Sock puppet

The pending failure of a major Chinese property developer looks a lot like Pets.com

March 18, 2014
March 18, 2014

The news that Zhejiang Xingrun Real Estate, a property developer, is close to a 3.5-billion-yuan ($570-million) default is the latest in a slew of high-profile Chinese default risks of late. Though defaults have been relatively few given the scale of China’s debt woes, analysts have already turned to historical shorthand to make sense of what’s going on, including:

  • “Bear Stearns moment”—Bank of America/Merrill Lynch’s David Cui recently likened the corporate bond default of Chaori Solar to Bear Stearns’ 2007 bailout of two of its hedge funds, which set off the first wave of panic about bank investment in subprime mortgages.
  • “Minsky moment”—Wei Yao, economist at Société Générale, declared last year China could soon face its “Minsky moment,” referring to a situation theorized by Hyman Minsky, the 20th-century economist, in which indebted companies are forced to sell good assets to repay debt (registration required).
  • “Lehman moment”—Back as far as 2012—and more frequently in recent weeks—analysts began wondering whether the combination of unexpected government policy, high debt, and plummeting investor confidence could spark something like the 2008 collapse of Lehman Brothers.

None of these labels really applies to Xingrun; its collapse (and it may yet be bailed out) would be minor for China’s overall real estate market. That’s one reason why a more apt comparison for Xingrun might be Pets.com, the poster child (sock puppet mascot?) of the 1990s internet bubble. The supplier of dog collars and bird toys became the first publicly traded online retailer to fail (paywall), less than two years after raising $100 million in funding.

Though Pets.com’s business model—which entailed, for instance, shipping 50-lb. sacks of dog food—seems easy to criticize now, Amazon.com and big-name venture capital firms invested in the company. Its failure happened as other online retailers, whose valuation had also been driven sky-high by enthusiastic investors and stock-promoting investment banks, also collapsed.

Something similar may be underway in China’s property market. Developers have borrowed heavily on the widely held assumption that Chinese real estate prices can only go up, benefiting from Chinese households’ tendency to use homes as a store of wealth. Now slowing sales in big cities—they’ve been falling in smaller cities for awhile now—are squeezing developers’ cash flows. In Chongqing, for instance, Magic Property faces a potential default later this month. Of the 200 biggest collective trust loan investment products, 70 are in property, amounting to 52.5 billion yuan, according to BofA/ML.

Like Pets.com, Xingrun is tiny. But if its debt woes prompt investors to question heady housing valuations, it could have the same psychological effect that caused the evaporation in funding that led to Pets.com’s rapid collapse.

The fallout from Pets.com and other internet startups ultimately destroyed billions in investor capital, crashed the Nasdaq stock market, trashed the reputations of Wall Street brokers and analysts, and left San Francisco with more than its share of empty office buildings.

That’s hard to remember now, when investors’ willingness to plow money back into internet properties has proved incredibly resilient (as have several Wall Street personalities from that era, not to mention San Francisco’s real estate market.) But it did take nearly 15 years to get to this point.

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