For at least 20 years there has been speculation that the housing market in China is heading into a bubble territory, but rapid urbanization and economic expansion proved the doomsters wrong. There seemed to be a limitless appetite for new accommodation. Newly prosperous Chinese didn’t only buy properties to live in. They also bought second and third apartments because they found it hard to invest their excess saving in the underdeveloped and restricted financial industry of China. The rising prices lured in ever more speculators and ever higher geared property developers.
The party is over now. The housing bubble has burst. The property prices have decreased by about 35% or more over the previous two years. That is about the same as the decline experienced during the 2006 – 2008 US housing market crash. Yet the wider financial fallout in China has been subdued. Why?
A steep decline in property prices has almost always caused havoc in the banking system. Yet we have not heard of any bank in China in trouble. Part of the reason for that is because no one in the world saves as much as the Chinese. Yet the overall consumer debt in China has been rising sharply over the last 15 years, which suggest that more and more property purchases were funded by obtaining credit from financial institutions. The banks are well funded and could probably absorb a modest decline in the property market. However, such a massive collapse of the property market would be hard to absorb for even the best capitalized banks.
The government had a few other tricks up its sleeves. For one, the financial institutions did not need to recognize some bad debts if they held on to them. The banks also sold portfolios of poorly performing loans to Funds whom the banks lend the money to buy the non-performing loans. By removing the non-performing loans, the banks look stable. Then there is the only lightly regulated shadow banking industry that is so murky that no one knows how much money they have lost because of the property crash.
The underlying problems have not gone away. If there is negative equity in some of the properties, then someone is going to have to take a loss at some stage, unless there a remarkable boom in property prices. That is unlikely. Declaring bankruptcy, especially for private individuals is almost impossible. This means that the over-leverage drag will carry on for years to come. The most likely scenario is that the property sector will just bumble by at 0% growth for decades to come.