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What could go wrong?

26 June 2012 By Robert Cyran

China Development Bank appears to be toying with a subprime idea. The Asian firm is considering lending U.S. homebuilder Lennar $1.7 billion to construct two housing projects, according to the Wall Street Journal – one of them on a polluted man-made island in an earthquake zone. It has all the hallmarks of globally distorted economic incentives forcing yield-starved investors to take risky bets they don’t understand.

Real estate investing can be tricky for any bank. And converting Treasure Island, a former naval base near San Francisco, into housing isn’t straightforward, due to the competing governmental, environmental and seismic issues. But a good rule of thumb holds that the further afield a project, the greater the danger that the lender is getting out of its depth.

Of course, the projects have potential. The timing looks promising, as they could be investing at, or near, the bottom for housing. Average home prices actually rose 1.3 percent in April, according to the S&P/Case Shiller index. These projects won’t be finished for a decade or more, by which point markets could once again be sizzling. San Francisco has few spaces as well placed geographically as these two for big developments. And China Development Bank isn’t completely naïve – it has increasing amounts of experience investing in countries ranging from Australia to Pakistan.

Yet it’s worthwhile pondering why exactly a financial arm of the Chinese state is thinking of investing in building U.S. homes. After all, this foray hardly fits in with the bank’s original goals of building infrastructure in the Middle Kingdom and promoting strategic industries.

Perhaps the most salient reason stems from China’s policy of favoring exports. At about 3 percent of GDP, the current account surplus is a fraction of what it once was. But the country still has massive amounts of cash to invest overseas. Meanwhile, U.S. monetary policy has resulted in ultra-low interest rates. With U.S. 10-year Treasuries at 1.6 percent and set to remain around that level for some time, bankrolling complex construction projects starts to look unhealthily tempting by comparison.


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