The Real Estate Bubble: The True Tumor of Economic Development

Author: [Mu Zi]
Source: [Fund Analysis]
Article type: Regular article
Published: 2007-9-28 19:30:04
Column: Expert Perspectives

Recently, regulatory pressure on real estate has been steadily increasing. "Minimum down payment for second-home loans raised to 40%" has become the most eye-catching new policy. This is an extremely timely and necessary measure, providing greater safeguards for continued smooth economic development.

In economic development, hoping for zero bubbles is unrealistic. Bubbles are inevitable, and the bursting of bubbles triggering economic corrections is an inevitable law of economic development — a phase that is essentially inescapable. But inevitable bubbles can be good or bad. The standard for distinguishing them is whether they ultimately affect the deep structure and operation of the real economy. Put plainly: stock market bubbles are good bubbles, while real estate bubbles are bad bubbles. Even when the stock market bubble bursts, since it does not directly act upon the real economy, its impact is limited. But once a real estate bubble bursts, the entire banking and financial system takes the most direct hit — the impact is catastrophic.

If a bursting stock market bubble is a bad cold, then a real estate bubble is cancer. In the history of world economic development, there are many classic examples of both types of bubbles and their aftermath. The most well-known are the American turn-of-the-century internet frenzy that created a massive stock market bubble and burst, and Japan's 1980s-90s real estate frenzy that created a massive economic bubble and burst.

There is an erroneous view that Japan's once-in-a-century mega-bubble was caused by the stock market. In reality, what ultimately triggered its economic nosedive was the real estate bubble and the severe damage to the entire financial system caused by its bursting. Purely in terms of the stock market bubble, Japan's was nothing compared to America's internet bubble — the U.S. even invented the concept of "price-to-dream ratio," and the Nasdaq collapsed from over 5000 to just over 1000 in a matter of months. Yet the U.S. economy was not significantly affected. Why? Because the real estate bubble never took off, the banking and financial system remained unscathed, and the real economy stayed healthy.

The reason America's current subprime crisis is dangerous is precisely because it originates from real estate. Such a small tremor has already sent waves through the banking and financial system. This shows that real estate problems are absolutely never small problems — their amplification effect and their impact on banking and finance are lethal. The reason America won't have real trouble this time is that its real estate hasn't formed a true bubble. So for now, it's a false alarm — but one sufficient to serve as a wake-up call to all parties.

Even more destructive than a pure real estate bubble is when real estate stocks carry excessive weight in the stock market, creating real estate bubbles on both the real and virtual sides. Real estate companies, through so-called revaluations, inflate their stock prices, then use these extremely high prices to raise capital in the market, which they use to acquire more land, driving up land and housing prices, then revaluing again, beginning a new vicious cycle. There is no game more capable of creating malignant economic bubbles — this is an absolutely lethal game.

Therefore, when certain companies don a crown proclaiming themselves the world's largest real estate enterprise and loudly charge toward a trillion-yuan market cap while aggressively issuing shares at elevated prices, and when some stocks pull dozens of consecutive daily limit-ups merely because of a real estate company's asset injection — the crisis created by the combination of real estate and the stock market, real and virtual, has reached a level that can no longer be ignored. Market manipulators in the stock market, as long as their capital chain doesn't break, can keep hoisting that barbell indefinitely. Those real estate developers who massively hoard land are essentially no different from market manipulators. If they continuously replenish their blood supply from the capital market and banking system, the real estate frenzy cannot possibly be calmed.

China's real estate industry is developing not too slowly but too fast. Real estate companies must be barred from listing and re-financing for a considerable period. Credit to real estate companies must be strictly controlled, and land hoarding must be severely cracked down upon. The strategic development of real estate, along with its policies and resource allocation, should all adopt a dual-track system. The vast majority of countries and regions worldwide essentially use a dual-track system to solve housing issues, rather than simply throwing the housing problem to the market.

For most citizens, housing is absolutely not a luxury but a necessity — a right that must be guaranteed. "A home for every dweller" — this is the most basic standard for judging all housing policies. For the majority of residents' housing needs, a fully marketized approach is absolutely unworkable. China's constitution stipulates public ownership of land. Therefore, national land must first ensure the most basic housing needs of all citizens. Only after this need is met can market-oriented demand be considered. For the minority of citizens with stronger economic means, higher-standard housing consumption through market-oriented methods is fine, with prices determined entirely by market supply and demand.

In summary, the real estate problem absolutely cannot be dealt with through delay tactics. The longer it takes to address, the greater the accumulated risk, and the fewer the available resolution tools. Once the situation becomes intractable, it is terminal — incurable. The hope of China's economy does not lie in how many world-class real estate companies it has, but in how many enterprises lead the world in technological development with genuine independent innovation capability. As for those real estate companies heavy on relationship capital and light on technology content — there had better not be too many of them on the wealth lists.

(Special Senior Advisor to this publication, Mu Zi)