Since 1998, in order to address the insufficient pull of an export-oriented economy and the lack of local development funding following reforms to the fiscal system, real estate — under official guidance, planning, and promotion — gradually became the core industry driving urban development.
The industry’s vigorous growth resolved a series of social problems: including but not limited to local development financing, residential asset appreciation, housing needs during urbanization, the migration and employment of surplus rural labor, and the stimulating effect on related upstream and downstream industries. When a single sector can benefit all major stakeholders across society, it earns unanimous enthusiasm from society’s key participants. Behind this enthusiasm lies not only a concentration of resources, but also policy favoritism and lagging regulation. This creates a spiraling, self-reinforcing surge — and in the process, forges new social power structures and new coalitions of shared interests. These become internal forces resisting change. As a result, any reform that touches deep-seated interests is difficult and delayed — and that delay often gradually ferments into a bitter outcome for society as a whole.
Real estate has always, from the very beginning, been a financial product. Every link in the entire chain is sustained by leverage. Local governments acquire land at low cost through requisition, or by reclassifying it — converting industrial land to commercial use — then auctioning off that commercial land to secure large-scale financing through land transfer fees. The developers who win those auctions with such massive sums — whether their capital comes from bank loans, asset management investment, or funds raised through other financial institutions — are not operating with fully self-owned capital. Every yuan is leveraged, and every yuan accrues interest. The up-front costs, the cost of assembling that capital, and the ongoing development funding all depend on profits from selling residential units to fill the gap. The value benchmark throughout the entire chain is not “a piece of empty land transformed into housing through construction.” It follows, entirely, the issuance and trading mechanics of financial derivatives. Every participant in the chain earns their return from the debt carried by homebuyers. And the homebuyer’s return, in turn, comes from the debt carried by the next buyer. Trace it to its root and the entire chain is like an inverted pyramid — the tip holding everything up is the aggregate debt load carried by homebuyers.
This is also why banks do not accept large-scale early mortgage repayments. Such repayments would directly and sharply shrink the total debt pool. That rapid contraction doesn’t just cost banks the interest income they’ve already transferred forward through the financial system — it also threatens many instruments previously invested across the real estate chain with shrinking returns, and potentially renders them unsustainable.
A simple example makes this clear. A certain asset management company raises a large sum by issuing financial products, to be invested in real estate development projects. Whatever method is used to raise these funds, a sufficiently high interest rate must be offered to attract capital. Future returns must therefore exceed that rate for the product to remain viable. On top of that, the asset management firm needs profit to sustain its own high operating costs. Industries that look prestigious and high-return depend on even higher profits to keep running than most. Where do those profits come from? From the returns on deployed capital. Those returns must cover not only the firm’s operational costs and profit distributions, but also the high interest promised to investors when capital was raised.
For instance: when you buy a wealth management product at a bank, that is a financial instrument issued through the banking channel to raise capital. Certain insurance policies you buy are another type of capital-raising financial product. In short, whether these products are sold to millions of retail investors or to large institutional accounts, they all carry interest rates above standard deposit rates. The capital raised is then deployed into projects, and the returns those projects generate must cover every participant in the chain — from the end customer, to the distribution channel, to the asset manager. If the project is real estate, the developer’s profit must also be added into that chain. All of these returns can only be realized through the buyer — more specifically, through the homebuyer’s debt. Because that debt is itself a stable-yield financial product that can be packaged and resold within the financial system.
Many people follow everything above but may not grasp that last point. Why is personal debt a financial product within the banking system? Here is an example. Say you owe me 120 yuan. Every month you steadily repay 10 yuan, plus 1 yuan in interest. Since you do this reliably each month, the expectation is stable — and that 1 yuan interest is quite attractive. So your promissory note for 120 yuan, repaid at 10 yuan plus 1 yuan interest per month, is essentially equivalent to a note worth 132 yuan. I could practically use it to buy things — as long as the other party understands its value. If I sell this note to someone else, keeping the principal at 120 yuan but accepting only half the interest — asking 126 yuan in cash for it — plenty of buyers would step forward. In doing so, I lent out 120 yuan and immediately recover 126 yuan. I carry zero risk and pocket a 5% return on a single loan. Under these conditions, wouldn’t it be in my interest to issue as many loans as possible? Without regulatory constraints, I wouldn’t just be writing mortgages for people with insufficient income — I’d be handing them to homeless people with no income at all. That is exactly what the United States did in 2008. And that is exactly how they blew it up.
What happens if the scale of residential mortgages shrinks sharply — if people carrying 30-year loans start paying them off early? Consider: I lent out 120 yuan, packaged the future interest into a face-value note of 132 yuan, and sold it at a discounted 126 yuan to the next party. If that party is sitting on a pile of these notes, and then many of the original borrowers pay back their 120 yuan ahead of schedule — not only does the note never reach 132, it might not even reach 126. Not only does the party who paid me 126 for those notes take a heavy loss — my own returns shrink dramatically. If I am a publicly listed company whose business model is built on this, won’t my earnings collapse? Won’t my market cap crater along with it? And if my counterparty is also a listed company — couldn’t it implode entirely?
By the same operating logic, total loan volume across the economy cannot be allowed to fall sharply — and property prices cannot be allowed to fall sharply either. Not only because the public’s herd mentality of “buy when prices rise, wait when they fall” would cause sustained transaction paralysis and shrinking loan volumes. More critically, a sharp decline would turn enormous amounts of existing transactions into bad debt and — following the logic laid out above — trigger a chain reaction through the system. According to banking statistics, 86% of homebuyers in this country own only one property. In other words, bank lending is primarily directed at ordinary families. These families, through stable salaried income, underwrite the value of those loans — principal and interest — as they flow through the financial system. But from another angle: if property prices were allowed to float freely in the market, and the market price fell below the price at which those properties were mortgaged to the bank —
These families carrying mortgages would be driven into insolvency, and would stop making payments on principal and interest. Look again at the cascading logic through every link of the financial system. You will find it is not merely a matter of bank bad debt — it would trigger a series of collapses throughout the financial markets.
The most essential factor in the real estate sector is the size of the population capable of taking on debt, and the scale of that debt. This is the foundation on which the entire financial chain connected to real estate operates. When that population and those debt levels shrink sharply, the profits at each link in the chain can no longer be guaranteed. Once guarantees fail, operating costs remain stubbornly high while projected profits are too thin to fill the gap. At that point, collapses across the financial markets become inevitable.
Capital always chases the highest-yield leading sectors. It is precisely for this reason that during the booming phase of real estate, funds from institutions across society participated — to varying degrees — in real estate-related project investments.
To be continued… About half remains — couldn’t post it all. Will revise and post the second half tomorrow.
Last edited: 2023-08-15 23:56