Unfinished blocks of flats stand at a residential complex in Guilin, Guangxi Zhuang autonomous region, on September 17. The struggles of China’s property market are reminiscent of the woes that plagued its US counterpart before the 2007-08 global financial crisis. Photo: Reuters
James David Spellman
James David Spellman

China real estate and global debt woes show problems that led to 2008 financial crisis remain

  • History shows that easy money inflates asset values but everything eventually comes crashing down in a reversion to the mean
  • The global financial crisis was a textbook example, and its trajectory suggests a replay is likely soon
Central banks are raising interest rates to quell inflation, China’s real estate market is imploding and public debt is at record levels worldwide. Could the maelstrom that is building turn into another global financial crisis to rival the one that started in 2007, which at the time was the worst since the Great Depression?
The bandwagon is filling fast, with many warning that the likelihood of disaster increases daily. The Asian Development Bank says “several downside risks loom large”, notably “a deeper-than-expected deceleration” in China.

Nouriel Roubini, who is credited with predicting the global financial crisis, has an even bleaker outlook. He sees a “hard landing”, beginning by the end of the year, with a “long and ugly” recession. Meanwhile, fund managers scurry to lower their forecasts for investment returns.

Equally sober were bankers attending the annual International Monetary Fund-World Bank meetings. The Federal Reserve’s tightening in response to strength in the US labour market is forcing them to counter depreciation in their currencies.
Will all these fears prove true? Some clues lie in parallels between now and the Great Recession.
Side by side, both periods are marked by a long stretch of prosperity with low inflation, home prices outpacing income growth and equity valuations exceeding historical averages – the still-puzzling distortions of Covid-19 notwithstanding.

Both reveal Asia’s vulnerability to headwinds from the West. Asia fell into a V-shaped business cycle late in 2008 after initial resilience.

Fed’s inflation fight could push US economy to breaking point

Both times also show capitalism’s reliance on cheap energy, predictability, trust in counterparties and expanding global capital flows. When those conditions go awry, as the war in Ukraine shows, economies capitulate.
The Fed’s approach has been key during each period. These days, Fed chairman Jerome Powell insists he will fight inflation “until we are confident the job is done”. That mission drove the US central bank in March to start raising the federal funds rate from near-zero levels to a range of 3 to 3.25 per cent, the highest since early 2008. Eighteen years earlier, the federal funds rate rose from 1.25 per cent in mid-2004 to 5.25 per cent by mid-2006.

History shows that easy money inflates asset values. Everything eventually comes crashing down in a reversion to the mean. The global financial crisis was a textbook example, and its trajectory suggests a replay is likely soon.

Real estate troubles in China are one early flashpoint of the next crisis. Citigroup sees nearly a third of all property loans as bad debts. Seeing their property values plummet, homebuyers are boycotting mortgage payments. More Evergrande-like defaults seem inevitable.


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Meanwhile, Moody’s estimates that local governments face large shortfalls in revenues this year. Tencent and Alibaba reported the first falls in revenue in their history during the most recent quarter. The outlook is further darkened by China’s “zero-Covid” policy.
We’ll know if China met its 5.5 per cent growth target when official numbers for July to September are released, but its woes are already having a global impact given that China accounts for a large percentage of global growth. Apple illustrates the country’s clout: iPhone 14 sales in the world’s largest smartphone market fell 11 per cent during the first three days after the product’s launch, according to the investment bank Jefferies.

Prior solutions to financial crises could be kindling for troubles ahead, too. Massive stimulus plans ushered in near-zero or even negative interest rates, fuelling a global borrowing frenzy. The era of free money banished prudence. Nowhere is that more clear than with China’s credit boom: years of steadily rising debt have reached nearly 150 per cent of GDP, according to the Bank for International Settlements.

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As a buffer, Beijing announced a more than 1 trillion yuan (US$139.6 billion) stimulus package in August meant to improve infrastructure, ease power shortages and fight drought. More stimulus is expected soon, but fighting fire with fire could fail this time.

Low rates also allowed corporations to use leverage to earn record profits during the past year. That strategy is now a fool’s game. Profits are decelerating and equity values are falling, stoking a global downturn. Investment-grade corporate bonds are riskier: the share of bonds rated AA or higher has fallen to 10 per cent, down from more than 35 per cent 30 years ago. This trend recognises how leverage magnifies and accelerates the impact of economic shocks.

The global financial crisis revealed hidden risks, from weak market infrastructures to haphazard management of liabilities and feeble early warning systems. Financial institutions deemed “ too big to fail” were restricted in size, their activities “ring-fenced” to contain fallout and their capital reserve requirements raised to prevent collapse.
A man leaves the Lehman Brothers headquarters in New York carrying a box after the 158-year-old investment bank filed for Chapter 11 bankruptcy on September 15, 2008. Photo: AP
These risks remain, as speculaton swirls about Credit Suisse and Deutsche Bank’s future. Meanwhile, nonbank financial institutions, seen as triggering and amplifying market stress during the previous crisis, have bulked up and added more kindling.

Getting a better handle on hidden problems is difficult since accounting shenanigans continue to allow fudging in securities’ values and moving toxic liabilities off financial statements into unclear footnotes. Auditors’ conflicts of interest persist. The clean-up sought after the global financial crisis fizzled.

All told, signs point to a painful downturn as the problems that led to the 2008 crisis remain. These and China are likely triggers as the curtain opens on the next global crisis. Already, investor hesitancy is supplanting eagerness. Seats on the sideline, remaining in cash, are more comfortable. Fewer are counselling that “ this time is different” and that we’ll muddle through.

James David Spellman, a graduate of Oxford University, is principal of Strategic Communications LLC, a consulting firm based in Washington, DC