Debt concerns plague housing market, SOEs, technocrat says

Beware the asset price bubbles in China's first-tier cities, especially those driven by credit.

That's the message from Lord Adair Turner, former chairman of UK's Financial Service Authority, and now chairman of the Institute for New Economic Thinking, a US-based think tank.

Turner expressed his concerns to China Daily about surging home prices in cities like Shanghai and Shenzhen, echoing his consistent warnings about how excess debts drive real estate booms and busts, leading to financial crisis.

Asked if the Chinese people should worry about asset bubbles in the country's largest cities, the self-described technocrat replied, without hesitation: "Yes, you should."

After becoming chairman of FSA in 2008, Turner witnessed the unfolding of the global financial crisis. In his latest book, Between Debt and the Devil, he set the record straight about what he believes really caused the crisis: the West's addiction to private debt. He also challenged the belief that a private banking system ensures efficient allocation of capital and that rising debt is OK as long as inflation remains low.

He alerted the "self-reinforcing cycle" in which credit drives asset prices higher, which then sustain expectations of further increases, leading to more borrowing. In China's wealthy cities, as in other sophisticated economies, too much credit is competing for limited properties. Unlike other assets, it's difficult to create more as demand surges.

Compared with cash-driven purchases, Turner said credit-financed purchases are more dangerous. A 20-percent down payment requirement on housing in some cities could be higher, and minimum payments for second and third homes, in particular, should be high. He also recommended the introduction of heavy taxes.

"The tendency to have credit-financed real estate is very powerful, thus you need very strong forces to slow it down," he said.

Conversations about China's economy inevitably lead to dissection of high corporate debt overhang, which Turner described as a "major problem". The sheer size of the debt at 160 percent of GDP matters, but Turner said it is also about "misallocation of capitals" as the bulk of new credit merely repays old loans, and new loans are issued to support wasteful local government investment or to keep poor-performing State-owned companies afloat. "Bad debt might end up significantly higher than current measures of nonperforming loans suggest. But it may not produce a financial crisis, because most of the debts are between different departments of the State," he said.

That means the government could manage these debts by moving debts around different departments, for example, from State-owned enterprises to State-owned banks. A domino collapse like that in West's private banking system can be prevented, but Turner cautioned that eventually it involves budget losses. "I'm sure there will be significant losses in the banking system, which will require recapitalizing some banks. That requires money, so some debt will move from State banks to the central government balance sheet," he said.

Government will not allow all defaults, but neither will it allow all debts to move to the fiscal budget. The answer will be somewhere in between, he said.

Talking about debt-for-equity swaps, the much-discussed option to tackle problem debts, Turner said the key is the banks treatment of equities.

"There is no magic here. You can't use financial engineering to walk away the fundamental problem: the debts are bad. At the end of the day, that is the problem," he said.

zhengyangpeng@chinadaily.com.cn

(China Daily 04/18/2016 page7)