Avoiding the pain of China’s housing crisis risks infecting the wider economy
- The growing housing crisis threatens to spread like previous financial contagions and damage economies across the globe
- Policymakers need to let poor performers suffer the consequences of bad bets while looking after solvent banks and enacting land and property reforms
History has shown that financial crises are often the story of either a housing bust or stock market collapse – or both. Think of the crash of 1929 that started as a Florida-driven housing boom-and-bust cycle and morphed into a stock market collapse that shook the United States and the world.
With construction making a significant contribution to China’s economy, defaulting developers are just the beginning. With developers in trouble, investors and Chinese mortgage holders are losing confidence in firms and the country’s economic outlook.
Research has demonstrated the key dynamic at play. Your house is a leveraged asset. As prices begin to fall, this magnifies owners’ losses and they can become “underwater”, owing more than the asset is worth.
But look a little deeper and it appears regulators are repurposing the “convoy” approach to bank bailouts pioneered by Japan in the 1990s. The central bank is forcing larger, more solvent banks to inject funds into failing developers and local banks. This is an effort to limit the damage and the costs to government.
Chinese authorities are also trying to limit price falls in the housing market. This looks sensible on the face of it – limit the downside, limit panic.
But such manipulation can stop developers from cutting prices to revive buyers’ interest and limit firms’ ability to generate funds to complete developments or service debts. The danger is that authorities might not be able to stop the erosion of confidence in property prices. Since so much rests on this foundation, a growing lack of confidence will have real implications for the wider economy.
Investors should pay the price for bad bets. This type of structure would punish poor performers while not undermining prudent, solvent banks. Ultimately, real estate firms, banks and poorly run local authorities need to be allowed to bear the downside risk and go bust, be restructured and send market signals for the future. At present, an effort to avoid pain risks infecting the wider economy, not strengthening it.
Property busts are painful. This one will test China’s policymakers. Can they deal with the pain and limit its spread, and do so in a manner that allows market signals to work?
William R. Rhodes is president and CEO of William R. Rhodes Global Advisors and author of “Banker to the World”. Stuart P.M. Mackintosh is executive director of the Group of Thirty