It finally has happened. A high level Chinese academic has admitted that there is a problem with the real estate market. Li Daokui, a professor at Tsinghua University and a member of the Chinese central bank’s monetary policy committee was quoted by the Financial Times as saying “The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis.” Well it’s a start. But recognition of the problem does not mean a solution. It also brings with it a whole set of assumptions about the future that are simply not true.

In the US, the UK and even presently in the Eurozone these crises have specific causes and run a predictable course. A financial panic starts because too much money was loaned carelessly during an expansion. When the cycle turns, what looked like a safe credit risk turns into a toxic asset. As fear spreads through the markets, all lending stops because of asymmetry of information. No one knows who is overextended or who made the bad investments. In the simplest terms you start with a solvency problem which eventually is exacerbated by liquidity problem.

If you look at the Chinese real estate market using these criteria, there does not seem to be anything to worry about. It is true that prices have risen dramatically. Depending on whose numbers you believe, real estate in 70 Chinese cities has risen between 12.8% to 18% over the past year and 95% in Beijing. To buy an apartment in Beijing would cost the average wage earner 17 years income.

To pay for these skyrocketing prices the amount of mortgages as a percentage of GDP has exploded from an average of 10% from 2005 to 2008 to 16%, while the amounts have tripled from 500 billion yuan to 1.75 trillion yuan. But is this a problem?

Economists argue that it isn’t. Most mortgages are for only 50% of the value of the property. So prices would have to plummet by 50% before the property is ‘underwater’. Besides mortgage loans make up only 23% of bank loans. What worries Professor Li is not a financial issue, but social stability. “When prices go up, many people, especially young people, become very anxious,” he said. “It is a social problem.” This perspective gives a hint that things in China may be different.

The toxic assets are not in residential mortgages. The toxic assets are from local governments through the 8,000 or so local investment companies, now banned. According to Victor Shih, a professor at Northwestern University these debts could be as large as 11 trillion yuan, or about $1.6 trillion. S&P, the people who messed up on the US toxic assets, feel that the problem is manageable and that the bad debts will stay below 10%. But does that include the bad debts left over from the last recession? Or the bad debts we don’t even know about?

Solvency is a legal term. It depends on how you count a debt. If a state owned bank doesn’t think that its loan to a local government or a state owned company is a bad loan, then it isn’t. Who is going to say something else? If the local government isn’t insolvent then neither is the bank. Solvency problem solved.

The same is true of the liquidity problem. It isn’t a problem in China because the government can simply order the banks it owns to lend to each other. Last year the Chinese government solved its liquidity problem by telling the banks to lend $1.4 trillion and they did so.

So the probability of a real estate toxic asset fueled melt down does not exist. Does that mean that there isn’t a problem? No, because there is. A big problem.

The Chinese financial system has failed in its principal economic task. As an intermediary designed to channel assets to the most efficient enterprises, it is a major flop. Not collecting a dud loan means that the money for that loan has been wasted. Evidence of the waste exists throughout China in empty buildings and unrented apartments.

But if there is not going to be a meltdown, what consequences will follow? Simple, slower growth. The burden of this absurd system will be borne by depositors and consumers. By keeping borrowing rates low, deposit rates low and increasing the spread, you can in effect transfer wealth from households to banks, businesses and government, which is exactly what happened before and what will happen again.

Of course shifting the cost to consumers means that domestic consumption remains low and requires the present imbalance in the Chinese economy to continue, which of course will exacerbate the international trade imbalances and slow growth. So Professor Li is right to worry, but until he worries about the right thing the problems will not go away.