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Chanos vs. China (Part Two)

Bill Powell 2010年11月24日


Chanos: Right or wrong?

    There's no question the speculative fervor in real estate has captured the Chinese government's attention. Last spring Beijing moved to stiffen financing requirements, and it is trying to limit the number of units any single investor can buy to two. For a time that did cool off the market. But Chanos points out that prices are rising again, and more than 30 million new apartments, villas, and houses are due to come onto the market next year. If the government intensifies its efforts to try to limit speculation, the market may turn down sooner than most think, Chanos believes. And if the government doesn't intensify the effort against speculators, "they'll just be climbing up a few more rungs on the diving board." Either way, he says, "they're going to end up in the same place." Consider Dubai, he says: At the peak of its building boom, there were 240 square meters of property under development for every $1 million in national GDP. In urban China today that ratio is four times as high. "We've seen this movie before," he says. Whether it was Dubai a couple of years ago, Thailand and Indonesia during the Asian crisis of the late '90s, or Tokyo circa 1989, "this always ends badly."

    Chanos puts his money where his mouth is. Late last month he went before the Grant's Interest Rate Observer conference at the Plaza Hotel in Manhattan and not only made his case for being bearish on China, but ticked off individual stocks that he is shorting. Poly HK is one: a real estate developer that trades on the Hong Kong exchange (and a company that Goldman Sachs (GS) recommended as a buy as recently as last month). It's a state-owned company that started out as a defense contractor but, enticed by the real estate boom, has plunged in as a property developer. Chanos is also short the listing for the Hong Kong Stock Exchange. And he believes that China Merchants Bank, one of Beijing's largest, is deeply exposed to the financing affiliates of local governments throughout China. About 11% of its total loans outstanding, according to Chanos, are to these local financing affiliates (known as local government funding vehicles, or LGFVs).

    Why does that matter? A key prop under the bullish case for China's real estate market is lack of leverage. The financial system is simply not going to be at risk, the thinking goes, even if there is a real estate bust. But Chanos believes the LGFVs are deeply exposed to property development, and that if there is a turn in the market, the pain felt by China Merchants Bank, as well as others, will be considerable. Victor Shih, a professor at Northwestern University, did a study earlier this year and concluded that these LGFVs accumulated $1.6 trillion in new debt from 2004 to 2009. As Chanos points out, China's own bank regulator has recently been moving to rein in local borrowing, after concluding that 26% of the outstanding debt is "high risk."

    A downturn in China would have serious ripple effects throughout the world. Chanos believes the iron ore producers, and Brazilian giant Vale (VALE) in particular, will be victims. China's huge capital investment has required vast amounts of steel and other metals, and that in turn has made it the largest market in the world for iron ore. Vale traded in early November near a 52-week high, and its CEO, Roger Agnelli, recently boasted that he has the biggest fleet of ships in the world outside of the U.S. Navy. If you take Chanos's view of the world, that's not a good thing. As he put it, "They're going to have a lot of empty ships on their hands."

A case for the bulls

    Short-sellers are generally derided until and unless they turn out to be right. So it is now. Sentiment about China is so optimistic that people think Chanos either has lost his mind or is somehow involved in a giant hip fake and can't really be serious. (For the record, he won't say how much of Kynikos's more than $1 billion under management is in play in China-related positions.) "Why do I go public with this?" he asks. "For the same reason I did with Enron. All the public ever hears is the longs. I have a case to make, and I have no hesitation making it. These are our convictions about China, and we're acting on them. So argue with me. We want to hear the counterarguments. Believe me, we do.''

    Plenty of people are willing to take him up. The China bulls' case has many parts, but the most important is leverage -- or rather, the lack of it. Consider the gentleman -- his name is Cheng Yue Shi -- who told me that he owned 43 flats in and around Shanghai. He doesn't rent out any of them -- which is not uncommon in China; rents are cheap, and many owners therefore believe the time and hassle of being a landlord isn't worth it. And of the 43 units he owns, he paid for every single one of them -- not a single mortgage involved. According to a recent study by CLSA Asia Pacific Securities, the use of mortgages is increasing in China, but only 40% of all houses purchased are debt-financed. Even when they are, Chinese buyers typically have to put down 30% or more of the sales price.

    No liar loans here. No securitization of mortgages. This is housing finance done the old-fashioned way: The buyers have skin in the game. The lack of leverage throughout the system should mean that even if there is a significant decline in real estate prices, the financial system in China is unlikely to be crippled.

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