China’s aim to lift the fortunes of a sinking stock market is throwing up some interesting results. From this week, Chinese margin traders will be able to purchase stocks by putting up their homes as collateral.
If that strikes you as desperate, you wouldn’t be alone.
The rules governing stock trading are being relaxed because Chinese markets are taking a battering. Since mid-June, a staggering $3.16 billion has been wiped off Chinese markets. The 24% fall amounts to double the entire ASX market cap.
It bears asking: what would happen if the stock market continued its freefall? Chinese traders, using their house as collateral, may find themselves homeless in due course.
Granted, the new guidelines will only apply to margin traders — bypassing investors that trade using cash accounts.
Cash accounts are regular trading accounts that most retail investors rely on. When buying stocks through cash accounts, investors must have the required capital to purchase stocks.
By comparison, margin traders aren’t required to have the money at hand. Margin accounts allow traders to borrow money from securities brokerages. Brokers essentially loan out this money, which can be used to purchase shares.
Many traders prefer this method as it allows them to buy greater quantities of stock. Margin trading is also popular among investors who bet on the future direction of stock prices.
Now, they’ll be able to hedge their bets by using real estate as collateral.
Giving traders this option seems both irresponsible and risky. Not least, it opens up a whole new can of worms, such as the trade-off between risk and reward. That’s not only true for margin traders either, but for securities firms that grant these loans.
But that’s not where the madness ends.
The rules will also allow margin traders to put up ‘other’ assets as collateral. All exaggerations aside, what’s to stop a broker from accepting a rare collection of stamps as collateral? For all we know — absolutely nothing.
All of this might be acceptable if the Chinese real estate market was stable. But the evidence suggests anything but.
Chinese real estate is in no shape to be used as collateral
The health of the Chinese real estate market is up for debate. The bubble like growth we’ve seen in the past 15 years is showing signs of cracking.
Take the Shanghai real estate market for instance. It’s grown by 650% since 2000, and 90% since the GFC.
Chinese real estate growth was driven by rural migration to the big cities. The vast number of these unskilled migrants found work in construction. They were the building blocks of China’s boom in real estate.
Now that migration is slowing down, there aren’t enough people to keep vacancy rates from rising. Over a quarter of all urban apartments in the biggest cities are vacant.
With the economy stagnating, and rural migration drying up, property prices are entering a correction. Prices across the largest cities have fallen by 23% in the last year.
The efforts to disguise this downturn is largely why the government was so keen to promote stocks to investors. They wanted to move people out of the sickly property market and into a new asset. That explains the astounding growth in Chinese equities in the past few years.
You can now see why allowing real estate to act as collateral makes little sense.
You’d end up with one fraught asset class being used as security against an even bigger basket case.
And it’s not just investors who stand to lose their most of their assets on a bad trading decision. The benefits for brokers aren’t all that clear either.
Some analysts predict that securities firms will stay away because of the risks in the housing market. While that would be a positive step, it’s guaranteed other brokers will accept real estate as satisfactory collateral. As long as that’s the case, margin traders will put themselves at risk of losing most of their assets.
There’s a reason why such guidelines aren’t accepted in Australia, or elsewhere for that matter. Illiquid assets like property aren’t as easily convertible to cash. That’s because selling a property is a drawn out process, making it harder to liquidate into cash. The market simply isn’t active enough to get money in your hands at the moment you need it.
Interestingly, the new margin trading rules did little to affect market confidence. Despite the announcement, the Shanghai Composite Index dropped below 4,000 points. Where the market ends up as we head into the second half of the year is anyone’s guess.
Unfortunately, this uncertainty may only increase the amount of hedging on the markets. There are big gains to be made whichever way the markets end up going. Just don’t be surprised if there are far fewer homeowners by the end of it all.
Contributor, The Daily Reckoning
PS: Speculation over the future of the ASX has been rife in recent months, amid heavy losses. The local stock market shed almost $40 billion this week on the back of the situation in Greece. That selloff reduced the share market’s gains in the 2014–15 financial year to just 1%. The long term signs aren’t good, with the S&P/ASX200 falling by 9% in June, down from a high of 5996 in April.
The Daily Reckoning’s Vern Gowdie thinks we’re on course for a major correction in equities. Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of Australia’s Top 50 financial planners. He believes we’re set for a catastrophic crash in stocks in the future. And he thinks the ASX could lose as much as 90% of its $1.8 trillion market cap.
Vern wants to help you avoid the coming wealth destruction. That’s why he’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report, he’ll show you which five blue chip Aussie companies could destroy your portfolio — and you almost certainly own one of them. To find out how to download the report, click here.