If you are a city or town in China, you must rely on the central government for the money you need to run things in a centralized economy… unless you find a BIG LOOPHOLE in the way economic value can be generated – on the side. What if you could buy (take actually) land in areas that you think could be valuable for residential and commercial property if developed, bring in some entrepreneur with access to cash and the knowhow to build, and flip that land for a massive profit? The old “buy low, sell high” maxim?
The loophole is precisely existing Chinese law that allows municipalities to confiscate peasant land, compensate or “relocate” the residents at clearly substandard levels, and then develop the “taken” land for profit. Not exactly the eminent domain concept that allows U.S.-based governments to take land at fair market prices for the greater social good. More like letting high profile financial institutions – like Goldman Sachs – borrow money from the Federal Reserve at close to zero interest so that they can speculate on their own account and make bazillions of dollars of profits. Folks in China turned out of their homes sometimes turned to suicide (some pretty nasty self-immolation included), but that made little difference. Municipalities bestowed lucrative development agreements with favored sons – clearly the politically we ll-connected – and built a class of real estate millionaires and more than a few billionaires along the way. The cities too prospered, often building massive architectural wonders into the local city hall. If you are ever in Shanghai, check out the amazing building with a pearl at the top.
For many cities, this build out did in fact generate the wealth that cities and towns expected. Add a transaction fee to the local government when land changes hands, and municipal revenues can soar. The new construction – much of it pretty shoddy since many cities had no real experience with solid building codes – sold like hotcakes. But then, there are the vast housing developments in outlying regions that lie empty; the plan didn’t always work. And with so much development and so many people borrowing to buy these properties – many purely for speculation and not actually to live in – there was this quivering sensation that a housing bubble was about to burst.
China promptly required larger down-payments – 30% for primary residences and 50% for additional homes – to help stem the tide towards bubbling… and to stop a growing populist backlash against such clearly unfair municipal practices in seizing land. Protests were building. The markets reacted: “May home sales in Beijing and Shanghai plunged 70% compared with April, while transactions in the southern boomtown of Shenzhen were down 62% over the same period, according to government statistics.” Los Angeles Times (June 8th). And China is even thinking about instituting an annual property tax to make it harder for people buying and holding spec homes.
Clearly, the people want to correct the process and compensate people at more economically justified rates. The New York Times (May 26th): “China is not a good setting for a Frank Capra tale, but people do have influence over their autocratic masters. Top officials are worried that the property rush — which has led to soaring prices for urban real estate and low prices for old homes and farmland seized for development — is enriching local governments and well-connected developers at the expense of ordinary people and social stability… Effective confiscation of land nominally owned by the state, but farmed or lived on by the poor, has been a major source of unrest for the past two decades… In a provisional move… [based on legislation passed two years ago by the National People’s Congress,] China’s cabinet issued an ‘emergency notice’ in recent days demanding that local governments hold officials accountable for ‘vicious incidents’ and, by the end of June, publicize ‘reasonable’ standards of compensation… But the question is whether that and the newly proposed regulations will be tough enough, or come soon enough, to make much of a difference.
“In China’s 70 biggest cities, government land-sale revenues leaped 140 percent in 2009, to $158.1 billion. Land sales provide up to 60 percent of local government revenues, by one semiofficial estimate — and much more by some private ones… The losers have been ordinary citizens, ousted from their homes with cut-rate compensation and scant legal recourse. The existing loophole-ridden land rules, dating from 2001, give developers wide leeway to clear property.” The Times. Local Chinese are skeptical that this reform will actually take place or that the politically connected will be deprived of this now-accepted path to riches.
If the bubble begins to burst, the central planners in Beijing may be faced with having to buy up many of these shoddy and unsold neighborhoods and empty commercial buildings in order to avoid a total real estate market collapse, like that experienced in many nations – the United States included – around the world. To do less would be to admit the error of this clearly egregious policy and show that China is no different from the other nations on earth… except they actually can afford to buy the properties, even if that is a wasteful use of sovereign wealth. “Central planners will be under tremendous pressure from city and provincial officials not to stifle the housing boom, said Andy Xie, an independent economist in Shanghai. Local governments rely heavily on revenue raised from real estate transaction fees. He said many have accumulated significant debt in recent years to finance infrastructure projects and need those property sales to continue.
“‘They don't want the bubble to pop,’ Xie said. ‘The government is leaning against the bubble, not popping it. Nobody believes this policy is sustainable.’” LA Times. Can central authorities afford to let those municipalities suffer the agony of misplaced development or will they finally come to the rescue? Or will they let a few cities and the developers that love them fall as a lesson to many others… before they step in and stabilize the market.
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