Chinese anti-corruption gun aims at land ponzi


Cross-posted from Investing in Chinese Stocks.

The word epic is overused these days, but it may apply in the case of China’s local government land sale abuses. With the audit underway, information is starting to leak out as developers and government officials start talking. The scale of the problem is still unknown, but there’s reason to be concerned by the numerous ways local governments have rigged land sales and inflated prices. It is not an exaggeration to say that if the examples listed in a new Ifeng article are not isolated cases, then even the most bearish forecast for the Chinese economy is far too optimistic.

During the housing bubble, Chinese media often reported on a local “land king,” a developer who paid an extraordinarily high price at a government land auction. Now we know why they were willing to pay sometimes seemingly absurd prices: the government was kicking back up to 80% of the total amount paid. Governments had already chosen the developer and fixed the price for the land, including signed contracts, with the auction a mere show for the public. If the auction price went above the contract price, the government would return the developer’s money, plus interest.

Besides fixing a land sale before the auction, governments also reimbursed developers for development costs such as roads, sewers, and improvements. Land prices rose very quickly because once developer costs were included in the land sale price, developers starting running up costs, for example turning a ¥100 million project into ¥500 million. Then if the land auction went for ¥1 billion, the developer would only have to pay ¥500 million for the land, with the other half reimbursed. This helps explain why land sales totaled ¥130 billion in 2001, but last year, land sales totaled more than ¥4 trillion, an increase of 30 times. The total sales over this decade plus comes to nearly ¥20 trillion.

Governments also forced their state-owned enterprises to join in land auctions once the market cooled, in a process that was in essence moving money from one pocket into the other. As was previously reported, this also worked in reverse as governments sometimes used proceeds from land sales to prop up their SOEs. Other times they told developers to stay away and transferred land to SOEs at cost.

Aside from the corruption involved, the worst aspect of this is the distorted market signals sent by high land prices. This adds a new layer the bear case because prices were not only elevated to unsustainable levels by the credit bubble, but went beyond into truly artificial territory. There’s also the land finance aspect: governments have trillions of yuan in loans from banks backed by land sale revenue, but did governments report the gross or net revenue to banks? This issue alone could severely impair bank’s ability to lend if governments have been overstating their land sale revenue to banks.

What is most worrisome is that the audit prior to the current strict audit found 95% of the provinces surveyed had evidence of corruption in land sales. A single case is evidence, so we can’t guess the scale of the problem, but there is no good news coming. The “good” news will be the problem is indeed isolated and costs limited. The bad news will be the real estate crisis you thought existed is really far worse than imagined.

This is the heart of the problem confronting the reforms of Xi and Li. On the one hand, they must constrain local governments’ ability to interfere in the market, including falling back on the “easy” growth model of infrastructure development. On the other hand, there’s going to be a serious debt crisis if the property market slows and cities can’t borrow. Solution: cut financing costs, From Reuters:

In a speech in parliament about China’s fiscal system, Lou said China will control the amount of money borrowed by its regional governments by ensuring that all their debt is accounted for in their budgets.

Regional governments, responsible for the bulk of China’s public spending but getting less than their share of total fiscal income compared to the central government, have relied on borrowing heavily in recent years to stay viable.

To ease the financing pressure, Lou said governments that are stuck with expensive debt can replace them with cheaper municipal bonds – subject to approvals – to lower their interest payments. No further details were given.

It is not a coincidence that the comments on muni bonds come as the government launches the strict land sale and land finance audit. Allowing local governments to lower their debt financing costs is a very pragmatic reform that deals with the crisis threat, but doesn’t let local governments off the hook.

This reform plan also kills many birds with one stone. The local governments can swap their debt, but will still be restrained by large debt levels. It creates a new market for savings to compete with shadow banks. It helps develop internal financial markets and importantly, deeper bond markets that will be necessary for a freely convertible yuan.

Power is being taken away from local governments and transferred to the financial markets. This was the reform template of Zhu Rongji in the early 2000s, but his plans were thwarted when insiders took power in 2005. One of his goals then was to open the A-share market to foreigners. That will finally happen less than two months from now. The SOE reforms underway are also a blow to local governments ability to dominate the market. This isn’t news.

Back in November 2013, Li Keqiang was telling governments to get out of the economy:

China Premier Li Keqiang said local governments should stop directly investing in or setting up companies “in principle,” according to comments released a day before leaders gather to discuss economic policy.

Allowing local authorities to invest in companies or to intervene in their operations can ‘easily’’ lead to monopolies and market barriers, Li was cited as saying at a Nov. 1 meeting, according to a statement posted on the central government’s website today.

Or Li reminding them this year:

At one meeting, on May 30, Li reportedly pounded the table as he blasted local officials for inertia in carrying out central government directives.

He accused departments of micromanaging the economy and wasting time and resources examining and approving projects and deals that were entirely commercial matters unrelated to national security or strategic industries.

Everything from the audits, anti-corruption campaign and anti-monopoly campaign to tight credit, financial market and SOE reforms, are all aimed at the same goal of a market economy. With the opening of the oil market, launching of the international gold market, growth of the muni bond market and opening of the stock market, the China of 2020 is slowly coming into focus. The short-term outlook is deteriorating but long-term the outlook is steadily improving.


  1. The Chinese are learning the costs and dealing with governments meddling in markets … land markets in particular.

    New Zealand is dealing with housing and Local Government reform as well. It is a major election (20 September) issue.

    What are the Australian Federal, State and Local Governments actually doing in addressing these serious issues ?

    • To paddle onto the iconographic set about to push up onto the beach of political message machinery, “missing in action”?

      Men and women of substance would see the irony of flying labour into battle on foreign soil for system protection cause, while kneeling young and other labour to be spiritually massacred by foreign exporters of dwelling purchase as the nations souls cry tears from an egalitarian heart reaching up foreboding from the graveyards scattered across our land.

  2. I have been suggesting for a while that the mitigating factor in China’s urban land price bubble, is that at least the “value capture” has been made by government rather than the private sector, enabling taxes to be kept lower.

    But this would not be the case if government has been giving the developers big fat refunds under the table.

    There is no rational reason for this other than to conceal corruption. It would be perfectly logical to just have lower land sale prices in the first place, and hopefully have more affordable housing and a better-balanced local economy.

    The question really now is, all the investors who have bought the finished “housing” at absurd prices, are “greater suckers” for what? Who has run off with the gouged profits? This changes a lot; no wonder the reformers at the top of the CCP are really going for people to make an example of over this. China’s whole economic magic is illusory, which would not have been the case had local government genuinely been capturing the full land sales price for spending on useful things like education. Now we can see that local government is actually in a massive fiscal crisis and has not been doing socially and economically useful spending to the potential extent at all.

    I had given the CCP credit for trying a bold experiment, but it seems now that the whole thing has not been masterminded at all, but was merely human nature unleashed and going for broke – and YEARS passing before anyone blew the whistle on it.

    But I wonder how many people, even in the west, will see true free markets and competition as the correct path? I have always said that China could have adopted Texas policies; what we are seeing now is the outcome of not doing so. Hugh is right – stooges from the Left will accuse people like us of being “ideological” – BAH. How about being “good students of the school of real life”?

    I was far too generous in assuming a cleverly managed plan by the CCP. Hugh’s assumption all along, of plain old corruption, was correct.

    We haven’t seen much evidence yet in contemporary western urban planning, of the same sort of thing, but the conditions for it would be hard to set up better than they have been.

    • PhilBest … Thank you for your comments.

      Those reading H&Hs article above would be well advised to follow up by reading Ludwig von Mises … PLANNED CHAOS …

      Possibly one needs extensive heavy duty and grounded development experience (we only learn adequately by “doing”) to appreciate the significance and gravity of all this.

      This command economy / bureaucratic nonsense is all about image and numbers. Reality … and spare the thought consequences … don’t matter.

      One of the most disturbing aspects of this, is in how so many naïve people from the business community fail to adequately appreciate the natural order of markets and importance of democracy and the rule of law. … and are stupid enough to have a sanguine view of command economies, where they can hold hands with the elites to short circuit the processes of doing business.

      Unfortunately too … too many economists have their innate sense of markets trained out of them with their playtime “modelling focused” training. They are not “grounded” … as I explained many years ago with … HOUSING BUBBLES & MARKET SENSE …

      They need to read and watch (video) what Daniel Hannan MEP had to say about the evolution of our “Anglosphere values”, incorporated within what I wrote early January … CHINA: BIG BUBBLE TROUBLE …

      The mal-investment in China can only be described as “horrendous” … and before long will show that the ’07 GFC was just a “walk in the park”.

  3. Do you reckon we could have one these land corruption thingies here as well? Or do lozzies not do that sort of stuff?

      • Strange Economics

        Or as the 4 heads of the big 4 banks said last week “We see NO bubbles just a nice normal market”.
        Here they keep the market up by the opposite – strangling supply not allowing apartment development – e.g in the inner suburbs of Melbourne.

  4. This just reflects the realities of the political economy of the place.

    The entire system has one ultimate goal which is to serve the needs of the CCP being to enrich its members and entrench its power.

    China at its core is not a market economy. The stock market is rigged, land auction markets are rigged…

    • A one-party, totalitarian system that uses “capitalism” as a convenience but individuals have no rights at all, is really fascism, and China really illustrates how close Communism and fascism are on the political spectrum. It is quite easy to reform slightly from pure communism, and be practising fascism.

      • Spot on PB !”

        As H&H’s article illustrates, President Xi, Premier Li and the others (including of course Wang … driving the anti-corruption campaign) are desperately endeavoring to move as quickly as possible to a market based economy … from the current fascist type one as you correctly note.

        In the late ’70s, fascism was as far as Premier Deng at the time could take it … with his exhortations … “I don’t care if a cat id black or white … so long as it catches mice” and “Its glorious to be rich”. Without the Rule Of Law (which still doesn’t exist … although it is actively being discussed and promoted now) Dengs call emboldened the bureaucrats to enable and participate in development … with corruption as well.

        There are about 155,000 SOEs … and of course Local / Regional Government as well. One shudders to think about the REAL state of their finances. What we do know at this stage is that charitably they are likely “fiction”.

        Zhou’s downfall, as a former member of the Politburo and Security Czar is enormously instructive. Accumulating $US14.5 billion in corruption money was a remarkable feat … and graphically illustrates the depth of the likely problem through the entire bureaucracy.

        The problem has been the corruption morphed from “enabling” to “predatory” … enough to wreck the economy and put the Communist Party out of power if allowed to go on. The Xi regime anti-corruption drive is hugely popular.

        What commentators to date have failed to pick up, is that the Communist Party has no intention whatsoever of propping up the massive housing bubble. It simply doesn’t have the capacity … and anyhow … has more than enough on its plate sorting out corruption, the SOEs, Regional and Local Government … and too in getting some semblance of the Rule Of Law in to place.

        My sense is that they are endeavoring to get in place a Singapore on a truly massive scale. The survival of the Communist Party depends on them being successful.

      • @Hugh, yes I know what you mean regarding anything to do with Chinese data. Who would know what’s what with any of their numbers. Why Phat Dragon etc even make any attempt to decipher the fictitious data is beyond me.

        Everything is built on ponzi credit.

      • Mikeinnz … the naivety of the finance / economics people on these issues with respect to China often amazes me.

        We need to hear from more grounded types, with a deep understanding of Chinas development … residential … commercial … infrastructure.

        Then the finance guys will soon learn they have lent in to thin air!

        They need to stop dishing us up the fiction finance stuff out of China and focus their attention on the structural approach to the Chinese housing market.

        And too, give us some idea of the scale in $US terms of the massive infrastructure waste and real costs of propping up the SOEs and Regional / Local Governments as well.

        My strong sense is that the Chinese Government doesn’t have the capacity to prop all that up with more stimulus … and the horror story of the housing market at the same time.

        Indeed, it seems very clear to me the Chinese Authorities would be very pleased to see housing become increasingly affordable … and if need be start a political campaign denigrating “speculators”. That would not be a problem to them !

        The Xi regime is a very tough bunch indeed … as the anti-corruption campaign led by Wang certainly illustrates. Lee Kuan Yew of Singapore holds Xi in the highest regard.

  5. On an amusing note … my understanding is the Chinese Communist academics are studying the Catholic Church, to see if they can learn any lessons about how the latter has managed to survive for about 2,000 years !

    Is the Abbott Government in Australia “researching” this issue as well … I wonder ? !

  6. The Cargo Cult mentality … playing it out in China …

    Cargo cult – Wikipedia, the free encyclopedia

    Cargo Cult – YouTube

    … so the Chinese have convinced themselves, that by building a replica of Manhattan … well it will all just “happen”. It appears this Cargo Cult thinking is endemic in China. Video incorporated within this article …

    China’s Manhattan Rip-Off is Another Ghost City (VIDEO) : Home : Realty Today

    Bureaucrats the world over are obsessed with image of course … reality too often is beyond their comprehension.

    This is why China is sometimes described as a “Corrupt Cargo Cult Ponzi”. The Xi regime has a massive job getting it on the road to reality.