The horizon is not so far as we can see, but as far as we can imagine

Correct Priorities in China’s Response to the Mortgage Boycott

So, China’s construction market has a problem, and vast numbers of Chinese have stopped paying mortgages on stalled out or behind construction projects.

The government’s likely response?

…a typical scenario would involve seizing land from a distressed developer and giving it to a healthier rival, which would in turn provide funding to complete the distressed developer’s stalled projects.

And there is this:

The focus on completing projects is the latest sign that policy makers are prioritizing homeowners over bondholders, who have been burned by a record number of defaults by real estate giants including China Evergrande Group.

This is a correct response. Investors who lend money (which is what bondholders are) are gambling. If whoever they gamble on can’t pay, they should lose their money. That’s how it’s supposed to work, and it’s how it has to work if markets are to do their job. A market assumes that someone making a profit is producing something other people want for less than they’re willing to pay. Investors are supposed to direct capital towards those sorts of producers. If they make bad bets, they should lose their money, and someone else should make the bets.

Lenders and developers exist to do things. Investors finance those enterprises which provide “utility” and make a profit. Developers construct buildings (which have utility) at a profit. If you can’t both provide a service or product with utility and make a profit, you should not survive in a market economy. That’s how it works.

So the bond-holders should lose their money, and the developers who can’t construct buildings at a profit should go out of business and, yes, the consumers should be protected as long as they acted in reasonable good faith. Ordinary people aren’t developers or financiers; unless there was an obvious reason to expect fraud which an ordinary person should have seen, they should be made almost whole. Not entirely, so that they become a little more wary in the future, but the delays already do that.

China’s central government should have acted on this much sooner, but if they go with this response, it’s a good one. Westerners should learn: Investors, traders, and businesses can’t be protected classes in a market economy.



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Open Thread


  1. Trinity

    “Ordinary people are developers or financiers, unless there was an obvious reason to expect fraud which an ordinary person should have seen, they should be made almost whole.”

    I think you meant Ordinary people AREN’T developers? Perhaps there is a missing connecting clause? I think what you are saying is:

    Ordinary people aren’t developers or financiers. Unless there was an obvious reason to expect fraud, they should be made whole.

    The phrase “which an ordinary person should have seen” is the part that is confusing me, as ordinary people wouldn’t foresee what they are enduring now? Maybe wheeler dealers would be “in the know” about who is over leveraged (or over scheduled), but not ordinary people.

    Well, like I said, I may be confused.

  2. Ian Welsh

    Thanks Trinity, yes that should have been an “aren’t”. Fixed.

  3. Lex

    I saw a random clip with a Chinese policy analyst/expert or something credentialed and he quipped that China has markets without capitalism. Maybe not quite, but this sort of response does indicate it is willing to reign its capitalists in, which is in defense of the market. I try to tell people there can be markets without capitalism sometimes, but those blank stares get old after a while. Why even Lenin was open to markets without capitalism. I’ve also read that Chinese leadership has looked to the NEP as a guide rather than sticking to doctrinal Marxism.

  4. Astrid

    The central government has been kicking the can down on the property bubble for 15 years. In the short run, the wealth effect is great for stimulating domestic consumption and fills the coffers of local governments from land sales (Shanghai pensioners probably receive more per month than their American counterparts in social security, and their retirement age used to be 50 for women).

    And yes, absolutely everyone there thinks that the “government” will step in to bail them out if things blows up. The central government would do well to pop some bubbles now and slowly deflate others. Maybe serious tendons with West would give them the pretext to act.

  5. Soredemos


    The NEP was s compromise made in the context of a devastating civil war. Lenin wasn’t particularly happy about it.

  6. somecomputerguy

    Quite a far cry from HAMP. Started on Reed Hundt’s book.

    If credit is socialized, is it still capitalism? Is making sure finance is under iron control, the biggest piece to a sustainable civilization, or could it be the only necessary piece?

    I have been waiting for the supposedly imminent collapse of Chinese zombie state-owned firms for many years now. I don’t think it’s going to happen. Why would it? They are state-owned, and their debts are in renminbi. At worst, the Chinese are just as free to simply print money, the way the FED evidently does now, secretly, in response to a bubble popping.

    Financial crises can be handled quietly with hardly anyone even noticing, by simply bailing out immediately. I believe that is what the recent quantitative easing means, right? The Chinese people get homes, and we get executed credit default swaps.

    Can it be called a bubble, if it is a controlled phenomena?

  7. bruce. wilder

    This post goes a long way towards exposing what is wrong with economics as a civic doctrine or ideology.

    As a civic doctrine, economics has to be absorbed and internalized by a large portion of the “educated” classes and it does this in part by burying its more problematic and paradoxical aspects underneath a faith that the architecture of the political system of social cooperation in production and trade (aka the political economy) is, or ought to be guided, by the principles of a secular, just world: the political economy, in other words, ought to be designed to be “fair” in some important sense to those who participate in good faith in its prescribed and regulated scheme of organized social cooperation through specialized production for exchange. Positing an ideal of economic justice as an architectural or design principle economizes on the cognitive capacity of the vast majority of students (and teachers) of economics, who are not that interested (beyond practical applications to business and “making money”) in the abstract, god’s eye view of “the system” as a whole. Moreover, not getting into the “technical details” of how governance is to be carried out enables people to agree to disagree without realizing it, postponing political controversy until after everyone has left the academic veil of ignorance for the real world.

    The traditional pedagogy of Econ 101, teaching how a system of imaginary “markets” would work to enable this, the best of all possible worlds (Voltaire’s summary of Physiocratic doctrine in Candide) reinforces an expectation of “just world” design in the otherwise weak mnemonics of a theoretical analysis that has few referents in the observable economy. That theoretical analysis, as most know, labors mightily to “prove” how competitive price resolves the conflicting desires of producers and consumer, supply and demand, in an optimal way. As long as the “market process” is fair (“competititve” with complete and symmetrical access to information and blah, blah), the conflicts inherent in social cooperation in a system of deeply-specialized production are resolved amicably and just at exactly and precisely the right distribution of goods and rewards, which is also just the right rate of output and consumption.

    It is mentally damaging crap, this Econ 101 of optimal allocative efficiency in a system of markets (sic). The “just world” drama in which it is encoated is saccharine to make it sweet enough to swallow. It is always assumed at the elementary level of classroom instruction, that the actors and agents of the economy are rational and well-informed — they know what they are doing, individually and, by implication, collectively, making decisions (bets) prospectively but without excessive risk-aversion, that is to say, with the confidence of competent entrepreneurs who know how to “handle” the uncertainty (and by implication to “hedge their bets” or insure against loss).

    The reality of the actual political economy is that there are very few actual markets in operation: a market (an actual market in design and function with bidding and so on) would be a highly impractical way to organize most production and exchange. Most production is organized around and by sunk-cost investments in structures, equipment, training, marketing, product and distribution design, location, all informed by knowledge gained from science and business or engineering experience. Once that sunk-cost investment is made — and it is made because the technical efficiencies achieved make such investments the apparent dominant strategy for supplying the goods — there is no inherent way to earn a return on those investments. Sunk-cost is sunk-cost — it means that there can be no call on subsequent choices in bargaining for a return on that investment . . . absent some form of political power built into the rules of the game.

    This last insight is a direct assault on the assumption of a “just world” principle of system design. In a “just world”, if you build a better mousetrap, the world beats a path to your door for your better mousetrap and you are rewarded for your inventiveness and sagacity. It does not work that way in the actual economy, unless the state intervenes somehow to make it so.

    If a gifted storyteller, composes a popular story — in the absence of copyright — the story is published and re-told without recompense to the author, perhaps not even fame and credit. If a bridge is built to nowhere, so that nowhere becomes somewhere to go, the owners of nowhere-become-somewhere may profit, and people and goods on their way to and from the new somewhere benefit from the reduced cost of travel and transportation, but the bridge-owner can charge only the marginal cost of crossing, which has been reduced considerably by building the bridge — and the sunk-cost of building the bridge can be no part of that toll. At best, congestion on the crossing may permit an elevated toll, but that kind of proves my point: the only way to “make money” on the bridge is to create congestion or a shortage of crossing capacity.

    The actual economy of ubiquitous sunk-cost investment and pervasive uncertainty is not a place of conflict neatly resolved by optimum prices. It is, in fact, an endless tangle of problematic conflicts and disappointed expectations, problems imperfectly understood, for which there are no neat solutions, only improvisation, and in which political power is a necessary element.

    Econ 101 is taught as if the key is getting the initial conditions right: given the right incentives and well-informed expectations, people will do the right things, and it will all work out in the end. Doesn’t happen that way in life. In real politics, things are always going wrong, things don’t work out, and the main problem is not setting expectations up “at the beginning” — winding up the toy and letting it run on a table’s level surface — the main problem is governance, arbitrating after the fact of the toy falling off the table and breaking into multiple pieces and then fixing it all in some way.

    I don’t know much about China’s property development, beyond understanding that China has been furiously building, building, building on an enormous scale for decades and now the huge sector of their economy dedicated to that high rate of construction has to be wound down in the transition to something else. Plenty of “ordinary people” who have invested in housing ownership as a way of parking their accumulated money savings are not going to be any happier than the property developers, when the money value of housing units settles to lower levels in the new economy of China.

    I am sure property developers who are made bag holders in the collapse will feel aggrieved. I would not assume that they are entirely wrong to feel that way. I doubt that it is as clear-cut a matter as making the American banksters take a loss on the collapse of a fraud-induced bubble in esoteric financial “products” — though maybe there is, in fact, plenty of fraud in Chinese property development. Certainly would not surprise me if there were: it is human nature and the Minsky Principle holds as far as the long continuance of any economic boom cycle is concerned.

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