Thread by @bauhiniacapital

An excellent treatment by @michaelxpettis. Frankly much more expert and adult than most of what has been written (long form helps).

Definitely worth a read. I would go one step further and say...

https://twitter.com/michaelxpettis/status/1440190915742633986

...the issue between "good growth" and "bad growth" has effectively resulted in the asset base (and GINI coefficient allowing it) which triggers the warning that houses are for living in, not speculation. The debt growth has served local governments, developers, and has served as

the primary outlet for excess savings for a high nominal growth economy. IF land prices had been fixed, land auctions were by lottery, and price/sqm paid to local govts rose at CPI+0%, developer margins were fixed at cost plus 10%, and land without permits were returned

to local govt after 12mos, and if permitted but pre-sale permits not acquired, returned after 24mos, then land would be a lot cheaper, housing a lot cheaper, and there would be a lot less gross debt applied to roughly the same function.

At the same time... as I was discussing

with someone this morning IRL, this would mean China's GDP would be a lot smaller. Would China's economy be better? Probably. It would be formidable. There is a LOT of benefit emerging economies gain from productivity gains elsewhere. There are, indeed, @nosunkcosts to weigh one

down. Investment done well is quite efficient.

That difference in GDP growth has manifested itself in gross asset base and debt base which is very high. That net "wealth" has assisted a "wealth effect" as well; it could be called 'malinvestment' but at the same time, when

China's social safety net is so limited, people are responsible for their own savings and there are not many alternative venues to apply that much of a savings glut. But with no social safety net, it is tough to explain to oneself why one would consume disposable experience and

materiel instead of building wealth. Indeed, as auto sales, and luxury goods, and foreign vacations (imports) have shown over the years, wealth effect from real estate matters to drive consumption.

The savings and safety net construct make it that way.

If one had magically understood the problem at the beginning, would it have evolved differently? If real estate prices rise faster than GDP does, and compound, while income rises similarly but debt service does not, wouldn't one want to own real estate anyway? Isn't it the best

way to grow wealthy and have access to "real wealth"? The way many countries deal with this is through property tax. That adds a drag which discourages speculation to some degree. Adding a transaction tax to non first home buyers is another way (👀 HK).

Much of what one has seen the past years and especially months in Chinese markets could be construed as regulatory nation-building - establishing new norms that say companies - social organisations in and of themselves (even in the origins of the words used in the west but also

in the Chinese characters used in China and Japan) - should act responsibly towards a wider set of stakeholders. The crackdown on real estate leverage does the same.

One can ask why they waited so long to act. I expect it is because no one party head in a given region wanted to

be the one to underperform other regions in GDP growth. Doing so would manifest itself in increased local govt funding stress, budget cuts, reduced services, etc. Not exactly what a rising star in the party wants on their CV. Incentives matter so herds are created and herds are

notoriously non-self-regulating.

The thing about dealing with problems like this one is that nobody comes out well.

But there is a difference between presumed wealth and actual GDP. If as many homes were built over the next 15yrs as over the last 15 but developer profits were

much smaller because they were not long a giant carry trade (long 5yrs of land bank against debt), and all home prices were lower, there would simply be less debt taken on to build and own. Secondary prices would be lower. There would be less "wealth" owned in real estate, but

over the medium-term, the loss of wealth might be much greater than the hit to GDP.

As @TheStalwart points out, there is a downside to knocking developers on the head.

https://twitter.com/TheStalwart/status/1440247977390395398?s=20

But this downside happens any time a sector gets knocked down. After-school education businesses teaching the national curriculum for profit are now history. Thousands, or tens of thousands of people are out of work. They may end up in the public education system tutoring after

school hours but they are not there yet. Any time one introduces uncertainty into the process, that hurts (cf Bernanke 1983).

This is why there are fintwit threads on 'contagion'. So far, the threads are pointing at other developers' USD bonds, and HKD stock prices, and the

prices of LVMH and Australian iron ore producers.

These are externalities. Regulators care less than zero.

Real contagion would be where a local healthy bank, with low exposure to real estate, decides not to extend a loan to China Res Land ($1109.HK) or Longfor or to a

first-time home buyer of one of their reasonably-priced properties because of what they see on social media about Evergrande.

Contagion in iron ore? Not a problem for China. It's a good thing. High iron ore prices are a tax. Reduced sales of LVMH goods? Yeah. Whatevs.

DIFFERENT problems are where people lose their jobs because there is less work to go around. Michael refers to those who are under-utilised but still employed, but not those who are cut off. And another problem would be suppliers who have done the work but EG has not paid.

I agree to some extent with Zhou Xin comment from the SCMP article referenced, "Beijing is likely to to use a cocktail of proven tricks: rolling over debt, haircuts on assets and emergency payments to the vulnerable."
scmp.com/economy/china-…

I tend to disagree slightly with @michaelxpettis' conclusions on who gets saved. The waterfall is complex. There is plenty of security for some bank exposure at the project level. There may be less security for homebuyers who put down deposits or even mortgages.

In the end, who matters?

Home buyers who only want to take delivery? Resounding yes.

EG employees? Ecosystem employees? Big picture, yes.

The supplier/contractor/local lender ecosystem? Yes but I expect haircuts may be taken.

WMP owners who expected a govt guarantee on an instrument yielding 10%? I expect these people are behind all of the above.

Unsecured bond holders? Equity holders?
You know...

But the Really, Really, Really BIG Question, which matters more than all the others, is...

What happens to Homeowner Wealth which has resulted from the malinvestment. Will EXISTING homeowners who had expected that wealth to be their retirement nest egg see it stop growing? Drop?

1) And how much of a drop would create a Real Problem? (and how do you define it)
2) How much would create a Global Impact? (and how do you define it)
3) How much would create a Domestic Social Problem?

And what is done to offset the risk of #3?