What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing the meltdown of china's real estate sector has continued into 2022.. The developer giant evergrand officially defaulted on 20 billion dollars worth of offshore bonds in december. They recently said that they plan to restructure the debt, meaning that bondholders will likely get much less than the notional value that they are owed if anything at all. In addition to dealing with the real estate freefall, china is also grappling with increasing lockdowns related to the highly infectious omicron coveted variant.

These headwinds have caused the world bank to cut china's 2022 gdp growth forecast down to 5.1 percent excluding 2020. This would be the lowest growth rate the country has reported in the last 30 years, with real estate, making up roughly one-third of the chinese economy. This shouldn't come as too much of a surprise. It's easy to see the direct effects of evergrand and other developers defaulting on their loans and being unable to start new real estate construction.

But real estate is so intertwined with the chinese economy that the second order effects may end up being much more important. Over the years, local governments across china have become increasingly dependent on selling land to property developers. It's estimated that land sales make up roughly one-third of total government revenues with the bubble. Finally, popping real estate sales are expected to fall by 15 to 20 in 2022, less real estate sales means there will be less demand for local government land.

Goldman sachs estimates that chinese local governments have more than eight trillion dollars worth of off-balance sheet debt. That's on top of four trillion dollars of debt that they officially report with their leverage. So high, even a small decline in land sales could push many chinese cities into bankruptcy with local government finances under so much stress, it may become difficult to pay for the basic necessities such as law enforcement and public utilities. They certainly won't be able to stimulate the economy with new infrastructure programs.

In 2020, president xi jinping started cracking down on excessive leverage in the real estate sector in an attempt to deflate the bubble and avoid a financial crisis in the future. But it looks like he may have already been too late in this video. We'll look at how the real estate meltdown is driving china's municipal governments to the brink of bankruptcy. Ever since the 1990s, the central chinese government has enforced stringent restrictions on how local governments can raise taxes or borrow money.

The idea is that if the central government can control the vast majority of the country's taxes and spending, they will have the power to manage financial risks in the economy and for most of the 1990s and early 2000s, this system worked out fine in 2009, china was Gripped by the global financial crisis, which threatened to tank their economy into a deep recession in response, the central government established a 600 billion dollar infrastructure program to create jobs and stimulate the economy. However, only about a third of this money would come directly from the central government. The rest of the money would be reallocated from provincial and local budgets. This put tremendous strain on local governments.

The central government greatly restricts how much taxes the local governments are allowed to charge so to fill in their budget shortfalls. Local governments became increasingly reliant on land sales. Much of the undeveloped land in china is owned by local governments. They generate revenue by selling this land to private developers such as evergrand as chinese real estate prices have inflated.

Over the past decade, local governments were able to charge more and more for their land sales by 2020. These sales were estimated to represent about one third of local government revenue, but for many cities, even the money from the land sales wasn't enough in china. It's all about making your numbers if you're a local official, the easiest way to rise. The ranks within the communist party is to exceed your gdp growth targets and the easiest way to achieve gdp growth is to start public infrastructure projects.

But there's a problem remember that the central government greatly restricts the ability of local governments to raise taxes or borrow money without being able to issue bonds. How are the cities supposed to fund their infrastructure projects? This is where the local government financing vehicle or lgfv comes in. This is how it works. Let's say: you're a mayor of a city in china.

The central government says your city's gdp should grow by 10 this year. If you miss the target, you'll probably lose your job. The only way you can make the target is by building a road or bridge, but your city already has too much debt from previous infrastructure projects. So you set up an lgfv.

An lgfv is an off-balance sheet entity that is in charge of the project, because the lgfv is technically not on the city's balance sheet. They are allowed to borrow more money from banks or other investors. However, most of the projects end up being bridges to nowhere. That are unlikely to be economically viable.

The only way the city can convince investors to finance the project is by implicitly guaranteeing the liabilities of the lgfv. It doesn't really matter if the infrastructure project ends up being a flop. The local government can raise money by selling land to evergrand or other real estate developers and make good on the lgfv's interest payments in real economic terms, it's very similar to if the city just borrowed the money directly. It's basically just an accounting gimmick that allows local governments to borrow way more than they're supposed to so that they can fund their unlimited infrastructure development.

Local governments have used lgf fees to fund ever-increasing budget deficits, with expenditures up to 50 greater than revenues. Nobody knows for sure how much debt these lgf fees have but goldman sachs estimates an aggregate 8.2 trillion dollars of off-balance sheet borrowing. Roughly half of china's gdp. The finances of china's local governments are built on a house of cards that can only be propped up by ever increasing real estate prices, and it looks like this house of cards is about to come crumbling down.

Major property developers like evergrand, kaiser, anteja and many others, are under financial distress and are struggling to finish their existing developments. They certainly won't be buying new land anytime soon. The county of san hot recently said they announced property sales to fall by 50 in 2021. After 30 decline in 2020., while that's an extreme example, municipalities, all over china are facing severe stress.

The ratings agency fitch says that they expect chinese new property sales to fall by 10 to 15 percent in 2022. Many of these sales will be from properties which are already under development, so the decline in new land sales will probably be much greater because the local governments have so much debt. Even a small decrease in sales could push them into bankruptcy and we're already starting to see signs of distress. In late 2021, the local government of bajo faced a dramatic decrease in land sales to make up for the shortfall they started, placing arbitrary fines and fees on small businesses and individuals.

In the month of november, they increased their fine revenue 80-fold compared to prior months. The central government criticized the large-scale, indiscriminate collections of fines as they stifle small businesses and put an undue financial burden on residents. While bajo was certainly acting out of line, they didn't really have much of a choice. China has some of the most inflated real estate prices of anywhere in the world.

The average home in beijing costs 50 times the average annual income compared to just 10 times in new york city. Obviously, these prices are not supported by regular people buying their primary residences. They are instead supported by speculators taking on excessive amounts of debt, hoping to flip the houses for a quick profit. Much of china's economic growth over the past decade has been filled directly or indirectly by this debt field speculation.

Everyone knows the debt-driven growth is unsustainable, but at the same time, government officials are incentivized to make their short-term gdp growth forecasts. That's why they've been willing to turn a blind eye to the excesses in the real estate market and the ballooning liabilities of the lgfs in 2020? President xi finally said enough is enough. He wasn't willing to kick the can down the road any further, so he implemented his three red lines, policy which aimed to reduce leverage in the real estate sector. While this triggered the downfall of evergrand, they figured it was better to rip off the band-aid.

Now, before the bubble gets even bigger by that point, china was the first country to break the back of the coronavirus and reopen after their harsh initial lockdowns with the economy booming. She thought that this was the perfect time to implement long overdue reforms. What he didn't anticipate is a new omicron variant. More than two years after the initial outbreak in wuhan, china is once again enforcing draconian lockdowns under their zero-tolerance coveted policy in 2022, the chinese economy is facing a one-two punch of deflating real estate prices, as well as coveted lockdowns, while the deflation of the real estate Bubble will cause an economic slowdown in the short term.

It's a necessary reform for the long run. The era of endless infrastructure projects and bridges to nowhere is now over going forward. Municipalities will have to tighten their budgets and the central government will have to decrease their gdp growth targets since the turn of the millennium, china's per capita income has increased at a compounded rate of 13 per year. This has turned them from one of the poorest countries.

In the world to the second largest economy today, while china still has an opportunity to grow its economy, the economic miracle of the past two decades has to slow down alright guys that wraps it up for this video. What do you think about china's municipal debt bubble? Do you think she can orchestrate a soft landing? Let us know in the comments section below, as always. Thank you so much for watching we'll see in the next one wall, street millennial signing out.