Chinese Bank Fights A Bubble

A few days ago, I wrote about how difficult it is to combat bubbles. Bubbles are something that all economies have to worry about. Bloomberg today has an article about China's struggle to avoid a real estate bubble. They may be learning from our mistakes. Unlike the banks here, at least one of theirs seems to have a little more foresight.

Bloomberg writes:

China Construction Bank's President Zhang Jianguo said new loans will fall by about 70 percent in the second half compared with the preceding six months, helping the nation's second-largest bank avert a surge in bad debt.

"We noticed that some loans didn't go into the real economy," Zhang, 54, said in an interview yesterday at the bank's headquarters in Beijing. "I feel that some industries are expanding too rapidly. For example, housing prices are rising too fast, and housing sales are growing too fast."

One of the reasons I explained that avoiding a bubble is so hard has to do with the temptation of enjoying its expansion. You can potentially profit in two ways. One is if you aren't really in a bubble. The other is when there is real profit to be made if your timing is right, and you get out before it pops.

The first of those possibilities is difficult to discern. But it sounds like this Chinese bank is looking at historical trends and doesn't believe that the current expansion is sustainable. That's sensible. Assuming that real estate appreciation has fundamentally changed from its historical trends and could never depreciate is not sensible. That's the mistake that the U.S. financial industry made.

As for the second way of profiting, that might show a difference between the U.S. and Chinese banks. In the U.S., banks might have been more comfortable writing loans that could ultimately go sour. That's predominantly because they were able to securitize those loans, consequently selling the risk to others. In China, the securitization market is not as robust as in the U.S., so Chinese banks will have to retain more risk on their balance sheets.

Does that mean securitization caused the bubble in real estate? Not exactly. The cause was irrational expectations. Securitization was just the vessel through which that irrationality traveled. If the loans originated had been evaluated properly, and investors had understood the actual risk inherent on those mortgage-backed securities, then securitization would have functioned effectively.

Will this Chinese bank's efforts prevent a bubble? It's too soon to tell. If other banks follow suit, then it could. If all banks willfully reduce lending for a long enough period of time, then maybe irrational exuberance will dissipate. The temptation of writing more loans is great, however, so their discipline will be tested. After all, U.S. banks could not resist.