Real Estate Bubble – Exit Strategy

Following comments are from Professor Pettis at Guanghua Univ, Beijing’s article: “China: The Pace of Change“.

The so-called “Anglo-Saxon” model would involve a rapid liquidation of loans, the seizing and selling of collateral, and bankruptcies. The advantage of this model is that assets are quickly re-priced and allocated to their most profitable or efficient uses.

Pure creative destruction. Socially painful, but the imbalance is quickly corrected.

The second way, broadly speaking, that the break in the housing bubble might occur, and without the brutal social adjustments, is what has sometimes been called the “Japanese” model. Rather than force bankruptcies and rapid liquidation, borrowers would be permitted easily to roll over their loans, financing costs would be kept low (at savers’ expense of course), and excess inventory taken off the market.

Preservation of the status quo. Competitively painful, because imbalances are slowly corrected and continue to create distortions in the economy.

China´s financial sector issues are different [than the US]. China´s systematic misallocation of capital is its biggest financial problem. China needs serious governance reform and interest rate liberalization so that capital can flow to the most dynamic parts of the economy and be made available to risk-taking entrepreneurs in a way the fosters productivity growth. It needs capital to be correctly valued so that it is not wasted on creating overcapacity, asset market bubbles, and trophy projects, all of which detract from future consumption growth.

Agreed 100%. It’s important to remember that the politicians aren’t the source of the growth, they are the providers of infrastructure. The platform. The framework. The politicians give us the roads, the bridges, the electricity, and the law that ties everything together. China’s success so far has been in removing the restrictions that prevented entrepreneurship.

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