By Zachary Cameron
While China has made considerable strides in aligning its economy more with market principles following Deng Xiaoping’s 1978 reforms, the Chinese government, the Chinese Communist Party (CCP), is still heavily involved in many aspects of the economy. Most notably, the CCP is active in the real estate sector, where it has utilized housing as a key driver of China’s overall economic growth. Some estimates even cite the real estate sector as accounting for 30% of overall GDP in China. [1] Although the CCP has effectively utilized low interest rates and other incentive mechanisms to prompt this incredible growth, many observers have worried for years that this growth is predicated more on unhealthy speculation than on substance. These critics claim that a significant bubble has been created which will inevitably burst, causing global repercussions similar to those caused by the United State’s financial crisis of the mid 2000s.
These worries abound within the top echelon of Chinese leadership, as evidenced by Chinese President Xi Jinping’s statement in his 2017 19th Party Congress that, “Houses are built to be lived in, not for speculation.” Xu Zhong, head of the research bureau at the People’s Bank of China, has similarly stated that, “We must be very aware that rapidly rising housing prices could not only hamper our economic development, but could easily result in systemic risks and negatively impact the macroeconomy.” [2] However, while skepticism is widespread, there are also some who claim that the Chinese real estate boom is unlike the United States’ experience due to relatively low leverage per capita and a “non-existent” sub-prime lending market. [3] These optimists state that down payment requirements in China are a sufficient buffer for banks if prices are reversed and that these requirements stand in sharp contrast to down-payment ratios that were near zero when the U.S market crashed in 2008. [4] While these claims are superficially accurate, a closer examination provides disconfirming evidence to this narrative.
The primary bridge that connects the current Chinese real estate boom to the mid-2000s U.S financial crisis can be traced to the widespread sentiment in China that property must be purchased as soon as possible. This sentiment is caused by rapidly escalating property prices, which drive Chinese citizens to scramble to put together enough capital for a down payment. With each passing week, citizens fear that they are losing out on profits and that they could even be shut out of the market forever. [5] However, because many prospective homebuyers do not have enough money to afford the 30% down payment that is typically required when purchasing property in China, illicit mechanisms are often utilized to acquire the necessary capital. At the forefront of these mechanisms are “yin-yang” agreements, in which multiple purchase agreements are drafted to enable people to borrow money from banks at a rate that would otherwise not be legally allowed. [6]
These agreements consist of one legitimate contract, in which the tenant agrees to pay the owner the true housing price, and a separate agreement, in which the value of the property is overstated. This second contract is drafted in order to increase the amount that the tenant is allowed to borrow from the bank (this amount is typically set at 70% of the property price). This in effect allows the prospective buyer to be illegally leveraged, which introduces risk into the marketplace, resulting in an environment similar to the U.S’ subprime lending market. Reuters estimates that about 60% of buyers are involved with these yin-yang agreements. [7] Further heightening the risk in the Chinese real estate market is the presence of loan agents who specialize in satisfying the demands for funds from poor credit borrowers, who would otherwise not be able to meet Chinese lending standards. These loan agents also utilize fake documents to allow borrowers to secure loans. It is in fact often bankers themselves that introduce borrowers to these agents, due to the pressure that banks feel to hit lending targets set by the Chinese government.[8] These illicit activities negate the claims that the Chinese real estate market is relatively underleveraged and as such these activities provide parallels between the current real estate bubble in China and the United State’s financial collapse in 2008. It is thus appropriate to fear that in a property correction, fraudulent mortgages would unravel in a similar manner, which would collapse housing prices and China’s financial system along with it.
This situation is all the more troubling given that the Chinese economy is slowing, as evidenced by the fact that last year marked the lowest annual growth rate in 28 years. Because the average Chinese citizen spends more than 160 times annual income to purchase a home and because the total debt in China is massive (roughly 2.5 times GDP), it is of paramount importance that the economy continues to grow and income levels continue to rise. This economic growth is paramount because when the government is in debt, the debt burden falls on individuals and their savings. However, if both are in debt, economic growth becomes dependent on inflation or financial bubbles, which creates the possibility of a financial crisis. [9] As such, even if the housing market is not the primary trigger for a financial crisis, it could very well act as the amplifier of initial economic stagnation, which could result in a 2008 style global crisis.
Zachary Cameron is a senior at Loyola Marymount University where he is majoring in International Relations.
Works Cited
[1] He Huifeng, “China’s Mortgage Debt Bubble Raises Spectre of 2007 Crisis”, https://www.scmp.com/news/china/economy/article/2112873/chinas-household-debts-soars-it-being-stalked-subprime-spectre, (September 27, 2017).
[2] Engen Tham, “Dangerous Deception”, https://www.reuters.com/investigates/special-report/china-risk-mortgages/ , (December 2, 2017).
[3] Kenneth Rapoza, “So Much For Your China Housing Bubble”, https://www.forbes.com/sites/kenrapoza/2015/11/02/so-much-for-your-china-housing-bubble/#3929f8145058 , (November 2, 2015).
[4] Engen Tham, “Dangerous Deception”, https://www.reuters.com/investigates/special-report/china-risk-mortgages/ , (December 2, 2017).
[5] He Huifeng, “China’s Mortgage Debt Bubble Raises Spectre of 2007 Crisis”, https://www.scmp.com/news/china/economy/article/2112873/chinas-household-debts-soars-it-being-stalked-subprime-spectre, (September 27, 2017).
[6] Engen Tham, “Dangerous Deception”, https://www.reuters.com/investigates/special-report/china-risk-mortgages/ , (December 2, 2017).
[7] Engen Tham, “Dangerous Deception”, https://www.reuters.com/investigates/special-report/china-risk-mortgages/ , (December 2, 2017).
[8] Engen Tham, “Dangerous Deception”, https://www.reuters.com/investigates/special-report/china-risk-mortgages/ , (December 2, 2017).
Kenneth Rapoza, “Why China’s Property Bubble is Different”, https://www.forbes.com/sites/kenrapoza/2011/04/22/why-chinas-property-bubble-is-different/#720310336044, (April 22, 2011).
Keith Johnson, “Just How Much is China’s Economy Slowing?” https://foreignpolicy.com/2019/01/25/the-challenges-of-chinas-slowing-economy-xi-trump-trade-gdp/ , (January 25, 2019).
