Real Market Control for Bubbly Real Estate

(Caixin Online) The real estate industry is a pillar of China's economy and has grown rapidly for more than a decade, contributing to improved living conditions for millions of people. But in recent years, overall housing prices have grown too quickly, often due to rampant speculation that not only endangers the healthy development of the industry but also greatly increases financial and social risks.

Based on ratios of housing prices to personal incomes, and per-square-meter monthly rental to purchased housing costs, overall housing prices nationwide have been too high since at least early 2007. According to nationwide official data, average housing prices in 2009 rose up to 30 percent from 2007 levels, proving that the international financial crisis has done nothing to effect an adequate adjustment of the Chinese property market.

Now that a new round of price increases has begun, China is feeling the negative effects of an apparent real estate bubble. More than ever, effective measures are needed to balance the market.

Financial risks are mounting, hanging a Sword of Damocles over the head of the Chinese economy. High costs and mortgages have squeezed consumers, limiting their buying power as well as profits in business sectors outside the real estate industry. A recent Shanghai Banking Regulatory Commission stress test of banks in its jurisdiction showed that if housing prices fell 10 percent from levels posted in late September 2009, the rate of non-performing personal mortgage loans would be 2.6 times above normal.

Some of the country's economic sages have generally blamed two myths for fostering market attitudes behind soaring home prices: Myths that say neither China's rapid economic growth nor housing prices will decline – ever.

China's success in achieving 8 percent growth in gross domestic product alongside steadily rising housing prices last year has been cited as powerful evidence that these are not myths. But such attitudes underestimate the risks of economic cycles and overestimate the government's ability to intervene in economic activities.

The success of the government's short-term stimulus policies since late 2008 has, in fact, added risks that could affect the nation's healthy, long-term development. We need to acknowledge this fact if we don't want the government to continue stimulus projects indefinitely.

It should be noted that awareness of real estate market risks can be found at all levels of China's central and local governments. Before and after the New Year, government officials and citizens expressed hope for stable housing prices, and several control measures were introduced in areas such as taxes, credit, land supply and housing construction. In January, housing transaction volumes fell sharply. The market started taking a wait-and-see attitude, as property sales showed signs of cooling.

Government measures and market reactions brought a measure of relief. But it remains to be seen whether the root problem has been cured. Actually, in past years, control measures led to more price increases. Costs climbed due to distortions in real estate resource allocation that created a severe imbalance for supply and demand.

But deeper factors include systematic deficiencies and excess liquidity have also contributed to higher prices. A guaranteed housing system is lacking, and land supplies are monopolized in a way that creates serious housing supply shortages. On the other hand, loose monetary policy and easy credit have stirred up speculative investment demand, leading to expectations for inflation that further propelled excessive consumption and speculation in the industry.

Lending volumes tell part of the story. In 2009, for example, banks issued 1.4 trillion yuan in new consumer housing loans, exceeding all loans issued over the previous four years. The year-end balance of yuan-based real estate development loans issued by financial institutions in 2009 was 20.4 percentage points higher the year before.

Excess liquidity piled into the real estate market, pressuring prices higher. Due to excess liquidity, a large number of enterprises invested in real estate through a variety of channels on the supply and demand ends. Some invested in development, while others bought housing. In addition, the supply side of the market was flooded by development funds and "land barons" who took advantage of the government's land monopoly. On the demand end, expectations that "housing prices never fall" prompted buyers to chase ever-increasing price tags.

Market prices never rise indefinitely. It's true that China's real estate industry has advanced to new heights, but the high prices seen now go far beyond what economic fundamentals can support.

We think government real estate controls should be properly suited to fit this situation. And two would be particularly helpful, even essential:

Since excess liquidity has contributed to high housing prices, credit should be gradually tightened to prevent an even larger bubble. For some time, we've heard market watchers call for "monetary policy that focuses on asset prices." This is exactly what's needed now. It should be put on the government agenda as soon as possible.

Second, the system that gives government an exclusive monopoly on land must be changed. The government need not and should not intervene directly in market prices. Nevertheless, the government does have a responsibility and the capacity to influence public expectations by adjusting policies that balance supply and demand, thus stabilizing prices.

Conversely, if the price issue is not addressed, trying to support the old land system and housing policies, coupled with a loose monetary policy that artificially sustains the housing market, will make it difficult to avoid a China version of the bubble bursts seen in the past in Japan and the United States.

Most recent government policies focus on the short-term and fail to address the core issue. Moreover, they are likely to simultaneously restrict demand and supply. As long as excess liquidity remains, and local governments rely on land transfers to balance their fiscal budgets, the real estate market will never shake bubble-making tendencies.

Truly effective control policies also must be credible. They have to conform to economic logic and involve real, effective action. Expressing an interest in housing price restraint without matching words with action will not win public confidence. Anything less than credible policies may simply delay trouble.

Admittedly, these proposed changes would not be easy to implement. And a single-stroke success would be difficult, given current situations. But by setting expectations for reform in this direction and giving the market clear regulatory signals, expectations for rising housing prices can be reversed.

Some preconditions are already being met: The economy is picking up, monetary policy is gradually being tightened, and land system reform appears inevitable. That leaves room for effective control measures.

(Translated by AHK)