Property Market Turning Sour in China

Bloomberg posted an article today about Chinese apartment/home buyers who are demonstrating against their landlords/developers as prices are falling:

On Nov. 19, Deng faced off a ring of security guards three rows deep wearing camouflage and carrying shields as he joined more than 100 homeowners rallying in front of the development’s sales office. His transformation from newlywed to street protester came after China Vanke Co. slashed prices for future buyers at the Qinglinjing complex, erasing about 20 percent of the value of his three-bedroom unit overnight.

The story goes on to explain how Deng's parents contributed their savings and Deng's boss provided a loan so that he could meet the 30% minimum down payment on the apartment.  He was only able to contribute 4% of the down payment himself.

The article also tells the story of Zuo Hangxai,who "became a home owner after losing patience waiting for years for prices to come down. She recalled the frenzied scene when she picked her apartment in the same development as agents crowded around urging her to buy and then clapped and congratulated when she nodded agreement."

Evil Developers and Buyers Remorse
While I will contend that even in Zuo Hangxai's case, the people now protesting were willing buyers, the Chinese market has experienced a super-bubble which was aided by the developers.  Developers near major cities had worked with the government to remove people from their current homes in order to demolish them and build massive complexes.  There were many stories and videos about these cases a few years ago.  Unlike here in the US, where there's a more rigid legal process for trying to evict someone, many of the Chinese who fought back would leave their homes for work and return to a pile of rubble.

Without a home, these people become buyers, and perhaps end up buying from the companies who destroyed their homes.

On the other side, China's super bubble was largely driven by rising demand and rising home prices, which led to price appreciation and speculation to an extreme degree.  Many middle class families were priced out of even modest new homes and apartments because of the rampant speculation.  Developers were happy to build more units knowing they could get a great price, and incremental buyers were happy to pay because they expected to flip the unit at a substantial profit.

As we experienced here in the US, eventually the music stops and some are left without a chair.

For the US, housing prices topped out sometime in mid-2006.  More than five years later, our housing market still hasn't recovered.  Anyone who bought near the top probably felt like demonstrating back in '07 and '08.  I would suppose the reality of the situation has sunk in at this point - those who bought at the top, for whatever reason, may never recoup their "investment".

For Deng and Zuo, I think the worst is yet to come.  The same Bloomberg article says that the home ownership rate in China is 87.8% compared to 66.3% in the US.  That is a staggering difference and is very bad news for current home owners.

In the US, that means as prices fall, 33.7% of the population could conceivably enter the market and buy a home.  In China, that number is 12.2%.  Roughly one in ten people are not homeowners!  Who do the other nine of ten sell their home to?

I don't know all of the socio-economic reasons behind such a high rate of homeownership, but the article does give a few hints:

Deng had moved to Shanghai three years earlier from a small city in the north to be closer to a girl he met in college. When talk turned to marriage, his girlfriend insisted they buy an apartment first, he said. “At my age, I should get married and I should have my own home whether or not I can afford it so that I can be the same as my classmates,” Deng said.

#1 - China's One Child Policy which led to infrantricide towards female newborns, has led to a massive imbalance in the sexes.  If you are a young adult male in China, looking for a wife, you've got some darn stiff competition and need to prove your worth (buy a home).  See also - China: Too Many Men.
#2 - China's burgeoning middle class also comes with "Keeping up with the Joneses" syndrome we know well in the US.  Deng feels like he should own a home whether or not he can afford it so that he can fit in and also get a wife.

Financial Crisis Looming
China's centrally managed economy may be able to weather the oncoming property bust better than we could here in the US.  Bear Stearns, Lehman, and other major financial firms collapsed or nearly did because of their exposure to the US housing market and because there were at least some rules they couldn't avoid (such as marking down investments to current market prices).  The US government then took steps that were clearly anti-capitalism and maybe illegal to prevent the situation from getting worse.

In China, I would suspect the government will be much quicker to support firms and the economy and can more easily re-write the rules.  If the Industrial and Commercial Bank of China found one day it was insolvent, the government could more easily make direct loans, rework the bank's lines of credit, or restrict withdrawals.

Given what seems to be massive over-development in China, I can't imagine this ending well.

Mortgage Forgiveness?

Bloomberg published an article today citing investors, funds, and economists who think principal balances should be reduced to help embattled homeowners

Greg Lippmann, of subprime shorting fame (more on him in a moment) says:

Principal reductions are necessary to help ameliorate the housing crisis. The step will also lower losses on loans underlying mortgage bonds

Who the heck is Greg Lippmann
Greg Lippmann worked for Deutsche Bank as was a key figure among those who made millions or billions by shorting subprime mortgages.  A client of his (forget the name at the moment, which is kind of the point) realized that these subprime mortgage bonds weren't worth the paper they were written on and got Deutsche Bank and others to help him position his investments to benefit from the housing bubble bursting.  Lippmann, realizing the opportunity, then brought the idea to others, including John Paulson who ended up as perhaps the face of the "brilliant" investors as he personally made billions of dollars.  I just gave you the quick summary of the book The Big Short by Michael Lewis - spoiler alert.

So Greg thinks he's got a good idea to help mortgage holders and investors in mortgage bonds, and several funds and economists agree with him.

Who would benefit and who would lose
I think the ship has long sailed on the opportunity for Washington to punish Wall Street on this.  Some of Washington's actions in 2008 and 2009 may have actually done some good - TARP being one of them - but that was in the heat of the crisis.  Laws and capitalism could be set aside to avoid a massive meltdown.  So while #OccupyWallStreet is still raging, I don't think DC has the power to force the banks to write down loans.

One major complicating factor that everyone hopefully remembers from a two years ago is that these evil bankers don't actually hold the loans themselves.  My mortgage is a great example - we used a mortgage broker who priced a loan for us based on what he saw in the market making sure he could sell the loan and make a profit for himself.  So our mortgage was originally funded by the broker's company and the investors who back it.  Within a month, as planned, they sold that loan to Chase.  Every month, we will write a check to Chase.  But chances are that Chase won't hold onto that mortgage for 30 years.  Instead, they'll likely pool our mortgage with many others and sell it to investors.  These investors could be Greg Lippmann's fund LibreMax Capital, or the California Public Employees Retirement System (CALPERS), among others.

My check then goes to Chase as the servicer, who pools all the monthly checks together, and distributes the funds to the investors such as CALPERS.

If, somehow Washington decreed that my mortgage principal should be reduced by 20%, the winner would be me, my mortgage broker and Chase would feel no effect, and CALPERS would be the loser.  This would be a transfer of wealth from CALPERS to me - probably not the intended goal.

How to select mortgages to reduce
You clearly can't reduce ALL mortgages by any amount that would be meaningful enough to solve any problems.  Washington also hasn't grown enough wherein you could reduce mortgages on a case-by-case basis.  Therefore, the program would have to be broad enough to be meaningful to the country and the economy / housing market, but have some parameters.

One would be whether you've defaulted or not.  If you've defaulted, that's a pretty good indication that you've hit rough times and could use help.  Is it because you bought your house at the top and have too much debt?  Is it because you lost your job?  Have you defaulted on a 2nd vacation home in Miami that you bought on speculation?

The government could also look at loan to value.  The difficulty here is what is the "value" part of the equation?  Is it based on the appraisal done when you purchased the house - are these appraisals of any use if they are 15 years old or if they told you your one bedroom shack was worth $2 million in 2006?  Or maybe to apply for this process you'd need to get a new appraisal.  Fun.

What would be the end benefit
Individual homeowners would have lower monthly payments and have money to save or spend (the government surely wants you to spend).  Some homes would be saved from foreclosure, which would help the housing market.

My suggestion
Leave it be.  Again, many are suffering because of the housing crisis, but I don't think the government should be getting involved in private transactions and trying to bail out those who made a bad investment.

If a homeowner was defrauded into paying too much for a home, or buying a home they couldn't afford, they should go through the courts individually.

The solution, in my mind, is time - it is going to take years for the housing market to work through the inventory of foreclosed homes which will keep prices depressed.

Donald Trump - Never A Better Time to Buy (from a bank)

Donald Trump, in the clip below, explains why he believes there has never been a better time to buy, as long as you are buying from a bank:

I think his comments are timely - six months ago, I believe banks would have been more reluctant or less likely to just "get rid" of properties they owned.  Now with the economy really struggling again and the focus on banks' balance sheets, both in the US and Europe, banks should be more willing to cut deals.

His comments on financing a deal when buying from a third party may be a bit off - we didn't have a problem getting a good mortgage, but I guess I can't speak more broadly than my experience and what I've read.

One point to highlight - Trump, love him or hate him, is all about confidence.  He sued a reporter who dared say his net worth was not in the billions.  Over the past several years, Trump has been licensing his name for properties (and other projects) rather than buying and owning himself.  It is interesting to note that he has now become a buyer again.  If you think he is a savvy real estate investor, maybe you should follow his lead.

Buyer's Market; Best Deals in a Generation?

Bloomberg has an interesting article today arguing that the current property market may be the best opportunity in a generation:

People like the Matthewses who are able to survive the scrutiny of mortgage lenders are getting the best deals of the five-year U.S. housing bust, and perhaps the best deals of a generation, after a 31 percent decline in home prices since 2006. It’s the bright side of an otherwise bleak real estate market: Good houses at cheap prices are plentiful, while loan rates are hovering at record lows.

How about this bold prediction:

“It’s hard to see the possibility of losing on a home purchase right now, with these mortgage rates,” said Dean Baker, an economist who in 2005 predicted a decline in the government’s home-price index that now is within two percentage points of his forecast. “Prices may go lower, but not by much. Even if they do, you’re still getting a good deal.”

Great time to buy - sure, but a no-lose situation?

There certainly are a lot of reasons why buying might be a sound decision right now, including rates and depressed prices.  But let's not get going down the path of five years ago where everyday people were buying several homes with the expectation that they would flip them in a few years.

The economy is in the tank, and I predict it will get worse before it gets better.  If your employer has been laying off workers, is it a good time for you to take on hundreds of thousands of dollars in debt?  

The weak economy and layoffs also reinforce the foreclosure cycle.  Layoffs lead to missed mortgage payments which lead to a foreclosure.  That foreclosure can lower the value of other homes in the neighborhood and multiple foreclosures in the neighborhood can cause real problems.  Mortgage holders who are current start to ask themselves if it is worth it to continue to pay a $500,000 mortgage when their house is only worth $350,000.  This can lead to "strategic defaults" wherein a homeowner can afford to pay his/her mortgage, but chooses not to.

Where are we in the cycle?

Mike Shedlock at Global Economic Analysis updated the pictorial below in late August.  The graph compares the US housing market's bubble and bust cycle to the cycle Japan experienced a decade ago.  His most recent commentary was in response to a reader's question on when to buy and how far are we from the bottom:

As you can see, the housing bubble in the US (red text) follows a similar trend to the bubble experienced in Japan (blue text matching the prices on the left and dates at the bottom).

In his opinion, there are still many sellers who are at the edge.  A slight push and they'll "Sell Before It's Too Late" which will compound the housing bust.  I don't completely agree with this, although I am fearful that if we do enter a full-fledged recession soon, we may see this.  My current expectation is for government support to keep the economy and housing market from collapsing, although I would not be surprised if we do technically re-enter a recession.  My caveat is that if the Super Committee gets bogged down by political ideologies, the markets will tumble and uncertainty will abound.  This will quickly reach the economy and the housing market.

Please note that in the above pictorial, the blue text highlights the psychology of home buyers and sellers.  When the market is at its worst, participants believe "It's Better to Rent", while on the upswing, they believe buying is the best option.  As I discussed previously, excluding potential appreciation of a home's value, I think the renting versus buying markets are priced quite similarly.

New Home Sales at Six Month Low

August government data showed new home sales at a six month low, led by buyer focus on distressed properties and increasing foreclosures which keep housing prices low.  According to a Bloomberg report:

Purchases of new houses in the U.S. declined in August to a six-month low as the biggest drop in prices in two years failed to lure buyers away from even less expensive distressed properties.

Sales, tabulated when contracts are signed, dropped 2.3 percent to a 295,000 annual pace, figures from the Commerce Department showed today in Washington. The median estimate of 73 economists in a Bloomberg News survey called for a decline to 293,000. The median price slumped 7.7 percent from August 2010, the steepest 12-month drop since July 2009.

Foreclosure-driven price decreases for previously owned homes may keep attracting investors away from new properties, hurting builders like Lennar Corp. Limited access to credit, rising unemployment and waning consumer confidence also signal the industry that helped precipitate the recession will take time to find its footing.

Looking forward, September and October data could show improvement with mortgage rates moving much lower as compared to August.