Introduction
The Chinese real estate market is one of the major industries which influence the steady economy growth of China in twenty century. It also experienced abnormal growth in price recent years (including the stock of Chinese real estate) which causes many young generations can not afford to buy commercial house (Zhu, 2010 and Gao, 2010). In this dissertation, the real estate is mainly considered as the commercial residential house. Take the well developed city Shenzhen as an example. According to the Shenzhen National Economic and Social Development Statistics Bulletin (2009) cited in Zhu (2010), 留学生硕士论文代写the disposable annual income of urban resident was 25,936 Yuan in 2003, which rose to 29,245 Yuan at the end of 2009, an increase of 12.76 percents over 7 years. At the same time, the average new home prices rose by 1.6 times in Shenzhen. Zhu (2010) refers to the Shenzhen Real Estate Market Analysis Report (2009) the average new house prices in Shenzhen was about 5,664 Yuan / square meter in 2003, which increased to 14,858 Yuan / square meter in 2009, an increase up 162 percents over 7 years. The increase in home price is 10 times more than the increase in disposable income. By applying some simple mathematics, an employee in Shenzhen can only buys two square meters of floor area with one year disposable income, under the circumstances of no expense at all which including no income spend on food. Therefore a commercial house which has 100 square meters with the price matching the average market price will take the employee 50 years of working to buy it under the circumstances of no expense at all. However, not all the commercial houses match the market price. Zhu (2010) also mentions that since October 2009, the monthly average price of apartments in Shenzhen has remained at 20,000 Yuan / square meters, in February 2010, the figure have risen to 24,000 Yuan / square meter. The skyrocketing price in some regions is more alarming, many real estate price increases are more than 5 times of the 2003 figures, especially the luxury residential area and the new planning area.
It is worth to highlight, the skyrocketing price of the urban housing markets contributed to China economic volatility. By employed various econometric methods, Hui and Shen (2006) demonstrate that there was a bubble in Shanghai’s housing markets in 2003. Similarly, Xie (2004) analyses market irrationality based on the price–rent ratios in major cities such as Beijing, Shanghai, and Hangzhou. Their studies clearly demonstrated the strong speculative mode of housing markets in Shanghai and Hangzhou since 2003 (Xie and Liu, 2004). Purchasing house has become the common speculation for many home owners (Wu, 2008). Zhang (2010) states that the rate of housing vacancy of new commercial houses in the major cities are as high as 40 percents, some cities even reach 50 percents, the figures is much higher than the “international warning line” which is 10 percents. This implies the level of speculation of real estate in the major cities is absurdly high which leads the skyrocketing price and also causes real estate bubble to be formed in China (Ifeng, 2010).
China Urban Development Report (2009) cited in People (2010) states that although China has the largest population in the world – almost 1.4 billion, but more than 50 percents - 700 million of the populations are agriculturists. In addition the urbanization level is still lagging behind the development of industrialization at present, from the development point of view, the urbanization not only well below the 85 percents of well developed countries, but also below the world average 50 percents, there is plenty of room for future development.
Chinese urbanization scale and pace will continue at an unprecedented rate. If current trends hold, the urban population will expand from 572 million in 2005 to 926 million in 2025 and hit the one billion mark by 2030. Which implies 350 million people will be added to the cities’ population in 20 years (Mckinsey & Company, 2008). China Urban Development Report (2009) cited in People (2010) also points out China has entered a period of accelerating urbanization, it is predicted there will be 50 percents of the population live in cities by the year 2020, and 75 percents of the population will live in cities by 2050. The urbanization of Chinese population will create enormous demand in the Chinese real estate market. Which implies the future of the Chinese real estate market will be optimistic. Doubtlessly, high demand and the limited supply of the commercial house led to skyrocketing of the commercial house price.
The emergence of the bubble can be traced to the China’s aggressive response to the global financial crisis; the central government spent 15 percents of its gross domestic product (GDP) which was roughly 575 billion U.S. dollars in direct stimulus. The Chinese banking sector also followed the government action, the credit extended by China’s banks also increased (Fried, 2010). According to the Banks' Annual Business Reports (2009) cited in Qiang (2010), 12 listed banks doled out total loan amounted to 21.77 trillion Yuan (3.19 trillion U.S. dollars) in 2009, with property-related loans totalling 5.28 trillion Yuan, where 1.66 trillion Yuan to property developers and 3.62 trillion Yuan to individuals for home purchasing. As majority of lending and stimulus spending were injected into real estate sector, the potential bad loans were accumulating. Which implies default risk was accumulating in the Chinese banking system.
Real estate bubble has been formed in China. The regional Chinese real estate market especially coastal cities have serious bubble (Ifeng, 2010). The bubble talk in China mainly targets the country's real estate sector, as there has been an increased in sales of 76 percents in property sector in 2009, meanwhile prices in some regional markets have recently been rising 8 percents to 10 percents monthly (Fried, 2010). The collapse of the Chinese real estate bubble is only a matter of time (Ifeng, 2010).
If the government still encourage to invest huge amount of money on real estate market and/or stock market, the real estate bubble might collapse which is similar to what happened to United States of American in 1930s, Japan in 1993 and South Asian in 1997 (Yang, 2006). Beijing, Shenzhen, and Shanghai are becoming the Chinese Florida, Nevada, and California (Ifeng, 2010). The collapse of the bubble may trigger the worst outcome of the default risk which is the collapse of the whole Chinese banking system and the stock of Chinese real estate. One main effect of the collapsing real estate bubble is the price of real estate will drop dramatically. The Chinese bank - Bank of Communications announced they can afford the real estate market price to drop within 30 percents. If the price drops more than 30 percents, disaster can emerge (BJ News, 2010). More detail will be discussed in the findings chapter. It is known the collapse of American investment banking system triggered the global financial crisis. Therefore the Chinese government will do everything it can to prevent the collapse of the bubble and the accumulation of default risk in the Chinese banking system. In order to avoid it happened, the latest policies toward the Chinese real estate were introduced by the government on the Saturday 15th April 2010 (Qiang, 2010). The detail of the policies and the implication will be discussed later on.
The characteristics of the Chinese real estate market
There are five characteristics of the Chinese real estate market. First of all, the Chinese government is the owner of all lands. When real estate firms seek the land from government to build properties, they have and only have the right to manage and control the land for 70 years (Land China, 2010). Secondly, as the amount of the raw material of the market – land is fixed, therefore the price of the real estate market is mainly determined by the demand of the market. Higher the demand, higher the market price. In addition, Chinese real estate market not only is highly related to the government, but it also involves the many activities with the financial institutions such as banks. Real estate in any countries shares one similar characteristic, which is the real estate investment worth high value to many individual investors. Also such investment tends to be long term investment to most of the individuals. Moreover, the Chinese real estate market is an imperfect competition market. Jain & Khanna (1981) notice that the perfect competition market can be defined as the product being homogeneous, zero entry/exit barrier, perfect information, and firms aim to maximise profit. As the end product – commercial houses are different to each other; entry cost is enormous; and the information in the market is definitely imperfect but asymmetry. All these determine the Chinese real estate market being imperfect competition market. The market information being asymmetry will be highlighted in this project later. Last but not least, the real estate market in China tends to be regional compares to many other industries. As mentioned earlier, the regional Chinese real estate market especially coastal cities have serious bubble. The real estate has the characteristic of the location being fixed and immobile, therefore different region of China will have different market price
Since the development of the Chinese real estate market began in 1978, Chinese real estate market has gone through more than 30 years of development. The Chinese real estate market is becoming well developed and it can be categorized as tier 1, tier 2 and tier 3 markets. Tier 1 market is also known as the land market. As mentioned before, the government is the owner of all land. And real estate firm is the developer of the land. So in tier 1 market, the seller is the government and the buyer is the real estate firm. The government is also the monopoly of the market. Tier 2 market is the market with these two parties involve, the real estate firm and the consumer, generally the new commercial house is the product of the market which can be sold or rented. Also tier 2 market is the market where the real estate firm sells the right to use the land to anther real estate firm. Tier 3 market is the market of the second-hand commercial house, the owner of the new commercial house sells it to the market for various purposes. In these three markets, there exists the asymmetric information. The seller in the market always has the information advantages and the buyer is on the information inferior side. Not only the information asymmetry led to the emergence of the bubble, but it also led to the accumulation of default risk in the banking system. Therefore the investigation of the information asymmetry needs to be carried out in order to resolve the issue of expanding bubble and increasing default risk (Lawerhfm, 2010).
Statement of purpose: Research questions and objectives
Title: The information asymmetric in the Chinese real estate market and its implication toward the bubble, Chinese real estate stock and default risk of the Chinese banking system.
Aim: To investigate the cause of the Chinese real estate bubble - information asymmetric, and its implication toward the bubble, Chinese real estate stock and default risk of the Chinese banking system.
Objectives:
Examine the information asymmetric between these four parties in the society: the government, the bank, the real estate firm and the consumer
Assess the role of asymmetric information in accumulation of default risk in the Chinese banking system.
Discuss the government intervention in order to find out whether the expansion of Chinese real estate bubble and the accumulation of the default risk can be slowed down.
The suggestions for the current issues of the Chinese real estate market.
Literate Review
Various researchers have looked into the issues regarding the default risk, information asymmetric, adverse selection, moral hazard and stock liquidity. In this chapter, detail will be discussed.
Default risk
Default risk is also known as the credit risk. It is the risk that borrower can not make the payments as promised. Lenders such as banks inevitably face default risk and the event which loss emerges from borrowers who fail to make the payment is known as default (Chance, 2001). More loan which are extended by the bank, more default needs to be faced by the bank.
Default risk is part of the financial risk. It is also an important risk in the recent global financial market as it brings challenge and pains to the global financial system. It can be reflected in such ways: the global debts are increasing dramatically, default risk is accumulating in the system; banks inevitably face the default risk and expose to the potential of huge amounts of bad loans; the market of financial /derivatives is developing rapidly. In order to measure default risk, these are the models which can be used: the KMV model developed by the KMV Corporation; the McKinsey's Credit Portfolio View model; the Credit Metrics model developed by J.P Morgan; the Credit Risk Plus and RAROC Model developed by Credit Suisse Financial Products (Westgaard & Wijst, 2000).
The uncertainty in decision making and the asymmetry of information lead to the emergence of default risk. In addition the asymmetry of information leads to the adverse selection and moral hazard which destroys the market equilibrium system. Improving the information in the financial system will reduce the level of default risk (Zhou, 2006). In Chinese real estate market, the information asymmetry directly leads to the dramatic increase of bank loan; this implies the potential of bad loan in the China’s bank system also increase. Therefore the default risk also increases.
Information asymmetric
Information asymmetry is defined as one party of the economically related parties have certain information which is relevant to the subject that matters but the other party doesn't possess the same information. In the asymmetric information environment, the party which possess better information may use such advantage to achieve benefit maximization, while the inferior information party’s interests are likely to be damaged (Cataldo, 2003). This is particularly true and common in the Chinese real estate market.
The asymmetry information theory was founded by Professor James A. Mirrlees of the Cambridge University and Professor William Vickrey of the Columbia University. They separately revealed how the asymmetry information affects the transaction, and how to deal with asymmetric information in 60s and 70s. 30 years later, the role of asymmetric information theory becomes more and more important in economic activity. Especially the response and action towards the asymmetry information becomes powerful tool in modern economic. They won Nobel Prize in Economics in 1996. In 2001, three U.S. economists shared this year's Nobel Prize in economics with their work on the dynamics of information flows and market development. They are Professor George Akerlof of the University of California, Berkeley; Professor A. Michael Spence of the Stanford University and Professor Joseph E. Stiglitz of the Columbia University. Professor George Akerlof proposed the model of the second hand vehicles market. In this model, the buyers do not know the specific quality of the second hand car, thereby they only bid on average, which lead to low-quality second hand cars take over the high-quality used cars, so there will be no high-quality car in the market. The model revealed the information asymmetry can lead to market failure. Professor Spence and Professor Stieglitz analyzed how to solve the information asymmetry from two parties. Professor Spence proposed signalling model which proposed the party which has superior information can send a signal to improve the information of the party which have inferior information, therefore the information of two parties becomes symmetry. Professor Stieglitz proposed the information screening model which proposed the party which have inferior information may use the contract, examination or various methods to design a screening mechanism to get some useful information, so two sides achieve the information symmetry (Li, 2005).
The basic content of asymmetric information theory can be summarized as two points: first the information relating to the transactions or to the subject that matters between the two parties are asymmetric, one party holds more relevant information than the other. Second two parties know their relative position regarding the information they possess. Asymmetry information may occur before two parties sign the contract or occur after the parties signed the contract. The investigation of pre existing asymmetric information is also known as the adverse selection model and the measure of asymmetric information after the event is called moral hazard model. The information asymmetry takes place in advance of the event implies a party prefers not to reveal certain information (or knowledge) in order to take advantage of other party, the information asymmetry after the event implies a party do not takes action as promised in order to take advantage of other party (Li, 2006).
In the modern day business point of view, information asymmetry can take place when supplier of an investment product possesses full and accurate information regarding the product but the consumers have limited knowledge. Or it can refers to manager of firms knows more about what happens in the firm than the investors (Redhead, 2003). This is practically true and common in the Chinese real estate as the consumers only have limited knowledge of the commercial houses that the real estate firm are selling. They also have no clue regarding the cost and the operation of the real estate firm.
Adverse selection
In the environment where information asymmetry is prevailing, it would lead to the adverse selection phenomenon. Adverse selection implies before contract is signed, the party has already possessed certain information that the other party does not have, such information may affect the interests of the party that does not have the same information, so the information dominant side are likely to use such information superiority to maximize the benefit, meanwhile the harms will be brought to the other party. In such environment the market efficiency and economic efficiency will be reduced. The product quality is an important feature in daily trading, in many occasions, buyers do not know the product quality, but the sellers do. Different vendors offer different product with different quality, the vendors of the poor quality products may hide the poor quality information for their own interests. When all the sellers say their products are the good one, this will lead to buyers cannot distinguish between where the best products are. Buyers could only evaluate the market and make up their mind of purchase quantities and the price they should pay. As good products and defective products are treated the same way by the customers, the defective products have advantage at the cost therefore may be an advantage in sales. When the buyers found the product they purchased was not as good as they estimated, they will further drop their expectation level of product quality and reduce the price they offer. At this point, good products lose the competition against the defective products; ultimately the good product with higher cost may be drive out of the market. Only the defective products are remained in the market, which implies the market competition under the principles of the fittest survive fail in the environment of adverse selection phenomenon (Li, 2005).
In terms of the Chinese real estate market where most of the defective products exist, the consumers face the question of which commercial house have better quality. Due to the consumers possess limited information regarding the commercial house; they will bid on the commercial house which has average level of quality. This lead to the commercial house which is better quality than the average becomes out of consideration and quit the market. The clever buyers know the remains in the real estate market are those commercial houses which are below the average quality, therefore they offer lower price. This further leads to certain products quit the market. In long term, even if the real estate market does have some high quality product, the consumers will still consider carefully before they buy them as they believe there are no good quality commercial house, or they prefer not taking the risk at all. According to information economics theory, adverse selection leads to the defectives products stay in the market and damaging the market as the good quality product with higher cost may be driven out of the market, and ultimately destroys the confidence of the consumers in the market. On the other hand, despite the fact that customer knows some vendors are good, but they cannot distinguish the good or bad one, so they may prefer not to buy instead of taking the risk of getting the defective product (Li, 2006).
In the traditional theory of perfect competition, the market is under the assumption of all products have the same quality. Therefore, in order to achieve lower price, the sellers necessarily need to improve production efficiency in order to beat their rivals in the market competition. Such price competition will not make the market deserted but boom. In addition the competition is conducive to the optimal allocation of resources and social welfare (Jain & Khanna Business economic, 1981). However, when the quality of information can be hidden, some companies can take non-price competition, which implies instead of increasing the productivity to lower the prices to compete, they prefer to lower the product quality to reduce costs despite the fact that consumers cannot distinguish a good or bad product due to limited knowledge toward the product in the market, therefore the companies achieve competitive advantage. Such behaviour is harmful to the market (Li, 2006).
Moral hazard
Moral hazard generally refers to the party who is engaged in economic activities try to maximize their benefit at the expense of other party after the contract is signed. Such phenomenon may cause the ineffectiveness of market due to the conflicts between two parties. As the client's interests still depends on the agent's action, whether to satisfy the client's interests or not is a matter of moral hazard, the client has no clue regarding the action of the agent, also the agent does not bear the full consequences of its action due to the asymmetric information and the contract is not being well regulated, therefore the agent tends to take less care or leave the client to bear some responsibility of the action. In economics, moral hazard mainly refers to the contract’s terms cannot specify the future action of the agent. The agents’ choice of actions will affect the client's interests. The fear of moral hazard will also lead to the desertion of the market as moral hazard seriously damage the economy and society. Moral hazard in the real estate market commonly refers to the real estate firms do not meet the terms of the contract after the sale stage. During the sale stage, the real estate firms make the wonderful promises in order to boost the sales, not only they hide the defectives in the product, but they make promises such as they will improve the public infrastructure in their real estate project in future. However, most the promises will not be fulfilled in future which leads to the conflict between the consumers and real estate firm in future (Deng, 2007).
The supply and demand of the Chinese real estate market model under asymmetric information
The Chinese real estate market is a place where most of the market information is asymmetry. In order to have a preliminary understanding of such market, it is useful to link the market with the micro-economic supply and demand model. Most of the micro-economic theories are based on assumptions. Different type of issues or different type of the models in micro-economic require different assumptions. To analyse the Chinese real estate market with the supply and demand model, certain assumptions can be applied to provide conveniences for the analysis, although the assumptions are unrealistic. These are the assumptions:
1. The participants of the real estate market act rationally. Rationality of participants simply implies the all the economic activities done by the participants are aiming to pursue the profit for their own. Also they aim to maximise economic profit by minimum cost. In the Chinese real estate market, the suppliers will always try to push up the housing price in order to maximise the profit. On the other hand, the demander will try anything possible to push down the housing price to maximise the utility of consumption.
2. The asymmetry of the information. This simply implies the information possessed by the suppliers will be different to those possessed by the demander. In the Chinese real estate market, information asymmetric is the most common issue, such as the real estate firms always possess better information regarding the residential house than the consumer. This lead to the real estate developer as being the supplier of the model can use the superior information to achieve profit maximization.
3. The perfect homogeneous of the commercial house. This implies the entire commercial houses in the real estate market are no different to the others. In reality, the difference in the commercial houses price is due to the inhomogeneous of the commercial house, such as floor area, the location. In order to simplify the model, it is more convenient to assume the perfect homogeneous of the commercial house in order to get rid of the difference in price (Xu et al., 2008).
The analysis of the real estate market model with asymmetry information
Xu et al. (2009) also mention in order to analyse the model with asymmetry information, it is useful to consider the traditional perfect competition market model. Under the perfect competition model, the market equilibrium E will be at the point where the supply curve S intercepts with the demand curve D (Please Refer to Graph 1).
Graph 1
Under the assumptions we made, the supplier of the real estate market which is the real estate firms, they possess better information than the demander of the market. They will also act rationally which implies they will use such advantage to push up the market price in order to achieve profit maximization therefore the market equilibrium will be diverged from point E. The real estate developer has two main ways to achieve the profit maximization.
The first method is to create an illusion in the market so the consumer in the market think the supply of the commercial house is way less than the demand, therefore the price of the commercial house will increase due to artificial supply shortage. The common method to create illusion is property hoarding. Property hoarding simply implies real estate developer delay the sale of the completed commercial housing project or not selling the project publicly in order to reduce the supply of the commercial house, thereby profit maximization and cost minimization can both be achieved (Sina, 2010). This simply implies real estate developer delay the sale of the completed commercial housing project or not selling the project publicly in order to control the supply of the commercial house in the market. As the supply of the commercial house is being controlled by the supplier, the supply curve S shift left to S1 (Please Refer to Graph 2). It shows the new equilibrium is shifted to higher left position which is E1, with price P1 increase to P2. Then the real estate firm will gradually sell the entire products at the higher price P2.
Graph 2
Another way to achieve profit maximization is also to create an illusion in the market, but this time the real estate developer tries to create artificial surplus demand. The phony real estate speculator will provide such service for the real estate developer. The phony real estate speculator is the new grey area industry, most of the real estate developer or their marketing department will hire the phony real estate developer during the sales of commercial house. These people were hired to either queue up during real estate buyer registration in order to create the illusion of surplus demand toward limited sale, or they will try to create the illusion of panic buying. But they have no intention to buy the commercial house at all. Most of the real estate firms in the city Dongguan have used such service before (Zhou and Zhao, 2008). As the consumers possess limited information regarding the commercial house, they are most likely to follow the trend. When consumer observes the action of the phony real estate speculators, the illusion of surplus demand will be created which implies they will think the demand curve D have now shifted D1 (Please refer to Graph 3), most of the consumers are willing to pay higher price as they think if they don't buy the house today, somebody else will take the opportunity. Thereby the price P1 increases to P2 while new market equilibrium shifts to higher right.
Graph 3
Stock liquidity
Stock market liquidity can be a good indicator of the economy as it predicts the current and future state of the economy. During the economic downturns the common observation regarding the stock market liquidity is that the liquidity tends to dry up. Liquidity tends to be a better predictor than stock price fluctuation is due to the stock price has more complex mix of information which blurs stock return signal. The common four liquidity measures are: Relative spread (RS), the Lesmond, Ogden and Trzcinka (1999) measure (LOT), the Roll (1984) implicit spread estimator (Roll) and the Amihud (2002) illiquidity ratio (ILR) (Naes et al., 2010).
Naes et al. (2010, p. 5) says that:
“Spread costs are observed in dealer markets as well as in limit order markets. The relative spread (RS) is the quoted spread (the difference between the best ask quote and bid quote) as a fraction of the midpoint price (the average of the best ask quote and bid quote) and measures the implicit cost of trading a small number of shares. Another liquidity measure is the Roll (1984) estimate of the implicit spread which is also known as the effective bid-ask spread, is measured from the serial covariance of successive price movements. Amihud (2002)'s illiquidity ratio (ILR), is a measure of the elasticity dimension of liquidity. Elasticity measures of liquidity try to estimate how much prices move in response to trading volume. Thus, cost measures and elasticity measures are strongly related”.
Lesmond et al. (1999) citied in Naes et al. (2010, p. 5) suggest that:
“A measure of transaction costs (hereafter the LOT measure) that does not depend on information about quotes or the order book. Instead, the LOT measure is calculated from daily returns. It uses the frequency of zero returns to estimate an implicit trading cost. The LOT cost is an estimate of the implicit cost required for a stock's price not to move when the market as a whole moves”.
Lesmond et al. (1999) citied in Naes et al. (2010, p. 5) also estimate that:
“How wide the transaction cost band around the current stock price has to be to explain the occurrence of no price movements (zero returns). The wider this band, the less liquid the security. Lesmond et al. shows that their LOT measure is closely related to the bid-ask spread”.
Summary
To conclude, the default risk as part of the financial risk not only increases in China banking system, but also in the globe. The information asymmetry plays a major role in the increasing default risk. The information asymmetry implies one party of the economically related parties have certain information which is relevant to the subject that matters but the other party does not possess the same information. It may occur before two parties sign the contract or occur after the parties signed the contract. The information asymmetry takes place before the contract is signed is known as adverse selection model and the after the event is called moral hazard model. By comparing the real estate market model under the traditional perfect competition mode and the information asymmetry mode, the price shifts to higher position can be identified. Finally, the stock market liquidity can be a good indicator of the economy as it predicts the current and future state of the economy. The common four measures of the stock market liquidity have been briefly illustrated.
Methodology
Introduction
In this chapter, secondary research method which has been used in this project to achieve the aim will be described and discussed. Saunders et al. (2007) says that as tools methods can be used for collect and analysis data. Blaxter et al. (1999, p. 59) notice that “method can be understood to relate principally to the tool of data collection”. Therefore, the methodology can be used to clarify the approach. In this chapter, description of secondary research, strength and limitation of the research design, how they have been collected, analysed and reported and ethical issues will be discussed.
Choice of Research Design
Secondary research mean to use the source, information and data which collected by others. The research questions can answer quickly and cheaper by using secondary information (Hakim, 1982 and Gorard, 2003). It provides higher quality data than primary research. However, if secondary source has not been evaluated carefully, it may be not proper and suitable for the some specific part of a research projects (Stewart and Kamins, 1993 and Saunders et al., 2007). The reason of used secondary research in this research was due to the data that the author wants had already exists in some form, plus less time and money cost (Ghauri and Gronhaug, 2005 cited in Saunders et al., 2007). Moreover, secondary research is compulsory in every research which implies researches can not be conducted without secondary research.
Construction of the Chosen Method
In order to provide various information and support author’s argument, books, e-journals, internet sites and newspapers were the main secondary research sources in this research. Books can provide basic idea about the research topic. More theories discuss than practical works in books. But the information may be out of date, due to the time scale from book write to publish usually takes up to one year. In addition, due to all chapters are interconnect in every books, author will not spend more time to read the whole book rather than one or two chapters. Even through experts will refer all the material in journal before it publishes, thus, journals are more academic (Denscombe, 2003). The “reputation” still need to access by author by check date of published and authority publisher. Journals are up to date due to they are published periodically. Journals are subject specific. Therefore, information can be gather quicker and easier from read one journal rather than read a whole book. Internet site become a popular source for information gathering, because it more convince to use and search information quickly. However, the information reliability needs to be carefully considered by writer’s background, published date and purpose of written. Newspapers are up to date, but information collection and gathering will take more time to complete. This is due to the newspapers are published everyday.
Sample
The information has been gathered in many occasions. Then divided into different categories for author used in different part of this dissertation. Even through this research focuses on real estate market in the China, secondary sources were from worldwide and there is no special need for the date of publication. However, up to date information will make the whole project more accurate and reliable.
Procedure
The e-journals were found through Aston e-library. The books were found by Aston university library and Birmingham Central Library. Newspapers were purchased from newspapers retailer in China.
Data Analysis
In order to provide arguments for the research aim and objectives, different authors’ ideas and opinions has been emphasize, compare and contrast by the author. Moreover, the Chinese stock analysis tool had been used to show the stock price on some important dates as it provides the snapshot of the price.
Strengths and limitations of the research design
There is no prefect research methods coordination. To ensure the research validity, accuracy and reliability, the author has been choose the most suitable research method. Due to the limitation of time and lack of public relation, primary research has not been conduced for this research project. However, due to the similar research topic has been written by various writers, there are huge amount of secondary information can be used.
Ethical issues
Data collection and using need to be considered, like only collect the needed information, make sure the information secure, accurate and undistributed. The secondary information which has been used in this project has been well referenced. Therefore, there is no ethical implication in this research.
Summary
The secondary information used in the project has been mentioned. The choice of research design, construction of the research methods, sampling used, the method of data collection and analysis have been described. The strengths and limitations of the research design and ethical issues have been discussed. In the next chapter, findings will be described, analysis and discussed.
Findings
Introduction
In this chapter, the author is going to analysis, discuss and evaluate the data which has been collected from secondary information in order to achieve the four objectives of this project.
Objective 1 Examine the information asymmetric between these four parties in the society: the government, the bank, the real estate firm and the consumer
The Chinese real estate market is formed by these four parties, the government, the bank, the real estate firm and the consumer (please refer to Table 1). As mentioned earlier, the government is the owner of all land. The buyer of the land only has the power to manage the land but not the ownership. And such power only lasts for 70 years. Government can sells the land and gains revenue. The real estate firm (developer) is the developer of the real estate which is granted the land development permission by the government. They are the controller of the price in the market as they can form the cartel; therefore they are one of the beneficiaries in the market. Consumer is the buyer of the commercial house. In the future 20 to 30 years, the consumers will increase significantly due to the trend of urbanization. Therefore the demand of the commercial house will increase in large proportion. Banks are the suppliers of capital, not only they supply capital by issuing loan to real estate firm, but they also supply capital to individual consumer. Banks try to maximize their economical profit by extending loan at the same time they inevitably face the default risk. Therefore they play a major role in the emergence of the bubble.
Table 1
Government（the owner of all lands） → Real estate firm/developer（controller of price） → Consumer（the buyer of commercial house）
↓ ↓
Banks（supplier of capital）
Li (2005) points out that the emergence of the asymmetric information in the Chinese real estate market is due to the parties who possess better information always choose to maximise profit with their superior information. Under the short term profit pursuing environment, each party decides to hide specific information. The professionalism in each party objectively leads to the emergence of information asymmetric. In addition the cost of gathering useful information in the market is high. In order for one party to gather the useful information from other party, various methods need to be applies such as primary research and secondary research. These researches will have high cost under the circumstance that the other party does not want to disclose certain information such as cost. Moreover the uniqueness of the real estate industry also leads to the asymmetry information. The end product of the real estate industry goes through different production processes; each process is involved with many other industries. Such as building of commercial house at the foundation process, not only it involves the construction industry in terms of building and developing the land, but it also involves material retailing business, such as cement, steel. Each party possesses specific information that is unique, unless they want to announce such information, otherwise to obtain the information will be costly and almost impossible. Last but not least the cost of preventing moral hazard in the real estate market is high. In order to prevent moral hazard, the contract needs to be well specified which is almost impossible, the reason will be discuss later. Also when moral hazard takes place and consumer’s interest is offended, the cost of resolving the conflicts through legal means is high, such as investigation and evidence collection, take the case to court. Time and money will be required and for most of the consumer, they can barely afford doing so. The moral hazard between the borrower and the lender ultimately leads to the increase of default risk.
The information asymmetry between the government and real estate firm
The government is on the information dominant side, the information which government possesses but the real estate firm does not can be reflected in three ways:
First the constant changes of the plan of the land supply. The latest policy regarding the plan of land supply was introduced at 2007 which was to hold no less than 18 hundred million Chinese acre of farmland, not only to ensure the China being free from food shortage, but also to protect the economic rapid development. Such policy implies strict control of farmland being transform to construction land, this will stop the excessive expansion of construction land and overheated investment in fixed assets, thereby ensure the healthy development of economy (Wen, 2007). As the local real estate firm possesses limited information regarding the local government’s future plan of land supply, therefore most of the real estate firms don't know when they can purchase the right land they want, this leads to the panic buying of land soon as the auction is available. The cost of the panic buying is real estate firm will pay high price for the land, and government benefits from the increase of the land revenue.
Second the government does not publish the cost of the land. The land auction was introduced in 1988. The reason for the government does not publish the land cost is due to the high revenue being generated from the sales of land. If the real estate firms know the cost of land is low, they are less willing to pay high price. In fact, in many Chinese cities, the land revenue has accounted for half of the local government’s revenue. The local fiscal revenue generates from land not only comes in as huge fiscal gains from the land auction, but also reflects in the real estate transaction process. Statistics show that during the construction and transaction process of the entire real estate development, the government tax and fees are accounted nearly 30 to 40 percents of real estate prices. If the real estate price also includes 20 to 40 percents of the land costs, the local government's income in real estate is accounted nearly 50 to 80 percents of the entire real estate prices. In western countries, land price, taxes and fees together add up to only about 20 percents of housing prices (Yuan, 2005). The majority of these wealth flows into local government and relevant departments' pockets.
Third is the constant adjustment of the government’s real estate policies. The latest policies were introduced from 15th April to 14th May 2010. The State Council announced the down payment for a family's first home with an area bigger than 90 square meters should be at least 30 percents. And for the second apartment, the required down payment was raised from 40 percents to 50 percents, and the mortgage rate should be no less than 1.1 times the benchmark interest rate. Moreover, a much higher down payment and mortgage rate will be required for third homes and above. In the area where the prices of commercial housing are too high, the commercial banks have the right to suspend the loan to investor who seeks to buy the third house according to their risk status; also the banks have the right to suspend the loan to those investors who cannot provide the local taxes or social insurance contributions for more than 1 year basis which prove them to be the non-local residents (The Central People’s Government of People’s Republic of China, 2010). Also the government introduced strict measures to curb land hoarding and property hoarding in order to resolve the imbalance of demand and supply of the commercial house in the real estate market (Wang & Wang, 2010). The real estate firm can only find out the impact of the policies after the policies are introduced, most of the times they are not prepared at all for the changes. Such as the real estate firms who are hoarding properties and lands would not know the measures against the land hoarding and property hoarding until the government discloses them. Therefore the real estate firm may have to face the punishment by the time they realise some actions must be taken toward the lands and properties they hoard.
The information which possesses by the real estate firm but not by the government is the creditability of real estate firm and how the firm will operate. The sales of land in China is in auction form, the highest bidder win, and the highest bidder only needs to pay 30 percents of down payment to get the permission from the government to develop the land, but government does not know whether the real estate firm has the ability to repay the 70 percents of entire payment. Bank will pay the 70 percents of entire payment and take the land as the collateral. Some real estate firms fail to repay the 70 percents of entire payment and lead to the emergence of many incomplete properties in different cities of China. In addition, the government does not know how the real estate firms will manage the land after the permission of development is granted. This leads to the emergence of land hoarding and property hoarding by the real estate firm. By hoarding the land and property, the supply of the commercial house will be controlled by the real estate firm which implies they can sell them for higher price and gain extra profit (Sina, 2010).
The information asymmetry between the real estate firm and the consumer
The real estate firm is on the information dominant side and the consumer is the victim. Such advantage allows most of the real estate firm to maximise their profit. Whether to be ethical or to be economical, most of the real estate firms choose to be economical. This implies they use their superior information to maximise the profit at the expense of the consumer. The information which the real estate firms possess but the consumers are listed below:
Most of the real estate firms do not announce the cost of their products; sometimes they don't announce the price of the presale commercial house as well. Journalist in Guangzhou randomly selected 10 commercial house sales departments to investigate the pre sale of commercial residential house on 20th April 2010. Only three out of the ten announced the pre sale house price to the buyer publicity, none of the others announce the price. Journalist asked one of the real estate firms to provide price lists of the presale commercial houses for buyer but he was turned down by the real estate firm (Wang et al., 2010). The professionalism of the real estate developers provides them the advantage of possessing better information of the cost than the consumers in the real estate market. Hiding the cost and price information allows the real estate firm to set the high price for their product as consumer can hardly finds out the actual cost (Yang & Zheng, 2010).
Many real estate firms are selling their products in different phase which is known as property hoarding mentioned earlier. In response, buyers are not likely to understand the principle behind such phenomenon due to the lack of real estate market information. They will believe the existence of supply shortage of the commercial houses and some of them are willing to pay higher price for the hoarded commercial house (Li, 2006). In addition most of the real estate firms also use media such as newspaper, television to advertise and publish some tempting product information to create the hype, or try to create the illusion of the excessive demand over the limited supply in order to increase the price of their product.
When signing the contract, the general offers are made by the seller, then buyers commit, the contracts and its terms are well developed in advance by the seller, even if the buyers are not happy about the terms, the contract and its term can not be changed, therefore, the two sides are not in an equal position which implies real estate firm can try to make contract’s term more favourite to themselves as most of the consumers lack of the professional knowledge of the real estate market and law. Real estate firms can also use their position of information superiority in product quality, facilities and property management to make profit out of nothing at all, such as developers can change the design without the agreement of buyers in order to achieve minimization of private use of space and increase total public area for other purpose; or making unrealistic promises in order to boost sales and pursuit short term profit, which lead to the poor management of property and conflict with residents in future, this is also known as the moral hazard of the real estate market (Huang & Chen, 2010).
The information asymmetry between the real estate firm and the bank
Real estate development requires large amount of capital, also it is a long term investment. From the launch to the maturity of the real estate project, it normally takes 5 to 10 years depends on the scale of the project. This implies the help from the bank to the real estate firm is inevitable in the real estate market. According to the Law of the People's Republic of China on Commercial Banks, the real estate firms must have their own fund as proportion of 30 percents of the overall capital requirement in order to apply the loan from commercial bank (Law Time, 2010). However, in order to get the capital from bank, the real estate firms use various illegal methods as result of the asymmetric information between two parties. The real estate firm is on the information dominant side and the bank is the victim.
Some real estate firms use "false mortgage" to get cash. This is done by the real estate firm provide their employees the various false materials in order to help them apply for personal housing loans from bank to buy their own product. This implies the employees of the real estate firm are also the customer of the real estate firm. The logic behind such activity is if a commercial house was selling at 1 million Yuan in the market, before the latest policies were introduced, then down payment of the house was 200,000 Yuan as 20 percents of the house price, the employees of the real estate firm don't have to pay this down payment to their firm at all. By providing the employee false material to apply the loan, this means the real estate firms can get 800,000 Yuan from the bank. It is worth to mention even the house price was selling at 1 million Yuan, but the cost of the house can be way below the cash they obtain from the bank loan. In addition, the price is set by the real estate firm; the price can be set unrealistically high due to the existence of unrealistic buyer. The profit will be generated if the cost of the house is less than the loan. Then the real estate firms have the options either to repay the loan for their employees, or not to repay the loan and let the banks claim the house for auction. If the bank claims the house for auction, the bank will suffers from the transform of its cash to the fixed asset – commercial house. The gain from the commercial house auction can hardly recover the loan (Huang & Chen, 2010). Another method is the real estate firm use the false materials and the fact that there is no interconnection between different banks in different regions of China，the houses which has been mortgaged to one bank can be mortgaged to different banks for more mortgage loans (China Real Estate News, 2006).
The information asymmetry between the consumer and the bank
The motives of consumers buying the commercial houses can be categorized into two groups. One is the motive of satisfying the residential needs. The needs can be the improvement on the current residential house, or it can be the graduates seek new commercial house to have their own family. Another motive is to speculate. The high return of real estate speculation is such a big lure to attract new speculators. For most of the consumers, buying one commercial house will take almost their entire working life time, especially when the bubble is expanding. Therefore the help from bank to the individual consumer is inevitable. Without the bank’s housing loan in the price skyrocketing real estate market, most of the graduates will have to live with their parents in the current residential house and work until they retire before they can afford one commercial house. But for some speculators, they are willing to take the risk base on their expectation of the real estate market and they borrow money from the bank and speculate, some of them may not be able to repay the money if the market trend reverses. The consumer is on the information dominant side, and most of the time the bank is the victim of the individual housing loan scam. Below are the behaviours of potentially increase the default risk in the Chinese banking system:
In China, the imperfect credit register and credit management system lead to the imperfect assessment of the income level of the commercial house buyers (Li, 2006). Nowadays, the bank requires individual consumer to provide these four materials before the loan can be issued, which are the personal identification, statement of personal income, the contract of purchase commercial house and the social insurance provided by the local government institution (Jian Ya Heng Tai, 2010). Apart from the personal identification, other material can be made false in order to deceive the bank. Consumers can simply make false materials such as false income statement in order to get the loan from the bank.
Objective 2 Assess the role of asymmetric information in accumulation of default risk in the Chinese banking system.
The emergence of the default risk in individual housing loan is mainly due to the asymmetric information in the real estate market. Recall the default risk is the risk that borrower cannot make the payments as promised. Lenders such as banks inevitably face default rise. The asymmetric information generally refers to as the seller has more information on the transaction items or subjects that matter than the buyer; however the opposite may exist. The trading mechanism between lenders and borrowers is using homogenous monetary exchange at different time points. Lenders lend the cash to the borrower and charge interest at the beginning; the borrower makes commitment to repay principal and interest payments of the loan within the agreed period of time by using their personal credit or residential mortgages. From the risk point of view, the risk of borrowers and lenders are asymmetric, lenders bear higher risk than the borrowers. The good example of the information asymmetry in the real estate market is the emergence of moral hazard. Due to the asymmetric information, the borrower will be clear about their own economic strength, and banks did not know the borrower's economic strength. Bank may have various ways to assess the ability of the borrower to repay the loans, but borrowers may use asymmetric information to delay repayment of the loans or carry out other activities that generate benefits at the expense of the bank (Zhang, 2010).
The Chinese real estate market is a market with obvious information asymmetry, as the result many resources has been wasted, it also created distortion of supply and demand. The information asymmetric has seriously affected the normal growth of Chinese real estate market (Li, 2006). Not only it leads to the corruption of the market order, but it also increases the financial risk in the Chinese banking system due to the accumulation of default risk. In the Chinese real estate market, the borrowers are mainly the consumers of the commercial house and the real estate firm. The consumers borrow money from the bank to buy commercial house and promise to repay the loan with interest within agreed period of time. The real estate firms borrow money from the bank to buy land from government, carry out real estate project and promise to repay the loan with interest within agreed period of time.
As the financial system of the Chinese real estate market is not complete, the real estate development and operation of the form of equity financing is far from perfect, corporate bond issuance has been strictly controlled. Therefore the funding channels of the real estate development are limited and they are mainly indirect financing. In the real estate industry chain, from land acquisition to commercial housing development, to final sale of the commercial house, the credit of the commercial banks covers almost the entire real estate market operation process; the supports of the bank become the main funding source of the Chinese real estate market. In other words, due to the low degree of development of real estate capital markets, project financing in real estate development is still not free from the over-reliance on commercial banks. TRUST, real estate equity financing, real estate bonds and housing asset securitization are rare in the real estate capital market. People's Bank of China pointed out in the "2005 China Real Estate Financial Report" that 70 percents of self-financing fund of the real estate firm comes from the bank loans, 30 percents of funds for housing deposit and down payment also come from the bank loans, the usage of bank loan in the real estate development is over 55 percents. This implies banks in fact, directly or indirectly take over the running of all aspects of the real estate market which also include the market risk and credit risk. The market risk for the real estate market is a serious threat to the banking system’s security and stability. In the real estate market, if disaster emerges such as the collapse of the real estate bubble, serious harms will be brought the entire banking system (Zhang & Wei, 2010).
In the real estate market where asymmetric information is prevailing, what is the implication toward the default risk in the Chinese banking system? In order to answer the question, it is worthwhile to revise the information asymmetric between the four parties:
First of all, the information asymmetric between the government and real estate firm has these impacts toward the default risk. As the government doesn’t disclose the cost of the land and the plan of the land supply, this generates enormous amount of income from land auction. Yuan (2005) suggests that the local government is undoubtedly the number one beneficiary in the real estate market as the government is the monopoly in the market; it implies the government fully controls the supply of the land. This can be shown from the revenue generated from the land auction. According to Sheng (2005) cited in Yuan (2005) says that the land auction revenue of the local government is 910 billion Yuan in 2001 and 2003. In 1998, the data was as little as 6.7 billion Yuan. Such dramatic increase in the fiscal revenue also implies the cost of land also increase dramatically. As the cost of the land increases dramatically, this implies the real estate firms will borrow more money from the bank in order to buy land. As banks extend more loan than before, the potential bad loans are accumulating, thereby the default risk too.
On the other hand, as government possesses limited information of the operation of the real estate firm, most of the real estate firms carry out illegal activities such as property hoarding and land hoarding in order to gain more profit. Both activities will lead to the increase of the commercial house price. As the commercial house price increases, the ultimate result is the consumers will have to borrow more money from the bank to buy commercial house. As banks extend more loan to individual consumer, it also leads to the increase of potential bad load and default risk. Moreover, the government doesn’t know the creditability of the real estate firm. This leads to the emergence of the incomplete building. The implication of the incomplete property towards the default risk is when the real estate firm provides 20 percents of the down payment to buy the land and get the permission from the government to develop the land; the land will be used as the collateral for the bank. The bank will pay the government rest of the entire payment. Some real estate firms fail to repay the 80 percents of entire payment and the bank claims the land for auction. Incomplete property tied up a lot of capital, including a large amount of borrowed funds. Therefore, banks are often the largest creditor, who is also the number one direct victim. Banks not only suffer from the loss of interest income, but also the loss the principal. The incomplete properties become the bank's bad assets (Sohu Focus, 2009).
Yuan (2006) refer to the central bank "Chinese real estate development and financial support" report (2005), the credit of the Chinese real estate in the overall credit was 6 percents in 2000 which dramatically increased to 21 percents in 2003. In 2004, this proportion further increased. In Shanghai, nearly 80 percents of all new loans in 2004 were invested in real estate. Such a high concentration of loans will create catastrophic impact to the entire financial system if the real estate industry trends reverse. As mentioned in the introduction, According to statistics 12 listed banks doled out total loan amounted to 21.77 trillion Yuan in 2009, 5.28 trillion Yuan as property-related loans which counts for over 24 percents of the total loan, where 1.66 trillion Yuan to property developers and 3.62 trillion Yuan to individuals or home purchasing. The figure shows the increase of the borrowed fund in the real estate market. As more funds are lent by the bank, it implies the default risk is increasing
Secondly the information asymmetry between the real estate firm and the bank has these impacts toward the default risk. As the real estate firms are the borrowers who clearly know their own economic strength, but the banks don’t know such information. This leads to the emergence of the moral hazard. Real estate firm can use the “false mortgage” to get money from the bank. The "false mortgage" will increase the default risk in the Chinese banking system therefore increase the financial risk (Huang & Chen, 2010). The legal representative Zou Qing of Beijing HuaYunDa Real Estate Company used the project “Sen Howe Apartments "to deceive the bank and successfully get large amount of cash. By using the “false mortgage”, 257 applications for mortgage loans personal information has been submitted to the Bank of China Beijing Branch Office and illegally obtained 750 million Yuan as individual housing loan (China Real Estate News, 2006).
In addition the real estate firms can also use the repeat mortgage to get more money out of the hole of the Chinese banking system. The large numbers of repeat mortgage and false mortgage scams objectively lead to the growth of the real estate market speculation; it also fuelled the over-consumption of housing. The repeat mortgage and false mortgage scams also lead large amount of bank’s cash transform to the fix asset – the collateral. The collateral may sell at the good price when the bubble is still expanding. However, if the real estate bubble crashes and the price of the real estate drops significantly, the banks who possess large amount of collaterals instead of cash will find themselves difficulties to turn all the collaterals into cash. Recall in early 1990s the collapse of the Japanese bubble, Japanese land price shared the same path as the stock market; the land price has gone through the process of long-term decline. Calculated from the peak in 1991, land prices in Japan fell by 80 percents. Also after Hong Kong real estate market collapsed in 1997, just five years time to 2002, the real estate prices plummeted by 70 percents (Yuan, 2005). Therefore some banks can only afford the market price of real estate to drop within certain range if the bubble crashes (China Real Estate News, 2006). As the asymmetric information directly lead to the expanding real estate bubble, and the collapse of the real estate bubble will lead to the increase of the financial risk. This implies the asymmetric information also indirectly lead to the increase of the financial risk. Another chain reaction of the crash of the bubble is people who are paying their mortgage may find the declines of real estate market price a pain as their house is not worth as much as before, but they still have to pay the mortgage. If the market price drops too fast or dramatically, it may also results many house buyers give up paying their mortgage and let the bank claims the collateral – house. As bank’s cash was paid to the real estate firm when the individual housing loan was issued, after the collateral is claimed, under the circumstance of market price drops dramatically, the bank will finds difficulty to sell them at reasonable price to cover the lost. This implies the financial risk in the banking system may increase if the bubble crashes. The crashes of the Chinese real estate bubble may trigger the collapse of the whole Chinese banking system and the stock of Chinese real estate.
Thirdly, the information asymmetry between real estate firm and the consumer has these impacts toward the default risk. Generally the information dominant side is the real estate firm. They have the power to use the asymmetric information to increase the price of the commercial house, such as by using the property hoarding to control supply or create the illusion of excessive demand of the commercial house to increase the price. The ultimate results of the increasing commercial house price are either the consumers cannot afford to buy the house, or they will have to borrow more money from the bank to buy the house. When more money is borrowed by the consumers, the potential bad loan will increase, so does the default risk (Please Refer to Graph 1 and Table 2).
Graph 1
Source: Statistical Bureau of the People's Bank of China (2009)
Table 2
China’s Individual Housing Mortgage（Unit: hundred million Yuan）1997-2007
Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Individual housing mortgage (hundred million Yuan） 281 426 1358 3377 5598 8269 11780 15922 19070 22700 31400
Proportion of GDP (%) 0.38 0.50 1.45 3.39 6.94 8.09 11.68 11.66 10.46 10.84 12.73
Proportion of the total credit (%) 0.38 0.55 1.65 3.76 5.84 8.46 9.06 12.25 12.50 12.83 15.27
Source: Statistical Bureau of the People's Bank of China and NBSC (2009)
Last but not least the information asymmetry between the consumer and the bank has such impact toward the default risk. Not only the real estate firm can provide false materials to deceive the bank for housing loan, but also the real estate speculator. Real estate speculator can also use the fact that there is no interconnection between different banks in different regions of China to carry out the repeat mortgage scam. The ownership of specific fix asset can be used as the collateral for many different banks in order to extract as much cash as it can, as long as the interconnection between the banks doesn't exist. Then the cash which has been extracted from the bank can be used to invest in real estate market again for higher return. Once again, the information asymmetry between the consumer and the bank not only play an important role on the accumulation of default risk in the Chinese banking system, but it also leads to the over-consumption of commercial house and fuels the expanding bubble.
The information asymmetry in the real estate market not only leads to the dramatic increase of the real estate priced – expanding bubble, but it also leads to the dramatic increase of the bank loan. Some of the bank loans are bad loans as result of scams. In order to prevent the accumulation of the default risk, to improve the information in the banking system is necessary.
Objective 3 Discuss the government intervention in order to find out whether the introduction of new policies is useful to slow down the expansion of Chinese real estate bubble and the accumulation of the default risk in the Chinese banking system.
The commercial house price is skyrocketing at present due to the information asymmetry in the real estate market, not only this is a serious threat to the security of the entire financial system and macroeconomic performance, but it is also a threat to social stability (Wei, 2010). Assume China will faces the similar consequences as the burst of the Hong Kong and Japan’s real estate bubble. So Chinese land price, stock price and real estate market price all goes through a long term decline. The result of land price drops directly affects the government’s revenue from auctioning the land. The decline of the real estate price not only will lead to depression of the real estate market, but it will also affect the other industries that rely on the real estate market, such as the raw material cement or steel industry. The stock price drops will be a pain in the heart of the stock market investor, also the firms who rely on the stock market for survival will suffer. Therefore Chinese government will do everything it can to prevent the collapse of the bubble and the accumulation of default risk in the Chinese banking system.
Every time when the government foresees something is about to go wrong, the adjustment policies will be introduced. Recall the most important real estate policies introduced by the government from 2005 till now: the State Council issued the "six measures" in June 2006 which proposed to effectively adjust the housing supply; mainly focus on the development of the low-cost, small condominiums, economically affordable housing and low-rent housing for the low and medium wage earners (Li, 2006). Later on in 2006, central government declared that real estate developers have to allocate 70 percents of the total area in each of their new housing projects to build the “affordable housing” in order to meet the housing needs of middle to low income households in the country (Wang & Wang, 2010). In 2007, central government declared to hold no less than 18 hundred million Chinese acre of farmland (Wen, 2007). The tightened land policy and the strict control toward the transformation of agricultural land to construction land led to the deceleration of land development, as the result the consumers expectation toward appreciation of the land kept expanding, thereby stimulated the real estate market. The latest policies were introduced between April and May 2010.
The impacts of the latest real estate policies
In most of the cities, the adjustment of the down-payment and the interest rate not only managed to inhibit the real estate speculation, but it also suppresses certain consumers’ desire of residential improvement. Banks play major role in applying the policies At least two banks in Guangzhou respond to the call of the State Council regarding the new real estate policy, they suspend the third housing loan for investors (Wang, 2010). Industry and Commercial Bank of China, China Construction Bank, China Merchants Bank have suspended loan to investors who seek the third residential housing in the Beijing area (Sohu News, 2010). As the demand and speculation have been inhibited due to the adjustment of down payment and the interest rate, the housing price in many major cities dropped. The average price for new commercial house in Guangzhou fell from 11,695 Yuan per square meter on 16th April 2010 to 8,914 Yuan per square meter on 18th April 2010; this was the lowest point of commercial housing price in Guangzhou for the previous month (Wang, 2010).
As the banks suspend the loan to the investors who seek the third commercial house, this mean the loan extended by the banks will decrease, therefore such action will temporarily stop the speculation and the accumulation of the default risk. The latest policies also bring down the real estate price and inhibit the investment desire in the real estate market. The decline of the real estate price not only slows down the expansion of the bubble, but it also reduces the default risk as the consumers will borrow less money from the bank to buy the commercial house; less borrowed fund give borrower more strength to repay the loan. The suppression of the investment desire will also lead to the same consequences.
In order to curb land hoarding, the Ministry of Land and Resources introduced strict measures which are real estate firm/developers must make a 50 percents down payment within one month after the contract is signed, otherwise they face the prospect of losing both the land and the deposit. In addition the remaining payments must be completed within a year. Professor Yan Jinming of Land Management at Renmin University mentioned the new measures of land curbing may help the real estate market to operate fairly (Wang & Wang, 2010). In addition, the increase of the down payment means the bank will extend fewer loans than before when it comes to transaction of the tier 1 market. Such adjustment will directly reduce the loan extended by the bank, therefore reduce the default risk.
In terms of the stock market, the policies also led to the stock market went south at the opening bell of Monday 19th April 2010. Most of the real estate stocks in the real estate sector experienced 10 percents decreases in price at the ending bell. This is largest fluctuation in Chinese stock in recent years. Not only has such a fluctuation shocked the Chinese investors, but also the globe. The property sector of Shanghai stock index went weak after Bank of China last Friday said it would raise interest rates for existing house mortgages. The central and local authorities continue to introduce real estate control policies since middle April, from the opening of stock market on 16th April 2010 to the closing of 11th May 2010, the biggest decline in the Shanghai Composite Index reached 16.24 percents. Just from the stock market point of view, the recent intensive real estate market control policies indeed had a strong impact on the stock market, especially the real estate sector. From beginning of April 2010 to 11th May 2010, the biggest decline in real estate index reached 27.43 percents. From the 16th April 2010 until 11th May 2010, real estate index lost 21.37 percents, much higher than the Shanghai Composite Index 16.24 percents decline (Yang, 2006).
In short term, turnover of the real estate market will be declined dramatically. In addition the investment desire will be inhibited. The impact of buyers’ power sharply reduce will have a tendency to adjust the price of real estate. Moreover, the deceleration of real estate development will certainly adversely affect many other industries such as the construction industry, the construction raw material industry. Bank sector will also be affected, as the new loans are expected to reduce which implies earnings decline, the new mortgage policy will have a direct impact on bank earnings. In long term, the recent series of control policies introduced are mainly to curb real estate speculation, they are not introduced to suppress the entire real estate industry, but to make sure real estate market become rational. The real estate market rationality not only can ensure the proper allocation of resources in those related sectors, but also improve the industrial structure. Although the latest real estate policies will inhibit certain normal investment behaviours, but they do not change the long-term trend of steady economic growth. As the result, the impact of the stock market will reflect more in the short term instead of long-term (Yang, 2010).
The assessment of the policies from 2005 till now
In recent years, state authorities have issued a lot of real estate market control policies; many policies have holes in them. This leads some local governments and commercial banks to make full use of the holes in the policies and led to some control policies could not be fully implemented, thereby affecting the effectiveness of the regulation of the real estate market. As the result the residential housing price is skyrocketing in such absurd rate and more people cannot afford to buy house (Wei, 2010).
Start from the latest polices, although all the measures seems harsh, but there is a hole in the latest policies just like there was hole in the previous policies. Recall the policies “in the area where the prices of commercial housing are too high, the commercial banks have the right to suspend the loan to investor who seeks to buy the third house according to their risk status”. Have the right to is not the same as must. Leaving such gap in the policy, it is inevitable some commercial bank will still provide credit extension due to economic benefit to those investors who seek the third residential house. Policy “to buy second residential house, the down payment shall not be less than 50 percents of the house price” may be able to partially inhibit some investment desire of the investor or speculator. However for those wealthy and powerful investors or speculators, these policies are not the most deadly weapons (Zhao, 2010). The wealthy speculators can still speculate as long as their pocket is not empty.
In addition, the latest real estate policies are made to inhibit speculation of residential housing and to suppress the desire of purchase/investment therefore reduce the demand of residential housing, thereby to decelerate the price skyrocketing in the commercial housing sector. But this is a typical example of puts the cart before the horse. Why using interest rate to suppress the demand instead of increasing the supply? The nature law of supply/demand is when the demand overweight the supply, the price will goes up, the skyrocketing of price will attract investment, thereby the supply will increase which implies the demand and supply find themselves balance again. But in China, the supply of land will only increase in certain phase as the government is the land owner, and the phase of supply is always lagging behind the demand of residential housing which lead to the skyrocketing of price. In addition 80 percents of reformed houses in China are small which has the floor area below 90 square meters with poor hygiene condition or poor infrastructure. Most of residents seek residential improvement such as buying new house with larger floor area with better condition. However the new policies only benefit those investors who seek the commercial house with floor area below 90 square meters. For those residents who possess the small reformed house with poor condition, they will have to give up the choice to live in a larger floor area with better condition residential house in order to keep the steady growth of real estate sector, or they will have to bear the pain of higher mortgage payment as a result of the new real estate policies. Which implies the latest polices not only can not satisfy the many investors' need of improving residential condition, but the interest rate adjustment will decelerate the phase of urbanization (Ren, 2010).
The inadequate supervision on the standard of the economically affordable housing and low-rent housing is one of the many reasons why affordable housing is no longer "affordable" for the low and medium wage earners. In many cases either the floor area is too large, or the developers only target the high income buyer. Thus, luxury commercial housing in the market has the problem of supply over demand, affordable residential housing has the problem of demand over supply. Not only the six measures did not resolve the structural contradictions, but also it failed to maximize the utilization of resources, thereby the resources have been wasted. The “90 – 70” unit is the perfect example of the policies failure. Although the “six measures” and affordable housing proposed by the government in 2006 sounds promising, It must be admitted up till now, low rent housing remains pitifully rare, and no one knows who the main customers for the affordable housing are (Li, 2006). (Please refer to the Appendix A for the affordable housing construction rate)
Even through the central government spend huge amount resources to build affordable housing project and introduced the 90-70 policy in 2006. However, the policy failed and affordable housing supply still did not meet the needs of middle to low income population. This is due to local governments cheat in affordable housing development in order to increase local GDP growth by selling high priced house, thus the government head can get promote easier. Meanwhile, the real estate developers always build luxury commercial house on the low-cost land which suppose to build affordable housing due to the fact that lack of incentives for real estate developers to building affordable house, by building the luxury commercial house they can maximize return from their capital investment (Jin, 2006, NBSC, 2009 and Gao,2010) (Please refer to Appendix B).
Objective 4 The suggestions for the current issues of the Chinese real estate market
No doubt that the information asymmetry led to the emergence of the bubble and accumulation of default risk. After the long discussion of the information asymmetric and the government policies, the question is will the bubble collapse and lead to the catastrophic disaster of the Chinese economy? And by improving the information asymmetry in the real estate market, will the default risk in the Chinese banking system be reduced?
The author believes the answer is no to the first question based on the following:
First of all, the real estate prices are only skyrocketing in the major well developed cities of the China, most of the developing cities’ real estate in China are still growing at the normal rate and no bubble emerge. Secondly the government introduced the strictest policies in 2010 to curb the speculation of the real estate. Although the policies are also likely to inhibit normal investment behaviours such as residents seek residential improvement. However, as the desires of investment/speculation are being curbed, the bubble will shrink. In fact, many well developed cities’ real estate price experienced decline not long after the policies were introduced. Thirdly the Chinese real estate market is different to the United States of America real estate market; the dramatic increase of the household debt played a major role in the emergence of the American sub-prime crisis. Li (2010) citied in China.com.cn (2010) says that the house hold debt in China is weighted 17 percents of the GDP, this figure is way less than the American figure of 96 percents. The excessive household debt and the mortgage securitization are the main sources of the American sub-prime crisis. Both issues will not be found in China. The main problem of the Chinese real estate market is too many investors believe the investment in the real estate can always maintains its original value, those investor also believes the risk of investing in real estate is way less than the risk to invest in stock market. But the latest policies not only can curb the real estate speculation, but they can also prevent the accumulation of the Chinese household debt as the down payment of commercial house has been adjusted to a high level. Last but not least the trend of urbanization will provide the huge demand for the real estate market. The demand of the commercial house will exist even if the bubble
The answer to the second question is not only a “Yes” or “No”. One thing can be sure is the information asymmetry led to the accumulation of the default risk from the illustrated example. Therefore, improve the information in the market will reduce the default risk in the system. The following is what the author believes must be done in order to improve the information therefore reduce the default risk.
The bank needs to improve the credit monitoring system as it plays a major role in fuelling the bubble and accumulation of the default risk - financial risk. The Chinese bank can learns how the foreign banks in the well developed countries operate; benchmark the foreign bank’s credit monitor system to prevent the accumulation of financial risk. In addition, the inter-connection between different banks in China must be established in order to prevent repeat mortgage. The latest policies have left the hole for all the banks to decide whether to be ethical or economical. Although extend more loan implies make more profit, but the banks need to make sure the judgement of the borrower’s risk status must be unbiased. Also need to make sure the documents supplied by the consumers are real. Therefore the default risk in the entire Chinese banking system will not be accumulated.
Before the latest policies were introduced, the government supervision of the real estate policies was always the weak link. The government need to closely monitor the implementation of the real estate policies and make sure no one try to makes profit out of the hole of the polices as mentioned earlier. Also the law need to be established specifically for the real estate market. The policies were always introduced after the problem emerged, which implied the policies could not be perfect. In fact, there has always been some hole in the policies. Therefore, it is necessary for the government to perfectly establish the real estate law system, and make sure everyone abides the law. Anyone who doesn't abide the law will be punished according to the law, this will ensure the illegal activities such as land and property hoarding will no longer exist. As the latest policies had a good beginning to curb the speculation and bring down the real estate market price, the close supervision from the government can make sure the policies have a good ending. The government should consider establishing the law in medium or long term in order to ensure the continuous prosperity of the industry.
The information asymmetry in the real estate market needs to be resolved. The government will play a major role for the problem to be resolved. The government should disclose the land cost in the first place to promote the importance of symmetric information. The government should also come up with the regulation to require real estate firm to disclose the cost information of the real estate project as such information is almost impossible for the buyers to obtain. The real estate firm also needs to be ethical instead of economical, disclosing the cost information can be the first step. Short term profit pursuing can lead to the depression of the industry but being ethical can promote the continuous prosperity of the industry. The reputation building can be the long term goal for the real estate firm. In order to achieve it, not only the firm needs to ensure the product is high quality, but the firm also needs to share the private information with the public in order to increase the organization transparency. Such intangible asset will ensure the long term profit for the real estate firm.
Moreover the technology can also be used to resolve information asymmetry, such as the use of internet. Government can set up a real estate information gathering centre to gather accurate information and use the internet to publish such information. Promote the website to the general public so the website will be the first place to visit when the consumer wants to buy a house. Although resolving the information asymmetry will be difficult, but the author believes nothing is impossible.
Conclusions and Recommendations
In literature review, the default risk as part of the financial risk is increasing in the global financial market. The one of the main causes of the increasing default risk is the information asymmetry. The information asymmetry implies one party of the economically related parties have certain information which is relevant to the subject that matters but the other party doesn't possess the same information. The asymmetry information theory can be studied from the timing when the asymmetric information takes place. The pre existing asymmetric information before the contract is signed is known as adverse selection model and the after the event is called moral hazard model. By comparing the real estate market model under the traditional perfect competition mode and the information asymmetry mode, it simply shows how the real estate market price increases. Finally, the stock market liquidity can be a good indicator of the economy as it predicts the current and future state of the economy. The common four measures of the stock market liquidity have been briefly illustrated.
In this project, secondary data collection has been used. Books, e-journals, internet sites and newspapers were the main secondary research sources in this research. The e-journals were found through Aston e-library. The books were found by Aston university library and Birmingham Central Library. Newspapers were purchased from newspapers retailer in China. Those secondary data has been gathered in many occasions. Then divided into different categories to use in different parts of this project. Research emphasizes, compares and contrasts different authors opinions and ideas. In addition, Chinese stock analysis tool has been used for data analysis. Even through primary research has not been conduct in this project, various secondary information has been written by various writers can be used in order to achieve the aim. The researcher has been well referenced the secondary information. Consequently, there is no ethical implication in this research.
The real estate bubble has emerged in China in recent years of real estate market development. Such bubble mainly refers to as the abnormal growth in the commercial house price. Many people can not afford to buy a commercial residential house. Not only has the real estate bubble become a problem of the Chinese economic stability, but the real estate bubble also indirectly increases the default risk in the Chinese banking system. As majority of loan extended by the bank found its way to the real estate market, the common collateral will be the real estate. If the real estate bubble collapses, the real estate price will definitely drops. Such a decline in real estate price will be the indirect cause of the increase of the default risk in the Chinese banking system. Another cause of the increasing default risk is the information asymmetry of the real estate market which is also the main cause the emergence of the real estate bubble. The information asymmetry is mainly referred to as the information asymmetry between these four parties in the society: the government, the bank, the real estate firm and the consumer.
The Chinese real estate market is very special compares to the others, it has the characteristic of: the government is the owner of all land therefore it controls the supply of land in the market. Without land, there will be no real estate. So the monopoly – the government directly controls the supply of commercial house in the market. Also the Chinese real estate market is an imperfect competition market due to the issues such as monopoly and information asymmetry. The Chinese real estate market also tends to be regional compare with other industry and it is highly related to the government and financial institution such as bank. The development of the Chinese real estate market has only got 30 years of history, which implies the Chinese real estate market is still not well regulated. As the result, many illegal activities such as land hoarding and property hoarding are prevailing in the real estate market and these activities are making the market ineffective. The government is the only party which can put the end to all of problem by introducing different measures and policies. In order to solve the problem, it is important to know what the problem is. The main problem of the Chinese real estate market is the information asymmetry. It can be categorized as: the information asymmetry between the government and the real estate firm; the information asymmetry between the real estate firm and the consumer; the information asymmetry between the real estate firm and the bank and the information asymmetry between the consumer and the bank.
The information asymmetry between the government and the real estate firm can be reflected as the government possesses more information than the real estate firm. This directly leads to the real estate firm will have to pay higher price for their operation. So in order to make profit, the price of the product increases and the high price are left for the consumer to bear with. In addition, the government also doesn't know how the real estate firm operate due to the information asymmetry. This leads to the emergence of the illegal activities such as land and property hoarding. The illegal activities further leads to the increase of the overall market price therefore the emergence of the real estate bubble. The information asymmetry between the real estate firm and the consumer can be reflected as the real estate firm possesses more information than the consumer, and real estate firm always use such information advantage to maximise the profit at the expense of the consumer. The illegal activity land and property hoarding is the perfect example. Not only such activity directly drives up the market price and forms the bubble, but also it leads to the consumer can not afford to buy commercial house at such environment. The information asymmetry between the real estate firm and the bank can be reflected as the real estate firm possesses more information than the bank. If the real estate firm decides to use the information advantage to maximise its benefit, the bank will be the victim. This directly leads to the increase of the default risk in the Chinese banking system. The good example is the “Sen Howe Apartments " billion Yuan scam. The information asymmetry between the consumer and the bank can be reflected as the consumer is on the information dominant side, and the consumer can use such information advantage to deceive bank and get the individual housing loan. This increases the potential bad loan therefore the default risk in the banking system.
As the bubble is expanding, the fear of the meltdown is the most worried issue of the government. The collapse of the bubble may trigger the worst outcome of the default risk which is the collapse of the whole Chinese banking system and the stock of Chinese real estate. It is known the collapse of American investment banking system triggered the global financial crisis. Therefore the Chinese government will do everything it can to prevent the collapse of the bubble and the accumulation of default risk in the Chinese banking system. The latest policies were introduced by the government on the 15th April 2010 which stated the down payment for a family's first home with an area bigger than 90 square meters should be at least 30 percents. And for the second apartment, the required down payment was raised from 40 percents to 50 percents, and the mortgage rate should be no less than 1.1 times the benchmark interest rate. Moreover, a much higher down payment and mortgage rate will be required for third homes and above. In the area where the prices of commercial housing are too high, the commercial banks have the right to suspend the loan to investor who seeks to buy the third house according to their risk status; also the banks have the right to suspend the loan to those investors who cannot provide the local taxes or social insurance contributions for more than 1 year basis which prove them to be the non-local residents. The new policies led to the stock market went south at the opening bell of Monday 19th April 2010. Most of the real estate stocks experienced 10 percents decreases in price at the ending bell. This is largest fluctuation in Chinese stock in recent years. Not only has such a fluctuation shocked the Chinese investors, but also the globe. The question is can the policies really stop the bubble expanding and put a stop to the accumulation of the default risk?
Recall all the polices which were introduced since 2005, all the policies seems to be a lagging measures as they were only introduced when the problems emerged. And most of the policies have got some hole in it which let the certain party of the four to decide whether to take advantage of the hole or not. The author believes this is the main reason why the previous policies which were introduced before 2010 could not put a stop to the expanding bubble and resolve the issue of people can not buy the affordable commercial house. As the latest policies have only been introduced for few months, it is too early to judge whether it is useful or not. However, by looking at the impact of the policies, one thing can be sure is the latest policies did have a good start to slow down the expanding bubble and put a stop to the accumulation of the default risk. Many cities experienced decline of housing price after the introduction of the latest polices. This implies the investment desires has been suppressed and the bubble is cooled down temporarily. Although the stock market has also been affected and the stock price experienced decline, but the author believes the stock market will only be affected in short term instead of long term as the latest policies were introduced to curb speculation of the real estate market but not the stock market.
In addition the author believes the Chinese real estate bubble is unlikely to collapse based on following: First of all, the real estate prices are only skyrocketing in the major well developed cities of the China, other developing cities’ real estate market is growing at normal rate. Secondly the government introduced the strictest policies in 2010 which leads to the desires of investment/speculation are being curbed, therefore the bubble will shrink. In fact, many well developed cities’ real estate price experienced decline not long after the policies were introduced. Thirdly the house hold debt in China is weighted 17 percents of the GDP, this figure is way less than the American figure of 96 percents. The excessive household debt and the mortgage securitization are the main causes of the American sub-prime crisis. Both issues will not be found in China. Not only the latest policies can curb the real estate speculation, but they can also prevent the accumulation of the Chinese household debt as the down payment of commercial house has been adjusted to a high level. Last but not least the trend of urbanization will provide the huge demand for the real estate market.
However, the latest policies also have hole in it, which once again let the party to decide whether to take the benefit or not. The hole is “the bank has the right to suspend the loan to individual who seeks the third commercial house.” This time the bank is in charged of being ethical or economical. If the bank chooses to be economical, the default risk in the banking system will increase once again. The following is what the author believes must be done in order to improve the information therefore reduce the default risk in the banking system:
The bank needs to improve the credit monitoring system such as to learn how the foreign banks in the well developed countries operate or benchmark the foreign bank’s credit monitor system to prevent the accumulation of financial risk. In addition, the inter-connection between different banks in China must be established and make sure the documents supplied by the consumers are real. The government need to closely monitor the implementation of the real estate policies and make sure no one try to makes profit out of the polices hole as mentioned earlier. Also the law need to be established specifically for the real estate market. Anyone who doesn't abide the law will be punished according to the law. This will ensure the illegal activities will no longer exist. The information asymmetry in the real estate market needs to be resolved. The government should also come up with the regulation to require real estate firm to disclose the cost information of the real estate project as such information is almost impossible for the buyers to obtain. Moreover the technology can also be used to resolve information asymmetry, such as the use of internet. Government can set up a real estate information gathering centre to gather accurate information and use the internet to publish such information. Promote the website to the general public so the website will be the first place to visit when the consumer wants to buy a house.
To conclude, the information asymmetry is the main cause of the emergence of the bubble and the accumulation of default risk. In order to resolve the problems, tons of efforts need to be put in. It will be difficult as people always prefer profit instead of being ethical; and greed is the root of all evil. However, the author believes nothing is impossible. Due to the limited time and lack of public relation, primary research has not been conducted for this project. For further research, primary research such as interview, questionnaires and observations should be used.
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Appendix A
Appendix B