Taking China's bubble to its logical extreme: the CCP is a hostage to its own bubble. (Long)

So we have this state "guided" banking system. It gives subsidized loans to SOEs, developers, etc. It "bails out" certain large corporations when they get into trouble because of connections and desire to avoid systemic risk. These SOEs on the other hand are run for the purpose of grabbing power. The beneficiaries of these SOEs and mega corporations don't think about systemic risks when they're acquiring assets and loading up its balance sheet with debt. They have a free lunch with their underpriced loans. They will take whatever they can. This is why there's so much corporate debt in China now.

Because the corporate sector isn't "allowed" to get into trouble and be forced to liquidate assets, the end buyers of property, the citizens, have always felt an urgency to buy because there's no indication that prices will come down or ever will come down. Many have taken a large amount of debt to purchase multiple properties in order to get on this ride. Monthly debt payments may even take on a significant portion of their wages. Perhaps the lower their wages, the more desperate they are to get on the easy real estate ride often putting in two generations worth of life savings to scrape together the down payment.

So we have these two classes of players in the game. One the corporate actor who uses state resources through their incestuous relationship with the state. The second group consists of regular citizens who slave away to service the debt they've taken on in hopes of an easier tomorrow.

The CCP talks about cutting its corporate debt, but what would be its consequences? Without large spending by SOEs and mega corporations, economic growth must take a big hit. This pressures the citizens' cash flows and ability to drive up real estate prices further. If the corporations cannot continue to spend, the illusion of unstoppable development will be put into question. Losses will begin to mount in the banking system impeding their ability to lend further.

There are several major things that must be tested under such a scenario. One is how willing the banks are to enforce repayment of debt by its citizens. If the decline in prices is too steep and affects too many, this becomes a very big political issue. You have untold millions servicing significant debt for the sole expectation of seeing prices go up. Will they be willing to continue the service of that debt when their equity is wiped out or negative? In terms of mass incidents, this would probably be the mother of them all. Another test is how far the CCP is willing to go to bail out these mega corporations by rolling over their cheap credit? The bigger they get, the more systemic risks they create. On the other hand, "development" goes hand in hand with their growth. They also "bail out" smaller corporations by putting a floor on their asset values due to their cheaper financing and desire to dominate the private sector.

The hostage situation is one where mega corporations and some SOEs are increasingly burdening the financial system by drawing resources to themselves. If they have indeed made poor investments, calling their mistakes will very likely reset asset prices and test the entire system on both a legal and political level. So the CCP is held hostage to taking the choice that avoids testing the system due to their legal and political insecurity. They will continue to choose to accept the growth of these systemic problems until all these assets need to be nationalized because the problem has become too large. If they wanted to choose the other path of testing the system, they should have done so a long time ago when the problems weren't nearly so pervasive. Instead, they chose to believe that their pursuit of development was a heroic endeavor. Little did they know, it was a trap they've set for themselves.

People speak of the 80s and 90s when the assets behind bad loans were moved into nationalized entities only to be partitioned off to connected businessmen when growth began to take off again after China joined the WTO. The losses at the time, much smaller in scale were effectively socialized by the state. This replay will have much worse consequences if this is the ultimate solution once again. Regular citizens are now a part of the game and somebody must bear the brunt of the losses. Households are stretched as it is and there isn't a second coming of the WTO on the horizon.

Edit: I suppose the simple one sentence conclusion here is that there are far worse fates than a simple U.S. style collapse correction.

Edit2: Imagine a scenario under which prices stop going up or have even declined by a material amount. The Most citizenry do not want to walk away from something they're so vested in because they may lose everything. There is also the hope that one day things will reflate. So rather than enjoying life, working on new projects or consuming new products, all of their income goes into interest payments and debt reduction. This is the so called Japanese lost decade or two decades probably by now. But China's fate will be even different from that. China's legal framework is weak and the political leadership is insecure. Japan had already become generally wealthy while there remains tremendous wealth disparity within China.

If there is a correction that wipes out a large portion of homeowners, the entire game will have to change. Inequality will explode if the CCP only rescues a portion of the players while leaving the weaker and more desperate players behind. The CCP's thinking is probably along the lines that they must either rescue the weakest players and thereby rescue everybody or not let a correction happen at all.