The result, said Mr Wu, was that the property market was likely to experience only a 'mini burst' that would not trigger a devastating impact on the economy.

Data also shows that while loan defaults are rising they still come off a low base and bank exposure to the mortgage market representing a small proportion of total assets.

The Shenzhen Banking Regulatory Commission said last month that only 0.79 per cent or 1.38 billion yuan (HK$1.58 billion) of residential mortgages by the end of June were non-performing, which it said was 'within the control level'.

But for homeowners, both genuine buyers and speculators, the outlook is bleak.

Home prices in Shenzhen have plunged by up to 40 per cent from their peak levels this time last year, and transaction volumes are down 50 per cent. Many buyers who took on more debt than they could afford in the hope of 'flipping' properties at a profit have now been trapped in negative equity - a concept that is entirely new to the mainland property market.

The lesson would prove a costly one, said Frankie Wong, chief operating officer of Pan Asian Mortgage, which helped Hong Kong homeowners in a similar dilemma four years ago by pioneering 140 per cent loan-to-value negative equity mortgages.

'Average outstanding mortgage loans on the mainland are up to 13 times average household incomes - a level even higher than Hong Kong's record 10 times at the market peak in 1997,' said Mr Wong.

That shows the gearing level of mainland homeowners has reached alarming levels.

It means they are living beyond their means and a downward adjustment in property prices was inevitable.

'Negative equity is a new term to mainland buyers who believed flat prices could only go up and up. Now they have to pay a costly price to learn their lesson,' he said.

Zhu Zhiyou, a property researcher at news website szhome.com, which is a unit of the Shenzhen Municipal Bureau of Land Resources and Housing Management, estimated that 10,000 new flats sold between July and September last year at the market peak had now lost 30 per cent of their value.

'For this group of buyers, who made 30 per cent of down payments, their equity has been wiped out and they are now in negative equity,' he said. No official data on negative equity was available, he said.

But Shenzhen home sales paint a bleak picture, with the number of transactions per day in the primary market last month down more than 50 per cent from a peak of 117 daily deals done in September last year, to just 57.

Mr Wu said it was mainly speculators that had been caught out by the turnaround in the market.

'Seven out of 10 defaulters were holding more than one flat,' he said, blaming flawed credit approval procedures and lax risk controls in some financial institutions.

That view was endorsed by Shu Weidong, partner at law firm China Commercial Law in Shenzhen.

'Some financial institutions did not even know that a number of their clients had signed up for loans on five or six apartments,' said Mr Shu.

He said that for the past month the firm had been engaged by 10 lenders to sue or send letters to homebuyers who had missed their repayments for the past month.

'Most of these buyers bought middle- to high-end residential projects at the height of last year's market boom, and some even purchased two or three years ago,' he said.

According to Citic Ka Wah Bank's latest research report, average residential prices in Shenzhen fell 36.5 per cent at the end of May compared to seven months ago in October last year.

Mr Shu said many homeowners believed that by walking away from their properties they could limit their losses.

'It is wrong to believe that returning the flats to banks will be the end of the story. Owners have to make up for the balance if the money generated from the resale of their foreclosed properties is insufficient to repay the outstanding loans,' he said.

In one case more than 80 owners in a single project, named Bi Shui Long Ting, in Baoan district stopped making their loan repayments from July 20 and banded together to put pressure on their bank Shenzhen Ping An to either restructure their loan or lower their interest rates. One of the participants, identified only by the surname Li and, quoted by news website Hexun.com, said he bought a 70 square metre unit for 11,000 yuan per square metre at Bi Shui Long Ting phase two development in June last year.

But prices had since fallen by more than 30 per cent to as low as 7,000 yuan per square metre.

'My outstanding mortgage loan owed to the bank exceeds the value of my flat. I am totally trapped in negative equity.

'Rather than continuing to make a mortgage payment, I'd prefer to spend the money on a new unit that now costs much less,' he said.

Mr Li also owns another unit in a nearby development.

Banks are now reviewing their credit policies and a credit officer at Bank of Communications in Guangzhou said the China Banking Regulatory Commission had ordered banks to undertake such reviews.

'Banks are likely to see higher non-performing loans in the mortgage segment, particularly in regions where property prices soared last year due to speculative transactions,' said Qiang Liao, associate director for financial institutions ratings at Standard & Poor's.

But he pointed out that overall exposure to residential mortgages was still sound.

The US rating agency has downgraded the ratings of seven out of 13 Chinese developers in the past year.

'We have not seen any meaningful recovery in terms of market sentiment, or transaction volumes across cities,' said Bei Fu, an associate director for corporate and infrastructure ratings on the property sector at Standard & Poor's. But S&P said it did not foresee a major shake-out for mainland lenders.

For Hong Kong, it is a case of history repeating itself.

Ten years ago, negative equity accelerated the collapse of Hong Kong's runaway property market in late 1997, when prices nosedived by more than 50 per cent across the board.

It took almost eight years for tens of thousands of Hong Kong owners to emerge from the resulting negative equity.

Raymond Ngai, a property analyst at JP Morgan, said that the central government would certainly now be vigilant in the wake of US banks' huge write-downs for housing loans, but on the mainland defaulting on loans had not yet expanded into a nationwide problem.

'There are hundreds of cities on the mainland, and cases of defaulting on loan repayments largely occur in Shenzhen,' he said.

Eric Wong, a co-head of Asian property research at UBS, said the sharp correction in Shenzhen would be positive for the real estate market in the long term.

'Even if there were 10,000 owners who fell into negative equity, the number would still be below 0.5 per cent of total flat owners,' he said.

But industry observers were still concerned that property prices in Shenzhen might fall further as lenders foreclosed on overstretched borrowers and so put their properties up for sale to recover their debts.

In order to cash in on the foreclosed properties, Mr Wong of Pan Asian Mortgage said banks would not wait until property prices improved, but they would usually sell the foreclosed properties at 20 per cent below market transaction prices.

'Confidence will be shattered by this negative news,' he said.