Thursday, April 29, 2010

Why Take a Chance on Moody's?

By Eric Jackson
RealMoney Contributor

4/29/2010 1:15 PM EDT
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Investors have been lulled into a sense of complacency about the prospects for Moody's (MCO -commentary - Trade Now) since its recovery off the March 2009 lows. Even though the stock has dropped since the SEC leveled charges against Goldman Sachs (GS - commentary - Trade Now) a couple of weeks ago, investors seem to have looked past all the market turmoil over the last two years and assumed that life is going to go back to normal for Moody's.

That is a false assumption. There are many reasons to avoid holding Moody's long at the moment.

The case in favor of owning Moody's is that the government is going to take a hands-off approach to regulating the ratings agencies that control anoligopoly (including S&P, which is owned byMcGraw-Hill (MHP - commentary - Trade Now), and Fitch). If this is the case, and if you have a recovering economy, then companies will need to issue debt as part of the lifeblood for growing their businesses, and they will need Moody's (and others) to sign off on that debt.

Moody's has historically printed money from this business. Gross margins for Moody's in 2007 were 74%. As a friend of mine who used to work for Moody's said to me, "The only people who get margins like that are gun-runners and drug cartels."

Up until the SEC's case against Goldman, I might have had to buy the status-quo argument -- as much as it sickened me. After all, how can you not say that Moody's and the other ratings agencies don't deserve to be further regulated after the Lehman market meltdown? Yes, there were many actors who deserved blame (including politicians and consumers, not just Wall Street banks). Yet the ratings agencies' remarkably blissful ignorance and failure to warn investors of possible risks to the housing market are shocking even now.

In the fall of 2008, post-Lehman, the agencies threw kerosene on a fire by classifying formerly AAA-rated super-senior tranches of housing-related debt as junk -- overnight. I'm not saying it wasn't junk, but how does AAA become junk in 12 hours? Clearly, the agencies should have flagged this as a concern much earlier and gradually marked the assets down. Instead, their helter-skelter move sent shockwaves of panic through the market, leading to a further decline in market prices.


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Note: Jackson had a short position in MCO at time of publication.

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Wednesday, April 28, 2010

Citi Ex-CEO Prince: Blinded by Hubris

By Eric Jackson

04/28/10 - 06:00 AM EDT

Stock quotes in this article: C

A few weeks ago, the day after he testified in Washington before the Financial Crisis Commission, I heard former Citigroup (C) CEO, Chuck Prince, speak to a friendly business audience at a closed-to-the-business-press luncheon. I went into the meeting thinking Chuck Prince was a fool; one of the poster boys for the out-of-touch Wall Street CEOs whose actions helped bring the world economy to the brink of collapse two years ago. I left the luncheon with a much more nuanced view of the man.

Prince raised some interesting questions that I -- and I suspect many -- would have a hard time answering, making me concerned about how much we've really learned.

Prince was criticized by author Michael Lewis and others for his quote, "When the music is playing, you have to get up and dance and we're still dancing." That was his explanation, in early 2007, for why Citigroup was so heavily invested in the subprime mortgage space.

It would be easy to write off Prince as a buffoon; someone in over his head. He was a lawyer, after all. He should have know better. People who make big mistakes in business are either idiots (like Prince), unethical (like Skilling or Kozlowski), or evil (like Madoff). We write them off, and move on.

So the obvious question for Chuck Prince is, what the hell happened to almost kill what was once thought of as the world's leading bank?

According to Prince, they held $40 billion in super-senior tranches on housing assets. Alan Greenspan had referred to these assets as "as safe as U.S. Treasuries." Overnight, they went from AAA to junk, according to the ratings agencies. At first, Prince (and his CFO Gary Crittenden) thought it was a $200 million problem. Then, it became an $8 billion problem, then an $11 billion problem, and later back to an $8 billion problem. By the time it was settled, however, Prince was long gone.

It's clear that Prince seethes at the ratings agencies' role. Since his world changed overnight -- with AAA assets becoming junk -- Prince obviously believes he deserves some understanding. At one point in the luncheon, he said:

"I guess what you should take from my story is, don't trust conventional wisdom. Even if theFederal Reserve chairman says some asset is rock solid, don't take his word for it. I guess in 2006, I could have gone down to our trading desk at the tip of Manhattan and told the traders, 'You know guys, I just don't think Greenspan or anyone else knows what they're talking about in reference to these super-senior tranches. I know we're at the top of the pyramid to always get the cash flow from these products, but I just think the world is going to change. Sell them all.' They would have looked at me like I'd lost my mind. They would have wondered, what does this lawyer think he's talking about?"

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China Trip: China Wind Systems

By Eric Jackson

RealMoney Contributor

4/26/2010 1:32 PM EDT

Three weeks ago, I met with Ryan Hua, vice president at China Wind Systems (CWS - commentary -Trade Now), at his corporate offices in Wuxi, China. The company has attracted attention because it produces components for large windmills that generate alternative energy. It is one of the only Chinese-based, U.S.-listed public companies operating in that space. Overall, I like the company a lot for the long term, but any potential investor should be aware of some potential short-term challenges to the stock.

Wuxi, the headquarters of China Wind, is about an hour and a half northwest of Shanghai, up the Yangtze River. Most Americans would have a hard time finding it on a map. Yet it's a city of about 5 million -- larger than the city of Los Angeles -- that's home to many industrial and tool companies with a lot of wealth.

China Wind Systems was founded in 1995 by the current CEO, Jianhu Hua, as a heavy machinery and dyeing company. The company developed a cheaper way of dyeing fabrics in large vats. This older business still exists today, and although it is declining in revenue in comparison with the wind systems business, Ryan Hua told us that the dyeing business has shown some renewed strength over the last couple of quarters, compared with the post-Lehman days when business dried up. Besides this legacy dyeing business, China Wind Systems also sells industrial equipment used in the coal power industry.

In fact, to this day, when you walk into the China Wind Systems corporate offices, the legacy company name, Wuxi City Huayang Dyeing & Finishing Machines Co., is displayed on the building prominently.

From Dyeing to Going Green

Most investors in the business are attracted not to these legacy businesses but to the wind power component. The origins of this business date back to 2005, when CWS began to manufacture "green" equipment that was environmentally friendly, for sale to the coking and coal-powered industries in China. By April 2007, things were going well, and Jianhu Hua recognized that the wind power industry would be significant in the years to come in China. Remember, the company had been operating in the clean coal industry. China's power usage comes predominantly from coal power, which, although plentiful in China and relatively cheap, is highly polluting. Citizens of Beijing and Shanghai count the number of "blue sky days" they get annually, because they are so rare.


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Thursday, April 22, 2010

Reader Question about China Mass Media


I've written about China Mass Media (CMM) before and said that I have a long position in the company.

Earlier this week, a reader asked me:

"How is it possible that CMM's operating cash flow exceeds its revenues? I'm looking at its financials from Yahoo! Finance."

I posed this question to Eric Cheung, CMM's CFO, with whom I met last month in Beijing. Here's his response:

Here is the reason for our operating cash flow is greater than our revenue for the years ended 2005, 2006, 2007 and 2008.

One simple sentence answer:

We were able to manage payments of media cost liabilities to be settled at a much slower pace than we collected revenue from the advertisers or their agency firms.

A full story version of the answer:

During this four year period, the overall Chinese economy is rapidly propelling and advertising industry was one of the industries receiving such benefit. Being a huge earner of the Chinese advertising budget cake each year, CCTV also enjoyed a steady and significant growth in terms of revenue.

Due to high quality of CCTV's air time resources, CCTV requires prepayments from advertisers for their advertisements to be broadcasted on its network. We leverage on this bargaining power and be able to request prepayments from our customers in most of the case. So, our revenue collection is very timely.

Due to our advertising air time contracts structured with CCTV, for most of CMM's products, we were obliged to pay CCTV after the advertisements have been broadcasted as we adopted "revenue sharing" type of business model with CCTV. We paid CCTV when they billed us. And CCTV did not demand for significant payments of media fees during this period of time. Hence, we had accumulated significant amounts of accounts payable on the balance sheet during this period as well.

A little extension to the answer:

However, such situation was reversed in 2009, when the global economic crisis finally hit China starting from late 2008. CCTV started to collect our payables to them starting from mid 2009. Hence, you can see from my balance sheet, the balance of accounts payable has been significantly reduced in 2009 and the company have a negative operating cash flow in 2009.

Following the change of the Station Chief of CCTV in 2009, the new officer had installed many new mechanisms when dealing with advertising agency firms. Now CCTV increasingly used underwriting model rather than commission model to deal with its advertising agency firms if they want to secure some exclusive ad resources. Personally, I see the significant negative operating cash flow in 2009 was an one-off event and everything should be "reset" to the normal level starting from 2010 and we should not have significant accounts payable accumulation anymore in the future. Generally, my expectation is 1-3 months creditor turnover days.

I hope I had made a clear explanation and thank you once again for your interest in our company.

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Apple and ARM

By Eric Jackson
RealMoney Contributor

4/22/2010 10:53 AM EDT
Click here for more stories by Eric Jackson

There has been speculation overnight that Apple (AAPL - commentary - Trade Now) may be interested in purchasing ARM Holdings (ARMH - commentary - Trade Now) for $8 billion. ARM is the company behind much of the intellectual property for microprocessors embedded within mobile phones. ARM was up yesterday on the rumors, while Apple was flat for the day after announcing its blowout earnings on Tuesday night.

As an Apple shareholder, I would support this kind of deal. Here's why:

1) Apple gets a pass from shareholders to stockpile its cash, but any normal company would feel the heat to do something with it.

  • On Tuesday night, Apple told us that it had just under $42 billion in cash on its balance sheet. To put that in perspective, Microsoft (MSFT -commentary - Trade Now) has $33 billion of cash,Google (GOOG - commentary - Trade Now) has $27 billion and Berkshire Hathaway (BRK.B -commentary - Trade Now) has $31 billion. Does Apple really need 35% more cash to fund its business than Buffett?
  • The press likes to talk about the cult of Apple and how all the analysts on the Street worship this company. Obviously, given its performance, admiration is deserved. But all companies -- even the most successful ones -- deserve to be questioned. And someone with authority should legitimately ask Steve Jobs and Tim Cook why they don't do something with their cash.
  • Some value-oriented shareholders would like to see Apple dividend this cash out, either through a one-time mega-dividend (which did nothing for Microsoft a few years ago) or through an ongoing large yield. Paying a dividend goes with Valley companies as well as a three-piece suit. Therefore, I think it's highly unlikely.
  • What else can Jobs and company do with it? Buy something. Some shareholders worry that Apple's never been an acquisitive company and that it would foolishly spend its cash if they went after a big prize. However, may I humbly ask: what was the last stupid decision Apple made? Sure, Apple TV hasn't fully panned out (yet), but that hasn't cost shareholders. When was the last Iridium-like decision that Apple has made? Probably Newton. And when was that? Pre-Steve Jobs' return. My point is, give AAPL some credit to make a smart acquisition. And, to me, ARM sounds like a smart acquisition.
  • ....
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    Wednesday, April 21, 2010

    Chinese Pharma Firm Ramps Up Production: $CHBT

    By Eric Jackson, Senior Contributor

    04/21/10 - 09:28 AM EDT

    Stock quotes in this article: CHBT

    I recently met with Travis Cai, the chief financial officer of China-Biotics(CHBT) in Shanghai. The company is the largest provider of probiotic bacteria in China -- a segment of biopharmaceutical research that's often misunderstood and under-recognized by investors.

    Travis, a well-spoken CFO, just joined the company in February. It's clear he's here to help the company cultivate its image in front of Western investors. He did his undergraduate work at Tsinghua University in Beijing and has a master's degree from the Stern School at New York University.

    So, what are probiotics? You might have seen them mentioned in Activia commercials with actress Jaime Lee Curtis. They are live micro-organisms which, when administered in adequate amounts, confer a health benefit on the host (user). They can play an important role in immunological, digestive and respiratory functions.

    Some of the uses for probiotics include improving the health of your gastrointestinal tract, stimulating your immune system, helping to break down nutrients properly, reducing the creation of toxins, and reducing symptoms of lactose intolerance. They get added to nutritional products (supplements/powders), dairy products, food additives, animal feed additives, and pharmaceuticals.

    The key thing for investors to understand about probiotics is that the market is large and underserved in China. The Asian market for probiotics is expected to reach $9 billion by 2014. Asians, especially women, have a higher need for this type of bacteria to help their digestive systems.

    The biggest area in the Chinese market is dairy, which isn't fully served by Chinese producers and still relies on European suppliers. China-Biotics hopes to exploit its current position as the largest Chinese producer of probiotics.

    China-Biotics, founded in 1999, has its headquarters in Shanghai. It has been growing like a weed. Its top-line revenues have a CAGR of 35% for the last three years. The company, which had a trailing 12 months revenue of $71 million, recently guided a 50% increase in its top line for this year.

    It sells its supplements and powder to retail customers through over 100 outlets in 13 cities (mostly in or near Shanghai) under the "Shining" brand. It certainly has an expansion opportunity in retail to the rest of the country. However, China-Biotics biggest opportunities are in dairy and animal feed, not retail. It wants to provide the additives to yogurt-based drinks and infant formula sold in China, as well as to the $58 billion Chinese animal feed market.


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    Tuesday, April 20, 2010

    Why Goldman should overhaul its board

    By Colin Barr, senior writer, Fortune Magazine

    (Fortune) -- Not so long ago, it would have been heresy to say Goldman Sachs should take a cue from Citigroup. But as Goldman's sins come to light, Lloyd Blankfein could do worse than to follow Vikram Pandit's path to redemption.

    Goldman (GS, Fortune 500) said on Tuesday its first-quarter profit nearly doubled from a year ago. But all is not well.

    Goldman's giant pay packages and its omnipresent ties to Washingtonhave made it a target for populist outrage since the financial crisis hit. That anger is now bubbling over following Securities and Exchange Commission allegations that Goldman ripped off some clients by aiding a hedge fund customer thatprofited from their misguided bets.

    Goldman denies the charges. But even some who take the firm's side say big changes are overdue. They start with the composition of Goldman's board and the tone of the firm's dealings with the public -- two areas in which Citi (C, Fortune 500) has made real strides.

    "Goldman has taken a real drubbing in the court of public opinion," said Eric Jackson, an activist investor and hedge fund manager in Naples, Fla. "That is a perfect reason for making some changes."

    Jackson has been saying since last year that Goldman's board is too cozy and lacking in financial know-how to diligently oversee top management.

    The board is packed with honchos who led companies that have paid large fees to Goldman, such as Indian steel magnate Lakshmi Mittal and former Fannie Mae (FNM, Fortune 500) chief James Johnson.

    The problem with these choices, Jackson said, is that "these people seem to be favorably disposed to senior management's way of thinking," and are therefore unlikely to act as a check on CEO Lloyd Blankfein and his team.

    Coziness isn't the only strike against Goldman's board, Jackson said. He believes it is also lacking in financial savvy. Where Citi has reshuffled its board to add the likes of former U.S. Bancorp (USB, Fortune 500) chief Jerry Grundhofer and onetime Philadelphia Fed President Anthony Santomero, Goldman's board lacks any bank CEOs or former top regulators.

    And then there are the scandals.

    Regulators are examining the role of Rajat Gupta, who said last month he won't return to Goldman's board, in the Galleon insider trading case. Stephen Friedman, who remains on Goldman's board, quit the New York Fed after he was found trading Goldman stock, which is a no-no.

    "The board is becoming a lightning rod," said Eleanor Bloxham, who runs the Corporate Governance Alliance in Westerville, Ohio. "Lightning keeps striking them over and over."

    All of this has added up to a significant blow to Goldman's once glowing reputation.

    "I don't know who's been giving Goldman advice about their public relations, but it has been a disaster," said Jackson, who has no stake in Goldman but owns shares of Citi. "They need to get ahead of this train."

    Pandit, after his bank's many brushes with disaster, has recently tried to make amends. Citi's board has added eight members over the past year and the bank lately has been emphasizing its gratitude for taxpayer support extended in the dark days of 2008-2009.

    "We owe taxpayers a huge debt of gratitude for assisting us at a critical time," Pandit said in Citi's earnings release Monday.

    Of course, Pandit has an easier task than Blankfein in the sense that Citi's governance couldn't get worse than it did in the bubble days. Back then, the firm ended up loaded with toxic investments and prominent board members professed total ignorance.

    Still, Goldman has been all over the map. Blankfein issued a vague apology late last year for the bank's role in the subprime crisis, not long before he infamously told a British newspaper Goldman was doing "God's work."

    And though Goldman has highlighted its support of pay reform measures such as clawbacks and bans on guaranteed bonuses, in one way its corporate governance is behind the times. Blankfein continues to serve as chairman and CEO, even as the trend in recent years has been toward independent board leadership.

    At a time when every decision at the firm is going to come under scrutiny, that conflict doesn't look like a winner in the eyes of the public.

    "The issue for Goldman directors is whether they have been able to control the agenda," said Bloxham. "Directors must be asking, can we do our job?"

    Given Goldman's unsteady response of late, it's hard to believe the answer is yes. To top of page

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    Monday, April 19, 2010

    China Trip: China Mass Media

    By Eric Jackson
    RealMoney Contributor

    4/19/2010 3:30 PM EDT
    Click here for more stories by Eric Jackson

    Three weeks ago in Beijing, I met with the management of China Mass Media (CMM - commentary - Trade Now), one of the few U.S.-listed Chinese advertising agencies. Despite some challenges in the past year, it's trading at an attractive valuation and is worth a closer look.

    I met with CEO and Founder Wang Shengcheng and CFO Eric Cheung. Mr. Wang launched China Mass Media in 2003 and has always had a special relationship with CCTV -- China's largest domestic broadcaster. As a former producer, he enjoys a relationship with a range of CCTV's senior ranks, which helped early on. CMM has traditionally made its money bidding or brokering for ad slots on CCTV.

    The Chinese ad industry is still growing by leaps and bounds. During my recent trip, I was amazed by how bombarded consumers are with TV, outdoor, and print ads. You can't ride public buses without seeing ads playing on a couple of screens inside. Of all these ad mediums, TV is the biggest, accounting for $5.9 billion, or 40%, of the total ad market in China as of 2007. Since then, the TV ad market has been growing an estimated 14% yearly.

    State-owned CCTV is the dominant player. It's like a combined version of the Big Three U.S. networks, though, like the BBC, it has multiple versions of itself. The niche cable and satellite specialty channels continue to grow, buy CCTV still holds the bulk of national Chinese viewers.

    In addition to being a broker for key programs on CCTV, CMM has enjoyed substantial profit margins for years as the exclusive ad agent for CCTV's broadcast of the Chinese New Year Gala. Imagine an ad agency with a lock on selling Superbowl slots in the U.S. and you'll get the picture.

    At the moment, some of the changing industry dynamics have rocked CMM. First, CCTV recently announced that CMM would no longer be its exclusive agent for New Year Gala slots. At the same time, the ad business has been so red hot in the past couple of years that last fall's CCTV auction for media underwriters yielded record results.


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    Thursday, April 15, 2010

    Where Do We Go From Here?

    By Eric Jackson
    RealMoney Contributor

    4/15/2010 9:15 AM EDT
    Click here for more stories by Eric Jackson

    Earlier this week, I reviewed my long picks and macro predictions from the start of the year. They did pretty well as a group, assuming you held them through the quarter: up 22% through earlier in the week from the publication date.

    This is my updated list for the current quarter. I included only China-based U.S.-listed stocks last time, this being a focus of mine. For balance, I'm presenting five China and five non-China picks. Here they are:

    Top 5 China Picks

    Orient Paper (ONP - commentary - Trade Now): Iprofiled the paper-printing company a couple of weeks ago. This is my top China pick at the moment. It will be interesting to see the company's first-quarter results and possible analyst upgrades or research initiation.

    Puda Coal (PUDA - commentary - Trade Now): This is a holdover from my initial list. It has performed well in the first quarter and still looks appealing. It is still transitioning from a coking-coal company to owning and operating thermal-coal mines in China's Shanxi province. The market hasn't yet digested a local government move to encourage consolidation of the many small mines operating in this coal-rich province. As one of the beneficiaries of this policy, Puda has already acquired a handful of mines, but more should develop this year.

    China-Biotics (CHBT - commentary - Trade Now): This is a new position. I met with its new chief financial officer, Travis Cai, in Shanghai a couple of weeks ago, but I hadn't had the opportunity to write up my notes for RealMoney(although I will, soon). This probiotics company sells to three key markets: Retail, through a chain of shops, mostly in Shanghai, that sell health supplements; dairy, supplying additives to China-based milk and yogurt producers; and feed, via health-supplement additives for livestock feed. It has more than $150 million in cash from a recent secondary issue. It has opened a new production facility, and could easily open a second one. It also has strong opportunities in the dairy and feed segments.


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    Wednesday, April 14, 2010

    Chanos' China Correction Overstated

    By Eric Jackson, Senior Contributor04/14/10 - 06:00 AM EDT

    NEW YORK (TheStreet) -- Jim Chanos has been saying since last November that China is experiencing a property bubble.

    On Monday night, he went on Charlie Rose with more colorful phrases about why China's property market will crumble by the end of 2010, saying "they're on a treadmill to hell." Chanos went so far as to suggest that the renminbi will actually decrease in value over the next couple of years because of soured real estate loans.

    I disagree with Chanos' "hard landing" view on China. At worst, I think the current property boom might result in a 30% correction in which the government is forced to help banks and Urban Development Investment Corporations get bailed out. They have the fiscal strength to easily do that and allow China's economy to continue to grow.

    Let's separate Chanos' rhetoric from the facts.

    Chanos claim: China's GDP is 50%-60% based on construction that is not sustainable. Chanos argues that China is addicted to property development like a drug addict to heroin. Because China's national and local governments depend on revenue from this growth, he says they will keep developing. This will, in turn, lead to bad loans for projects that aren't needed. Chanos notes that there is currently a project on the outskirts of Beijing "replete with 32 Broadway theaters." He draws a parallel between this one anecdotal project and excessive property development that occurred in Miami in 2005 and Dubai in 2007.


  • We know that China's GDP was 53% construction-related in 2005. If we accept Chanos' current number, construction activity has not changed as a component of China's overall economy in five years. It's flat -- even after the financial collapse of 2008 and the Chinese government's $600 billion (which some same may in fact be more like $1.2 trillion when you add in local government contributions) stimulus package that brought about what Chanos says is now a bubble. If Chanos' view is correct that rampant property speculation and silly (e.g., "indoor ski resorts") construction has increased because of a "Dubai times 1,000" bubble going on, wouldn't it follow that construction as a percentage of Chinese GDP has increased in the last 18 months compared to the middle part of last decade? It has not.
  • Is "construction" bad? Chanos believes having so much of the Chinese economy devoted to construction -- at least, by Western standards -- is terrible. But "construction" isn't limited to expensive luxury Shanghai condos that a farmer in Xi'an province can't afford. "Construction" is roads, railways, airports, sewers, high-end housing, low-end housing,commercial real estate, office buildings, distribution centers, manufacturing plants, etc. Is income "bad" that is derived by workers building these projects, or by local governments benefitting from increased tax revenue, or by farmers who sell their land for it to be developed into a large manufacturing plant? Of course not. These "construction" projects are laying the foundation for future growth and development for generations. This is not an economy like Dubai built only on real estate and debt. It is built on manufacturing, farming, exports and -- more recently -- internal consumption.
  • There are certainly expensive real estate projects in China. This is the second largest economy in the world with 1.5 billion people. It would be alarming if they didn't have expensive projects. Canada has the largest indoor water park in the world. What of it? Let's not bolster an argument with a titillating but inconsequential anecdote. Chanos is implying that the only development going on right now in China is expensive residential condos, at the expense of affordable middle-class housing. That's simply not the case. Even in Shanghai and Beijing, according to the Chinese equivalents of Craigslist, there are affordable two-bedroom apartments available at approximately 25 %-35% of an average couple's income.
  • Chanos claim: From the Rose interview, when asked what makes China a bubble, Chanos said, "We define as a bubble ... any kind of debt-fueled asset inflation where the cash flow generated by the asset itself -- a rental property, office building, condo -- does not cover the debt incurred to buy the asset. So you depend on a greater fool, if you will, to come in and buy at a higher price."

    Rebuttal:Property prices have increased in China. In some cities, housing prices doubled from 2003 to 2007 and have doubled again since then. That's rapid acceleration, but there's no evidence to suggest the appreciation was fueled by debt. There's much more Chinese "skin in the game" in terms of cash down payment on primary or investment properties. Surely, there are many average workers now who are watching the price increases and believe they must buy now to avoid paying more for housing later. That is a sign that the market could and probably will correct. But, without the debt fueling the price increases (at least in the residential market), this is neither Miami nor Dubai and -- in my opinion -- suggests a soft landing, not a hard one.


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