China’s real estate: Housing collapse explained, developers’ mechanism and relation to Ponzi schemes

Imagine if you had to endure the situation where your bank account was frozen and you couldn't take possession of the house you paid for. At the moment, Chinese residents have to face many problems. China is facing a deep economic crisis. Protests are being waged at banks and on the doorsteps of real estate developers. A nationwide wave of mortgage payment boycotts by homebuyers, responding to unfinished projects, is putting significant pressure on Chinese developers and authorities. The number of bad buildings has gone up to 327, spread across 115 locations in China. According to Moment News, homebuyers are being reassured that getting the problem resolved is a top priority. Meetings have been organized and bailout funds have been set up for all parties. But how did the seemingly unstoppable juggernaut of real estate become a major economic crisis? Some analysts relate China's real estate mechanism to a Ponzi scheme. In this video, we'll figure out their relationship and get to hear some analysts' comments. Chinese Property Sector's Mechanism and Ponzi Scheme Before getting to know how the property sector works in China, let's watch this video to become familiar with what a Ponzi scheme is. The Ponzi scheme. This is a scheme where you promise investors a very handsome return, and as you find new investors, you simply use their money to pay the investors who came before them. Then as people see the returns being made in this scheme, they too sign up as investors and their investment gives the investor before them the very impressive payout they were expecting. The schemes rely on a steady flow of new money to keep old investors profitable. When that flow dries up, the scheme collapses. Chinese Property Developers' Mechanism Chinese have long been savers. People put their money into real estate, especially into residential homes. Fortune.com cites US-based investment management firm Loomis Sales, saying that over the past two decades, the boom in home ownership has led to 70% of China's household wealth being invested in real estate. So how do developers in China apply the Ponzi scheme method? They use a pre-sale strategy. As Chinese language media outlet Daji Yuan reported, real estate developers can sell apartments before the buildings are completed. Buyers must pay the full purchase price after signing the contract. It includes a down payment and a mortgage. Previously, the cash held in escrow by the developers was 50-70% of the pre-sale funds. Regulations differ between cities and counties. Data from the National Bureau of Statistics shows that 34.5% of property developers' funding came from this source. Some YouTubers and brokers gave their opinions on how Chinese real estate developers work. YouTuber Andrei Jikh said, In his video, broker Mark Mitchell confirms China is using the Ponzi scheme. Mark said that China's real estate continues to plummet despite efforts from the government to make it easier to buy homes. It's also bad for government revenues, which come from land sales. According to Mitchell, the Chinese Communist Party uses Local Government Financing Vehicles, or LGFVs, as a means to borrow money off the books. These LGFVs involve investment firms selling bonds to finance the real estate development of other infrastructure projects. Rizhao City held a 4-bid land auction this year, and the price was $170 million. Bloomberg noted it appears to be normal on the surface. But the offers were reportedly made by a financial institution backed by the Rizhao government, meaning the city sold the land to itself. Mitchell said China effectively bids through LGFVs to buy properties from itself. It's basically like using a credit card to buy goods from a small business and claiming profits from this business. China is using debt only for growth, not in a productive way. Pre-sale System Problems Speaking on the matter of the pre-sale system, some netizens shared their opinions. A user called EverRingTheBell shows in his video that developers just take a piece of land, make sand models, then start selling houses. It leads to some problems. According to Ren Zeping, chief economist of Beijing Rongzhi, it's time to end the pre-sale system of commodity houses. They build houses with people's money, but now they're rotten. He says, Two Massive Factors That Might Cause the Collapse There are two major factors that we need to talk about. First, the Chinese Communist Party has begun to limit leverage. The company imposed three red-line policies on select developers after an August 2020 conference amid rising debt levels, rising land prices, and surging sales. The 12 pilot developers are required to submit detailed reports on their funding status for evaluation. For line 1, developers must show the liability-to-asset ratio, excluding advance receipts, of less than 70%. For line 2, the net gearing ratio should be less than 100%. For line 3, cash-to-short-term debt ratio should be more than one times. According to UBS Asset Management, the policy, in short, means forced deleveraging for developers. S&P Global estimates only 6.3% of their rated developers can fully comply with all three red lines at the time of writing. Evergrande itself crossed all three red lines. SupChina reported that nearly half of China's 30 largest property developers by sales were found to have crossed at least one of the three red lines as of 2021. It caused a sector-wide crisis as developers sought new funds to pay the old debts. Developers are still struggling to find funds to complete the unfinished projects. Some experts share comments. In response to an interview by Chinese media outlet Xintangren Xie Tian, a professor at Aiken School of Business at the University of South Carolina, said that the three red lines are an attempt to diffuse the real estate bubble and protect the interests of the Communist Party's central government, local governments, and vested interests. The real estate bubble in China should have burst a long time ago. Ren Zhengdao, researcher at the European Tianjin Political and Economic Think Tank, said that the three red lines limit corporate finance. It will lead to many broken buildings. Those pre-sale housing buyers may be empty. Xie believes it is difficult to draw these red lines to prevent the doom of the real estate collapse. Poor exports, excessive spending on real estate, and foreign debts make it challenging for the nation. But leverage restrictions were not the only factor. Damages from the pandemic lockdown are also a factor. As of this July, restrictions were placed on 41 cities, covering 261 million people. Such pandemic restrictions affect China's GDP, as people are forced to stay home, limiting economic and social activities. Under current economic pressures, the CCP is worried about the domino effect on banks. If so, how can they save the real estate sector as planned to bail out $148 billion when banks are affected? Moreover, the key to the success of the Chinese real estate sector is investors' sentiments. Now it seems more challenging for the regime.