this case, it's tough to see who
Speaker 1: picks up the slack. If you look at foreign markets,
Speaker 1: you know, the European markets or US markets, when the
Speaker 1: end user stops buying, usually it comes out to longer,
Speaker 1: more patient money buying at a discount. Oftentimes that's some
Speaker 1: kind of private equity venture where people pull their funds together,
Speaker 1: either incorporated or in a very professional fund buy the
Speaker 1: assets and rent them out and hope that they can
Speaker 1: wait for five years and sell them at a at
Speaker 1: a markup. In August of two one, the government basically
Speaker 1: ordered the entity which approves funds to stop approving private
Speaker 1: equity funds in the residential real estate market because obviously
Speaker 1: housing is for living in, not for speculation, and that
Speaker 1: means that you won't see non developer companies coming in
Speaker 1: to buy these projects unless they can convince people that
Speaker 1: the project which they buy is for the betterment of
Speaker 1: the company. Maybe they buy a project and develop an
Speaker 1: asset and turn it into dormitories or something like that,
Speaker 1: and they can convince the local government that it's the
Speaker 1: appropriate thing to do to further, you know, the development
Speaker 1: of the local economy. But it's basically going to come
Speaker 1: down to s O s and s OE developers financing
Speaker 1: the purchases of assets from troubled developers, and the other
Speaker 1: place is going to have to be, you know, end
Speaker 1: users are going to have to step up and right now,
Speaker 1: you know, for the longest time, China has had a
Speaker 1: real estate market which was characterized by prices go up
Speaker 1: and demand goes up, prices go down, demand goes down.
Speaker 1: It's a combination of a gift and good and a
Speaker 1: Veblin good, depending on whether your status is housing as
Speaker 1: a staple or housing is a luxury. In this case,
Speaker 1: the government has warned, you know, pretty clearly, we don't
Speaker 1: want you to speculate. So there goes the Veblin good.
Speaker 1: They've introduced the concept of a property tax, and the
Speaker 1: property tax means that everybody's ownership gets registered. There are
Speaker 1: a whole bunch of people out there who don't want
Speaker 1: to be known as the owner of five different properties.
Speaker 1: And if you're if you're a communist party cadre in
Speaker 1: some regional city where you you purchased a bunch of
Speaker 1: properties at a very low price, and now you're the
Speaker 1: owner of those properties, and it's really great, and you
Speaker 1: are independently wealthy because you, your dog, your three year
Speaker 1: old daughter, they all own properties. You don't want to
Speaker 1: have the property tax come in and suddenly have to
Speaker 1: figure out what to do. And if that happens, then
Speaker 1: that actually creates, you know, another problem. Currently the developers
Speaker 1: aren't selling as many properties as they want to, and
Speaker 1: if luxury buyers and savings buyers, investment buyers can't buy
Speaker 1: multiple properties anymore because of a they want to discourage speculation.
Speaker 1: Then that reduces the total you know, new home sales
Speaker 1: and a property tax would invite increased secondary home sales.
Speaker 1: That's not a great thing for the market, and it's
Speaker 1: honestly not a great thing for local governments because local
Speaker 1: governments make their not by selling land to new property development.
Speaker 1: And if if new property development stops and the rotation
Speaker 1: comes from secondary property market where you know, must must
Speaker 1: sell holders transfer to new people, well the local government
Speaker 1: doesn't take a cut of that. So it's not sure
Speaker 1: where all this money's gonna come from. It's so it's
Speaker 1: so interesting. We just did an episode recently on the
Speaker 1: lack of inventory in the US housing market and this
Speaker 1: sort of rise of small landlords, people who might own
Speaker 1: one to three or four homes, and the same issue
Speaker 1: of like in states, California being the big one where
Speaker 1: there isn't much of a tax on property, you just
Speaker 1: get incentivized to hold and how placed, whether it's higher
Speaker 1: taxes that match the value of the home, you sort
Speaker 1: of create that churn and greater inventory. So it's interesting
Speaker 1: to hear the same dynamic. I mean, it makes sense,
Speaker 1: but it's interesting to hear the same dynamic in China.
Speaker 1: So that I wanted to focus on though, is you know,
Speaker 1: it seems to me when we talk about like debt,
Speaker 1: you know, there's sort of like the financial debt and
Speaker 1: the real debt and of course the financial data, the
Speaker 1: bonds and the various payments that these companies have to make,
Speaker 1: and then the real debt is of course the housing
Speaker 1: units that the companies owe to people who have put
Speaker 1: down a down payment, and it's a very big deal
Speaker 1: if those aren't delivered in a timely manner. Talk about
Speaker 1: the connection, like, what is it that has made the
Speaker 1: actual like process of creating new units, creating new homes?
Speaker 1: What caused these sort of like the physical process to
Speaker 1: slow down such that the real debt has been difficult
Speaker 1: for some of these developers to fulfill. Well, that comes
Speaker 1: down to a financial debt actually, I mean the process
Speaker 1: basically is developer says, I got a project, I want
Speaker 1: to go bid for this land. He bids for the land.
Speaker 1: He doesn't have to pay for it usually on day one. Instead,
Speaker 1: he pays for it in a year, or he's got
Speaker 1: a time limit says you must develop this within three years,
Speaker 1: so you know, two years and a half later he
Speaker 1: goes and starts developing. And developing means that they probably
Speaker 1: have to break ground and put a foundation in. There
Speaker 1: are different definitions depending on the different contract the developer
Speaker 1: signs with the local government. When the local government sells
Speaker 1: the land, however, you know, land prices go up ten
Speaker 1: percent a year. If you don't have to pay until
Speaker 1: year two and a half, you can promise to pay
Speaker 1: a hundred, and land prices go up, you know, ten
Speaker 1: percent a year, let's say, and in year two and
Speaker 1: a half that hundred is now worth a hundred and
Speaker 1: twenty five. And you all you gotta do is now
Speaker 1: you've got to go fund a hundred two pay the
Speaker 1: local government, and it's worth a hundred and twenty five.
Speaker 1: It's on your books on a hundred and twenty five.
Speaker 1: Then you go out pre sell it and because it's
Speaker 1: worth and you only paid a hundred, the bank will
Speaker 1: give you a small loan to start, you know, construction,
Speaker 1: and you pre sell it and once you get to
Speaker 1: a certain level of construction, then you can take the
Speaker 1: full payment from the mortgage and that will all go
Speaker 1: into an escrow account, and you know, different different localities
Speaker 1: have different rules on how much money can be taken
Speaker 1: out at what point in the process. Some of them
Speaker 1: are extraordinarily detailed schedules. You know, if you if you
Speaker 1: have a height of the building of forty then when
Speaker 1: you get to seven ms and you can take out.
Speaker 1: When you get to twelve ms, you can take out
Speaker 1: a different level. And that money is meant you know,
Speaker 1: to fund the work in progress so that the end
Speaker 1: the money is out and the and the delivery is made.
Speaker 1: A lot of these processes or projects were perhaps less
Speaker 1: well supervised then they should have been. And this is
Speaker 1: one of the things we're going to see, I think
Speaker 1: in in Evergrand. What we saw last year was that
Speaker 1: when it came out at ever Grand had taken money
Speaker 1: out of the escrow account faster than it should have.
Speaker 1: A bunch of local governments came in and started suing
Speaker 1: ever Grant to get money put back in, and they
Speaker 1: were successful and never Grand put the money back in.
Speaker 1: But that was you know, again part of the Q
Speaker 1: two problem last year where things started going south for
Speaker 1: them as a result, you know, with the government cracking
Speaker 1: down on banks saying you have to be more prudent.
Speaker 1: You have to make sure you're not letting lending more.
Speaker 1: They went in and did line by line on all
Speaker 1: the exposure to the major developers, including especially Evergrand, and
Speaker 1: all the local governments were you know, brought in to cooperate,
Speaker 1: and that meant that they had to you know, excuse
Speaker 1: my French, but do a c I a exercise, and
Speaker 1: that meant that they got very strict. And one thing
Speaker 1: we've seen here very recently is that there's been a
Speaker 1: proposal in the past week or so which says that
Speaker 1: the national government will come out with a new rule
Speaker 1: on escrow accounts to supersede the local rules because perhaps
Speaker 1: the local governments have now been too strict in in
Speaker 1: releasing funds. So you've got this problem where it was
Speaker 1: loosey goosey, and now it's much less loosey goosey. And
Speaker 1: so there's been a there's been a a swing from
Speaker 1: kind of over the curve to under the curve, and
Speaker 1: developers use that money to go speculate, like you ever
Speaker 1: Grant has a soccer team, it's building a stadium or
Speaker 1: a bunch of stadiums. It owns this, that and the
Speaker 1: other thing. There's been some large dividends paid out over years,
Speaker 1: and there's certainly been some luxury spending on expenses, and
Speaker 1: if you look at some of that, the money just disappeared.
Speaker 1: There's just not enough money in the pot. And when
Speaker 1: the government local governments start restricting the amount of money
Speaker 1: coming out, you start being unable to pay your suppliers,
Speaker 1: and instead you pay your suppliers with a note. We said,
Speaker 1: rather than pay you cash, now, i'll pay you ten
Speaker 1: percent more cash in three months. Well that starts that's
Speaker 1: a financial liability because if you actually have to go
Speaker 1: pay that guy in three months, well, now you need
Speaker 1: to source that cash from someplace else, and they just
Speaker 1: don't have that. They just started basically creating non interest
Speaker 1: bearing but premium payout liabilities which they couldn't they couldn't
Speaker 1: keep up with. So suppliers didn't get paid and they
Speaker 1: stopped work. And then you know what really happened was
Speaker 1: the government stepped in and said, you will pay your
Speaker 1: suppliers in order to start these things working again, and
Speaker 1: whatever you need to do it to pay your suppliers
Speaker 1: to start working again. So you mentioned the possible change
Speaker 1: in escrow rules, and I think this was one of
Speaker 1: the things that sparked that very very brief rally that
Speaker 1: I was talking about in the intro in property bonds.
Speaker 1: And of course this week we also saw China cut
Speaker 1: interest rates, and you know, it seems to be embarking
Speaker 1: on some sort of easing cycle, which presumably would help
Speaker 1: the property sector. I guess my question is, how do
Speaker 1: we feel about the policy response right now? Does it
Speaker 1: seem like the authorities are maybe trying to calibrate their
Speaker 1: crackdown and their efforts to reduce leverage in the opposite direction,
Speaker 1: So maybe they think they've gone too far and they
Speaker 1: need to start to roll back some of these measures.
Speaker 1: That's a good question. I think that we will continue
Speaker 1: to see statements from the PBOC, from the c B
Speaker 1: I r C, from the Financial Stability and Development Commission,
Speaker 1: who's the you know, the top financial regulator. I think
Speaker 1: we'll continue to see statements from all of these bodies
Speaker 1: saying that China will not return to aggressive growth of
Speaker 1: real estate to bail out the on me. They've said
Speaker 1: that constantly. I think it's going to be the mantra
Speaker 1: for a long while. The question I think we have
Speaker 1: to get to is, and I think I mentioned this
Speaker 1: The last time was you know, China is teaching a lesson,
Speaker 1: and the question is how hard and to whom are
Speaker 1: they teaching this lesson? And I don't think we've answered
Speaker 1: that yet. The beginning question here was what is the
Speaker 1: end game? I think the end game is is a
Speaker 1: two thousand thirty to two thousand fifty outlook where we
Speaker 1: have a China is a moderately prosperous society in two
Speaker 1: thousand thirty and is a leader in global and regional markets,
Speaker 1: and is has common prosperity for all. And if you
Speaker 1: look at what Shi Jimping has said with regard to
Speaker 1: his common prosperity, this is not a two thousand twenty
Speaker 1: two thing. This is a long dated thing. So we
Speaker 1: really have to look at where the long dated end
Speaker 1: game is. And a long dated end game for common
Speaker 1: prosperity means a reduction in inequality. And I think the
Speaker 1: question has to be asked because China has a fujie
Speaker 1: system where you have a you have your effective household
Speaker 1: registration or if you will, local citizenship based on where
Speaker 1: you live, and that really comes out to where you
Speaker 1: were born. Uh, And the question is should Chinese people
Speaker 1: have their relative wealth and prosperity determined by where they
Speaker 1: were born, and that is a particularly un siji being
Speaker 1: kind of attitude. So I think that he's looking at
Speaker 1: that and saying, no, that's not the way it should
Speaker 1: be done. And if you look at, for example, to
Speaker 1: the changes in the education sector in the past year,
Speaker 1: that's very clearly you know, let's not give excess advantage
Speaker 1: to those who happen to have excess funds right now,
Speaker 1: let's make education something accessible to all. And I think
Speaker 1: that he's looking at real estate much the same way.
Speaker 1: And the question here is, well, is that unfair to
Speaker 1: the people who bought all the property? Well, then the
Speaker 1: question is is that unfair to all the rich people?
Speaker 1: And I think his answer might be, well, you know,
Speaker 1: that's just one of those things. So I think if
Speaker 1: we look at the end game, the endgame is clearly
Speaker 1: a very non capitalist, non libertarian, socialist view of the
Speaker 1: way assets should be distributed across an economy. And if
Speaker 1: I look at that, that means that there's a bunch
Speaker 1: of people who are going to hurt. And if you
Speaker 1: think about what the developers really represent and all of us,
Speaker 1: you know, there's been something like eighty billion dollars of
Speaker 1: value lost in the offshore bond markets or Chinese developers
Speaker 1: in the past year. Great well, most of the developers
Speaker 1: are still functioning and building houses. Contract sales are down,
Speaker 1: but they are still out there everyday building houses and
Speaker 1: delivering houses to their homes to their home buyers. What
Speaker 1: has been lost has been the capital ownership of those entities.
Speaker 1: Those operating entities continue to operate and will continue to build,
Speaker 1: and as long as they fulfill a social function, then
Speaker 1: that's what the end goal is going to be. Now,
Speaker 1: capital owners and capital providers are going to take a
Speaker 1: big hit here. They already have and I don't see
Speaker 1: it getting much better, but you don't see such pain
Speaker 1: they have to backtrack, and so you talk about twenty
Speaker 1: thirty or what what the endgame looks like. Real estate
Speaker 1: is not such an important part of the economy, and
Speaker 1: the wealthy who brought up multiple homes early have taken
Speaker 1: a hit. Can they? I mean, I guess the question
Speaker 1: is can they get there without having to backcheck or
Speaker 1: would there be so much acute pain in the meantime
Speaker 1: from people who do have equity in uh in their
Speaker 1: own home or so forth, such that it becomes untenable
Speaker 1: to go all the way through without further easy or
Speaker 1: without further sort of like juicing the sector. Again, I
Speaker 1: think this comes down to what is what is acceptable
Speaker 1: and what is not acceptable as a response, And if
Speaker 1: you look at what the PBOC and c d i
Speaker 1: RC have said specifically about Evergrand, it's almost exactly the
Speaker 1: same wording they used about H and A. This company
Speaker 1: exercised poor management and took blind risk for expansion. And
Speaker 1: this is the chickens coming home to roost and there's
Speaker 1: no pity for them here. And what that also tells
Speaker 1: you is that you know there will be heads will
Speaker 1: roll on this. There will be as John gall Braves
Speaker 1: put it in when you've described the bezel, and we're
Speaker 1: you know, Michael Pettis and I have both described this
Speaker 1: as the downside of the bezel, the discovery phase of
Speaker 1: the bezel. Audits are are penetrating and meticulous. People are
Speaker 1: assumed to be dishonest until they're proven otherwise, and commercial
Speaker 1: morality improves when the truth comes out. I think we're
Speaker 1: going to see that, and I think that's what that's
Speaker 1: what the goal is here. So the trick is what
Speaker 1: is acceptable and what is unacceptable. You know, speculators losing money,
Speaker 1: that's acceptable. Home Buyers in the streets, that's unacceptable. Forty
Speaker 1: million migrant laborers involved in the real estate construction sector
Speaker 1: out of work and not getting paid and not being
Speaker 1: able to eat. That's a real problem. And so I
Speaker 1: think that there's a there's a difference between what is
Speaker 1: deemed to be an acceptable risk and was deemed to
Speaker 1: be an unacceptable risk. In this particular case, there's obviously
Speaker 1: a path risk, and I don't think that China has
Speaker 1: adequately prepared to the ground for that financing path. And
Speaker 1: the financing path in the end comes down to the
Speaker 1: local governments. So this is something that you and I
Speaker 1: have discussed previously. And one way I like to think
Speaker 1: about the housing market and the way it fits into
Speaker 1: China's financial system is sort of like a supply chain.
Speaker 1: And I think you said this, but a supply chain
Speaker 1: of capital, right, it's moving in a straight line, and
Speaker 1: one disruption at one end of the capital supply chain
Speaker 1: is going to reverberate and have consequences for other things
Speaker 1: further down the supply chain. So maybe you can walk
Speaker 1: us through those connections and how a disturb in the
Speaker 1: housing market. Lower inventory, lower prices might actually have a
Speaker 1: knock on effect to things like local governments, Chinese banks
Speaker 1: so ease, state owned enterprises and things like that. If
Speaker 1: we look at the status, if we think about this
Speaker 1: as as a shooting star, it's shot up. There was
Speaker 1: a lot of profit under the curve, a lot of
Speaker 1: spread taken out by different parties, and growth, a nominal growth,
Speaker 1: which was quantity of growth rather than quality of growth.
Speaker 1: The pivot point in all of this is the supply
Speaker 1: of land. The government of China owns all the land
Speaker 1: in the early nineties that the decision on who sold
Speaker 1: land to whom was then delegated to the local governments,
Speaker 1: and the local governments could raise revenue because they were
Speaker 1: not allowed to issue definite bonds, they could raise revenue
Speaker 1: by by by selling land. And they would sell land
Speaker 1: and then the developer would develop it, and then they
Speaker 1: would earn a developer tax from the from the developers
Speaker 1: sale of the land and property to buyers. If we
Speaker 1: look at the local government funding sources, something like thirty
Speaker 1: is across all of China is in the sale of
Speaker 1: land and the special taxes which come from the development.
Speaker 1: That's a very big portion of you know, local government funding,
Speaker 1: and that has been growing, you know, roughly in line
Speaker 1: with GDP because it's a big part of GDP. When
Speaker 1: we look at this supply chain of capital, h you know,
Speaker 1: the people providing capital, those people providing capital, they provide
Speaker 1: it to a developer who buys the asset. Then the
Speaker 1: asset is rotated into savings capital, which is purchased by
Speaker 1: the the new home buyer or the investor. And if
Speaker 1: you think about these, there's a there are a bunch
Speaker 1: of flows going on. If the local governments have sold
Speaker 1: a lot of land and that is going to decrease,
Speaker 1: that means that the grade of growth that they are
Speaker 1: able to raise money at will drop. We can look
Speaker 1: at this and say, you know, in two thousand there
Speaker 1: was no such thing as a land bank. Governments were
Speaker 1: starting out from scratch, Developers were starting out from scratch,
Speaker 1: and then we ran into the you know, the late
Speaker 1: naughties problem, the GFC, and then there was suddenly a
Speaker 1: burst of financing. But the burst of financing allowed developers
Speaker 1: to build land bank. So if we take the idea
Speaker 1: of a land bank, from two thousand ten to two
Speaker 1: thousand twenty, developers have grown land bank to be you know,
Speaker 1: on average, something like three years worth of land on
Speaker 1: their books, and that means that local governments have sold
Speaker 1: thirteen years worth of land in ten years. If we
Speaker 1: look forward and we say that the developers aren't going
Speaker 1: to be able to carry that because you know, they're
Speaker 1: high funding costs uh and the lower sales rate means
Speaker 1: that they simply can't hold it. They will burn through
Speaker 1: their inventory. But over the next ten years, basically the
Speaker 1: low governments will sell eight years worth of land bank
Speaker 1: to the developers who will then spend ten years worth
Speaker 1: of land bank. So they were you know, earning at
Speaker 1: thirteen years out of ten so of what they probably
Speaker 1: should have, and now they're going to melt back down
Speaker 1: to eight years out of ten. Let's say that's drop
Speaker 1: versus your straight line growth, and drop is a lot
Speaker 1: of money to be taken out of the flow into
Speaker 1: local government coffers. And that's where the pivot point comes.
Speaker 1: If we look at all of these the logistics here.
Speaker 1: You know, real estate is a local government funding source.
Speaker 1: It is a g d P source because all of
Speaker 1: the development creates jobs. It creates construction jobs, financing jobs.
Speaker 1: Mortgage spread is the single biggest contributor to the bottom
Speaker 1: line of most Chinese banks. There's a there's a clear
Speaker 1: incentive for everybody to have this all go well. But
Speaker 1: when it doesn't go well, you know, volume drops, spread drops,
Speaker 1: volume drops on the sales, land sales, and local governments
Speaker 1: find themselves unable to fund their other infrastructure products. And
Speaker 1: that means fewer jobs. Uh, And it means that savings
Speaker 1: assets are not created at the same rate they were
Speaker 1: created before. In the end, I think that people are
Speaker 1: okay with the idea that savings assets, which are heavily
Speaker 1: levered aren't created because it's a relatively low spread asset.
Speaker 1: A lot of these assets aren't earning any money. People
Speaker 1: are financing them, but they're just held empty. So it's
Speaker 1: it's a relatively inefficient way to create a gross levered
Speaker 1: financial asset. But all of this stuff between then, you know,
Speaker 1: local government financing, GDP, jobs, bank health, it's all connected.
Speaker 1: And when you put a stop on one end of it,
Speaker 1: that means, you know, the block cascades through the chain.
Speaker 1: I'd like to point people to Michael Pettis is odd Lots.
Speaker 1: Back in October, he really addressed this issue of expansion
Speaker 1: and contraction and local government as a place where it
Speaker 1: was going to hurt. I think that is part and
Speaker 1: parcel of where we're going to see the problem addressed.
Speaker 1: In the end. The biggest savior here will be probably
Speaker 1: local governments selling land to local government financing vehicles who
Speaker 1: will then build low income housing that will create jobs,
Speaker 1: It will create spread, and perhaps they will rent those
Speaker 1: two low income households on a kind of a rent
Speaker 1: to own basis, so that people are building a certain
Speaker 1: wealth and basis of future prosperity for their household and
Speaker 1: it will in effect dampen the pain that we're seeing.
Speaker 1: But I don't think that we're going to see a
Speaker 1: return to people buying five or six apartments in a
Speaker 1: project because they can and expecting, you know, property prices
Speaker 1: to rise fifteen a year for the foreseeable future. I
Speaker 1: don't think that that's coming back. Travis. That was a
Speaker 1: fantastic explanation and update of what's going on. Really appreciate
Speaker 1: you coming back on all thoughts. Thank you all right, Travis,
Speaker 1: Thank you so much. So It's always great having Travis
Speaker 1: on because he's immensely knowledgeable about pretty much any space
Speaker 1: you throw at him. But I thought, in particular, what
Speaker 1: was interesting in that well, I thought the thing that
Speaker 1: stood out in that conversation was the emphasis on changing
Speaker 1: the quality or the makeup of China's growth, the idea
Speaker 1: that you don't want to have financialized growth anymore, or
Speaker 1: not as much of it. You don't want growth that's
Speaker 1: driven by asset price inflation and debt and leverage, and
Speaker 1: so you're taking leverage out of the system. I mean,
Speaker 1: China has been pretty direct about doing this. If you're
Speaker 1: taking leverage out of the system and saying that you
Speaker 1: don't want housing to be purely for speculation, then inevitably
Speaker 1: those prices are going to have to fall and funding
Speaker 1: is going to fall too, And that's the big question
Speaker 1: for me, like where does the money actually come from
Speaker 1: and how much of it will be available because that's
Speaker 1: also going to dictate warehouse prices actually end up, right, Yeah,
Speaker 1: And this idea that or the goal like can you
Speaker 1: sort of hurt the capitalists, the investors, the bond holders
Speaker 1: while also maintaining a healthy pace of volume growth in
Speaker 1: homes like building more homes or making more homes available,
Speaker 1: because obviously that's still a multi year priority and there's
Speaker 1: a lot of development yet to be done, and and
Speaker 1: as he described it, like the existing system was very
Speaker 1: friendly to capital and there were all these ways to
Speaker 1: I don't know if game is the right word, but
Speaker 1: let's say make easy money in the example of Okay,
Speaker 1: you buy land from the government at X, but you
Speaker 1: don't have to pay it for a while, and then
Speaker 1: by the time you do pay, it's up, and then
Speaker 1: you can take money out of the system by the
Speaker 1: time you've done a little bit. And so essentially, like
Speaker 1: there's the leverage, and the question is can you keep
Speaker 1: up that same pace of home creation while making it
Speaker 1: less capital friendly? Is like a really interesting thing to watch. Yeah, well,
Speaker 1: I thought the idea of China sort of killing two
Speaker 1: birds with one stone by building low income housing that
Speaker 1: will hopefully replace some of the lost inventory. Yes, that's
Speaker 1: a really interesting notion and it makes a lot of
Speaker 1: sense from a policy standpoint, So it'll be interesting to
Speaker 1: see whether or not we actually see that. Now. It's
Speaker 1: kind of interesting that, like in any economy anywhere around
Speaker 1: the world, like especially these days, it's like whether the
Speaker 1: US are trying to like there is this demand for
Speaker 1: more house like more home volume, like people want, and
Speaker 1: yet you know, you don't really see modern governments at least,
Speaker 1: you know, at least in the West talking about like
Speaker 1: the number of new homes built as a mad major
Speaker 1: measuring stake, you know, the US to talk about like
Speaker 1: wages and job creation, etcetera. But no, I've never heard
Speaker 1: like a politician say like, oh, well we built two
Speaker 1: million homes. Under my watcher, we built a million. You know,
Speaker 1: but it would be intuitive, and so it would be
Speaker 1: interesting if China, whe it's more sort of top down policy,
Speaker 1: can just sort of like manufacture homes in a way
Speaker 1: that's separate from the capital markets process totally. It makes
Speaker 1: a lot of sense from a policy standpoint. But yeah,
Speaker 1: you're right, historically it just hasn't been emphasized, although I
Speaker 1: think in the UK politicians do make housings supply quite
Speaker 1: a talking point. Um. But maybe that's yeah, maybe that's
Speaker 1: a conversation another day. Shall we leave it there. Let's
Speaker 1: leave it there alright. This has been another episode of
Speaker 1: the Odd Thoughts podcast. I'm Tracy Alloway. You can follow
Speaker 1: me on Twitter at Tracy Alloway and I'm Joe wi
Speaker 1: Isn't all. You could follow me on Twitter at the
Speaker 1: Stalwart follow our guest Travis Lundie. He's at Travis Lundi Asia.
Speaker 1: Follow our producer Laura Carlson at Laura M. Carlson. Follow
Speaker 1: the Bloomberg head of podcast, Francesco Levi at Francesca Today,
Speaker 1: and check out all of our podcast at Bloomberg under
Speaker 1: the handle at podcasts. Thanks for listening, O