The impact of a sudden credit crunch, which threatens to shut up China's financial system, is a big threat to China's real estate industry, which has been pummeled by three years of austerity measures. hotel
The People's Bank of China, China's central bank, has been squeezing money out of circulation in recent weeks, in an effort that many economists and China observers believe is intended at generating a shakeout in the country's "shadow banking" sector.
The crunch has the potential to put pressure on tiny, undercapitalized property developers, forcing them to sell off projects or possibly sell out completely to their larger, more financially secure competitors.
"We predict increasing demand for small and medium-sized developers," said Craig Blomquist, CEO of Fan Ya Tai Asset Management Co., a firm that specializes in the recovery of nonperforming real-estate loans.
"I believe it will put a lot more pressure on the smaller and intermediate players. Everyone I know is trying to figure out who has money."
"...the risk is that borrowers may be unable to repay their trust commitments, potentially prompting a run on trusts or their failure."
In China, shadow banking refers to nonbank lenders such as trust organizations that have exploded in popularity since the government imposed limitations on many traditional types of borrowing, including bank-issued mortgages. Many property developers turned to trust corporations for financing in the second half of 2011 to assist them complete projects.
Housing sales had recovered and home prices had continued to grow during the previous 12 months, alleviating the burden. Now, the PBOC's strong efforts enhance the possibility that credit could dry up once more.
The credit crunch's most immediate result was a sharp increase in bank borrowing rates. On June 20, the Shanghai Interbank Offer Rate, or SHIBOR, increased to 13.4 percent for an overnight loan, reflecting the amount banks charge each other for short-term borrowing. Another interbank rate reached 25%, reminding people of the credit freeze that occurred in the US in 2008.
The central bank's longer-term goal may be to penalise banks for "window dressing," or concealing debt levels by transferring exposure off bank balance sheets and into unregulated trust companies.
On CNBC, Simon Cox, a journalist who just authored a piece on the subject for The Economist, stated, "They have been wanting to punish the banks for doing it." "How banks respond to reorganizing their balance sheets is the key question now."
Banks frequently create trusts, which are supported by a limited group of affluent individual investors. Investors put up money, which is then loaned out at exorbitant interest rates, and investors are frequently given only a broad description of how their money is being used. While the earnings are appealing to investors, the trusts lack the financial strength of a bank if loans default. With China's economy weakening, there is concern that borrowers would be unable to satisfy their trust commitments, perhaps creating a run on trusts or their failure.
Blomquist, who is headquartered in the southern Chinese city of Guangzhou, stated, "The fundamental worry with the shadow banking system is that nobody knows how great the potential liability is." "That is what all investors are concerned about. And it should worry the government, because I don't believe it has a handle on it."
A large portion of the trust's funds have been used to finance property developments or infrastructure projects.
"Unfortunately, a large portion of the shadow banking system has gone towards infrastructure projects, some of which were intended to create jobs rather than be required," Blomquist continued. "How many airports does this country require?"
The rise of China's economy has polarized opinion, with bulls believing in the "China story" and skeptics forecasting economic collapse and gloom. With this latest crisis and the possibility that growth would slip to as low as 6% next year – most economists believe the country needs 7% growth to avoid social upheaval – the doubters are presently in the lead.
The author of The Economist, Cox, does not expect a general economic disaster, but rather a lot of suffering in the banking sector.
"You could have a lot of defaults without clogging up the system, fuelling growth, and generating the wasted half-decade we had in the US," Cox explained.
Blomquist, who works in the real estate market, is similarly optimistic about the prospective setback. Local governments, he says, will welcome financial assistance because so much of their economy is based on property or infrastructure.
"I believe it will generate some possibilities for others to pick up transactions," he said, adding that his company is considering two agreements in which it would take over a debt-ridden housing complex and hire a third-party contractor to finish it. "We'll be problem solvers rather than vultures. Some of these municipal administrations are experiencing difficulties."
Given China's increasing urbanization, he feels the long-term prospects for housing in China are certainly bright. He expects that the current crisis would open up chances for expatriate distressed-debt lenders, because the finest distressed property deals frequently go to domestic dealmakers.
He projected that "the administration will be little more accommodating in encouraging foreign investors to bring capital into the nation." "If the government makes it easy for foreign capital to enter, that is one of the things that will be very telling to me. Then they know it's a serious issue."