Back in 2017, we explained why the "fate of the world economy is in the hands of China's housing bubble." The answer was simple: for the Chinese population, and growing middle class, to keep spending vibrant and borrowing elevated, it had to feel comfortable and confident that its wealth would keep rising. However, unlike the US where the stock market is the ultimate barometer of the confidence boosting "wealth effect", in China it has always been about housing as three quarters of Chinese household assets are parked in real estate, compared to only 28% in the US, with the remainder invested financial assets, which is also why it has traditionally been Beijing's duty to make sure that home prices appreciate year after year, even if the broader economy is doing poorly.

Which is why a recent warning by a top Chinese banker that the days of steady home price appreciation are now over, should come as the latest flashing red alert of more turmoil to come first for the world's most populous nation and eventually, the rest of the world.

On Sunday, the chairman of a leading Chinese state bank warned Chinese investors not to buy property now because “there’s no money to be made” due to high prices and alarming vacancy rates (an ominous development we first discussed last month in "The "Nightmare Scenario" For Beijing: 50 Million Chinese Apartments Are Empty").

Tian Guoli, the chairman of China Construction Bank, which provides mortgage loans to millions of Chinese households, was quoted by China's Sina.com portal that the room for further property price rises was limited and it was unwise to buy at current rates.

Tian Guoli, chairman of China Construction Bank

Offering some surprisingly blunt advice which would appear counterproductive to his business model - after all Guoli is incentivized to make as many mortgages as possible - Tian said that "there’s no money to be made if you buy a flat nowadays. If you insist on buying a home, aren’t you trapped at the high price level?" The CCB Chairman was speaking at a forum organixed by Peking University’s Guanghua school of management.

As the SCMP reports, the warning by Tian, who is an alternate member of the Communist Party Central Committee, came at a time when the country is in heated debate about the role of the property market – whether it will lead to an bust or whether it can help shore up the economy.

At the recently concluded Central Economic Work Conference, which disappointed markets without providing any concrete additional stimulus measures, the top leadership promised to build a long-term mechanism for the property market, on the basis that "property is for living, not for speculation", adding that regulations would vary from city to city.

To be sure, China's fascination with housing is understandable: over the past two decades property has proved to be one of the best investments in China, and is the reason why unlike the stock market the bulk of China's household wealth is invested in housing. It is also why, despite occasional government intervention – from purchase restrictions and sales limits to mortgage loan constraints – the average price has soared, making property in Beijing and Shanghai as expensive as London or Tokyo.

However, amid reports of massive housing vacancies as Chinese builders overextended in recent years to prop up GDP resulting in over 50 million empty apartments, there has also been increasing concern that a downturn in the housing market would hit households, banks and developers hard – and this in turn would be a serious threat to China’s state banks and local governments, whose revenues are tied to the property market. Meanwhile, even the smallest turbulence in the market could unleash a furious firesale as builders seek to dump vacant properties: in China, some 22% of the total housing stock is unoccupied, roughly double that of other developed economies.

Meanwhile, the debt keeping China's housing bubble afloat keeps rising, with the value of outstanding real estate loans – including mortgage and development lending – reaching 38 trillion yuan (US$5.5 trillion) by the end of September 2018, or 28% of total lending, according to government data, while just personal home mortgages in China have exploded sevenfold from 3 trillion yuan ($430 billion) in 2008 to 22.9 trillion yuan in 2017, according to PBOC data.

By the end of September, the value of outstanding home mortgages had surged another 18% Y/Y to a record 24.9 trillion yuan, resulting in a trend that as Caixin notes, has turned many people into what are called “mortgage slaves."

The good news is that for now the value of the collateral is higher as the combined value of properties in China, Tian warned, has reached US$40 trillion, larger than the US$30 trillion in the United States; as a result any downturn in housing prices would lead to massive impairments.

Furthermore, adding to the vacancy problem, while many property speculators in the West prefer to rent out their properties to ensure a rental income, in China it is more common to keep newbuilds empty because lived-in properties lose some of their value.

Tian said China still an adequate supply of housing stock, with shortages limited to a few big cities. However, in these cases he said it was important to ensure there were enough rental properties available.

“It is very necessary for large state-owned financial institutions to penetrate into property rental markets,” he said.

Meanwhile, the latest China household finance survey conducted by the Southwest University of Finance and Economics, which was published last week, found that the number of vacant urban homes in China has risen to 65 million units in 2017 from 42 million units in 2011, with the vacancy ratio rising to 21.4 per cent from 18.4 per cent in the period.

China’s small cities had more serious vacancy problems than bigger ones, the research centre found, echoing Tian’s speech. Data from the National Bureau of Statistics showed that the average living area of Chinese urban residents already reached 36.6 square meters in 2016.

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What is most troubling, and what may have spurred Tian's warning, is that despite relatively stable home prices, the foundations behind the housing market are cracking. As the WSJ recently reported, in early December, a group of homeowners stormed the sales office of their Shanghai complex, "Central Washington", whose developer, Shanghai Zhaoping Real Estate Development, was advertising new apartments at a fraction of the prices of the ones sold earlier in the year. One apartment owner said the new prices suggested the value of the apartment she bought from the developer in March had dropped by about 17.5%.

“There are people who bought multiple homes who are now trying to sell one to pay off the mortgage on another,” said Ran Yunjie, a property agent. One of his clients bought an apartment last year for about $230,000. To find a buyer now, the client would have to drop the price by 60%, according to Ran.

Meanwhile, in a truly concerning demonstration of what will happen when the bubble finally bursts, last month we reported that angry homeowners who paid full price for units at the Xinzhou Mansion residential project in Shangrao attacked the Country Garden sales office in eastern Jiangxi province last week, after finding out it had offered discounts to new buyers of up to 30%.

Country Garden cut the selling price at one of its residential developments by 1/3. Those who paid full price smashed the sales office. Similar incidents had happened before, and will again. It’s impossible to remove “the guarantee of principal”（刚性兑付）in China. pic.twitter.com/UxHFODYxmc — Hao Hong 洪灝, CFA (@HAOHONG_CFA) October 6, 2018

"Property accounts for roughly 70 per cent of urban Chinese families’ total assets – a home is both wealth and status. People don’t want prices to increase too fast, but they don’t want them to fall too quickly either,” said Shao Yu, chief economist at Oriental Securities. "People are so used to rising prices that it never occurred to them that they can fall too. We shouldn’t add to this illusion," Shao added, echoing Ben Bernanke circa 2005.

But the biggest surprise once the music finally stops may be that - as a fascinating WSJ report revealed one year ago - China's housing downturn is likely far, far worse than meets the eye, as under Beijing’s direction more than 200 cities across China for the last three years have been buying surplus apartments from property developers and moving in families from condemned city blocks and nearby villages. China’s Housing Ministry, which is behind the purchases, said it plans to continue the program through 2020. The strategy, supported by central-government bank lending, has rescued housing developers and lifted the property market.

In other words, while China already has a record 50 million empty apartments, the real number - when excluding the government's own stealthy purchases of excess inventory - is likely significantly higher. It is this, and not China's stock market, that has long been the biggest time bomb for Beijing, and if Trump and Peter Navarro truly want to crush China in their ongoing trade war, they should focus on destabilizing the housing market: the Chinese stock market was, and remains just a distraction.

To summarize:

China has more than 50 million vacant apartments

Mortgage loans have grown 8-fold in the past decade

Prices are kept steady thanks to constant government purchases of surplus inventory

China's top mortgage banker is urging his potential clients not to buy as price appreciation is limited

Home prices are already cracking, with some homebuilders forced to cut prices by 30%.

Homebuyers revolt, forming angry militias and storm homesellers' offices when prices dip

For now, China has been able to maintain the illusion of stability to preserve social order. However, should the housing slowdown accelerate significantly and tens of millions in empty units suddenly hit the market, then the "working class insurrection" that China has been preparing for since 2014...