Chinese Mortgage Crisis Could Threaten Financial Stability

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The growing mortgage boycott in China already threatens almost C¥1 trillion (US$148 billion) in home loans but is escalating fast. As a result, it poses a threat to financial stability in the world’s second-largest economy.

The homeowner boycott currently affects C¥980 billion (US$145 billion) in mortgages, according to Standard & Poor’s, which amounts to 2.5% of all mortgage loans nationwide. That could blow out to C¥2.4 trillion (US$355 billion) and 6.4% of China’s mortgage-loan book, the rating agency predicts.

The standoff between homebuyers and developers represents a crisis in confidence. Although the current threat to Chinese banks is contained, the mortgage strike is weakening the strongest pillar in the Chinese economy. It is hitting a sector that accounts for 29% of China’s economy, according to a 2021 paper by Harvard professor Kenneth Rogoff and Tsinghua professor Yuanchen Yang.

“If there is a sharp decline in home prices, this could threaten financial stability,” S&P primary credit analyst Yiran Zhong writes in a report. “The government views this as important enough to quickly roll out relief funds to address eroding confidence.”

China is preparing to launch a fund backed by as much as C¥300 billion (US$44 billion) in capital to ensure that property developers do complete the projects that they have begun, according to Reuters. The fund would initially be set at C¥80 billion (US$12 billion), however, with backing from the central People’s Bank of China and state-owned China Construction Bank (CICHY) (HK:0939).

The PBOC would be backing CCB with money from its relending facility. If that plan works well, the central bank would also back China’s other major banks, the news agency reports, quoting a state-bank official.

The initial size of the fund would not be enough to stimulate the property sector, analysts say. Such a property fund would likely need to be part of a broader support package. But Beijing has resisted calls to provide direct stimulus to the economy and to prop up troubled developers, since the Chinese government is attempting to curb housing prices by forcing deleveraging on the homebuilding sector.

Confidence in smaller, rural banks in China is teetering after several ran aground in Henan Province. Depositors caused a run on the Henan banks in April, after police said they had opened an investigation into Henan New Fortune, the largest shareholder in four Henan banks. The police accused the owner of Henan New Fortune of defrauding the banks by falsifying loans and illegally transferring funds.

It could be an expensive process for Beijing to restore confidence in the sector. The China Banking and Insurance Regulatory Commission, the banking watchdog, said earlier this month that the government will pay back depositors with savings of up to C¥50,000 (US$7,400). S&P estimates that will cost the government around C¥20 billion (US$3 billion).

Even if strike-hit mortgages rise as high as US$355 billion, “the large, state-owned lenders that are active in mortgages can handle such an increase in bad loans,” S&P explains. “However, we see a possibility that the effects could spread. Distressed developers not hit by boycotters may yet be targeted in the strikes. This would deter banks from providing mortgage loans to developments, effectively stopping sales in their tracks.”

S&P calculates that 32 out of the largest 100 developers in China are already financially distressed. The worst problems are coming in smaller cities where property prices are already falling sharply. The ratings agency predicts that home prices in China will decline 6% to 7% nationwide this year.

Homebuyers are taking quite a risk in refusing to make their mortgage payments. A failure to make payments will hurt their credit score, which feeds into a national “social credit” rating that each citizen has. A poor credit rating can therefore prevent citizens from buying rail tickets, traveling by plane and accessing government services.

Policymakers are thought to be planning to offer “payment holidays” so that homebuyers can get back on track with payments without hurting their credit scores. Local governments and the Beijing administration are likely to prompt banks and asset managers to work with local governments and state-owned developers to ensure that projects get built.

The turmoil has already caused a sharp slowdown in property transactions. Home sales will drop 28% to 33% this year, S&P forecasts, double the size of the drop it previously predicted.

The issues in Henan Province have captured broad attention in China. Five Henan Province officials have been punished after they doctored the health codes on the phones of local citizens who went to the provincial capital, Zhengzhou, to protest against the banks. The protests spread to developers, which homebuyers fear will not be able to complete projects if the banks collapse. The actions of the provincial officials in trying to stop protests have received broad coverage in China.

The Henan government is now also trying to prop up the property sector. The state-owned developer Zhengzhou Real Estate has set up a bailout fund with state-owned Henan Asset Management to provide C¥20 billion (US$3 billion) to buy 50,000 units that it intends to convert into rental housing, Reuters reports.

The local issues at the provincial level come as China struggles to eke out growth this year, against a fraught global macro picture.

Presidents Joe Biden and Xi Jinping are due to talk by phone on Thursday, the White House says. But a planned visit by Speaker of the House Nancy Pelosi to Taiwan in August will overshadow any discussion they may hold about a thaw in the frosty trade war between the United States and China.

Biden’s economics team has been reviewing the possibility of lifting some of the trade tariffs put in place on Chinese imports under the Trump administration. With the added trade duties ultimately passed along to U.S. consumers, lowering them may help ease inflation, ever so slightly. China is extremely keen to see the trade tariffs lifted.

The Russian invasion of Ukraine has provided a prelude to what a Chinese invasion of Taiwan might look like. The threat of such a use of force to conquer the democratically governed island is thought to be as high as it has ever been. Beijing has hinted that its military would respond should Pelosi’s visit, a show of support for Taiwan as China keeps making numerous incursions into its air-defense zone, go ahead.

Pelosi would be the most-senior U.S. official to visit Taiwan since Republican Speaker of the House Newt Gingrich made a similar trip in 1997. Biden may paint the picture to Xi that he does not support the visit, but has no authority to stop it.

With China’s tactic support for Russia’s invasion of Ukraine also on their mind, it’s unclear to what extent Xi and Biden will end up discussing trade. U.S., Australian and Canadian forces have all also criticized what they say is dangerous behavior by Chinese fighter jets disrupting “freedom of navigation” sorties by the three countries over the South China Sea, near coral reefs that China has converted into island fortresses.

The International Monetary Fund cut its call for global growth in 2022 to 3.2%, down from the 3.6% forecast it made in April. Its forecast for growth in China was slashed to 3.3%, from 4.4%. The United States also saw a major revision, with the growth projection at 2.3%, rather than April’s 3.7% call.

And the risks remain firmly on the downside, according to the IMF. “The outlook has darkened significantly since April,” IMF chief economist Pierre-Olivier Gourinchas says. “The world may soon be teetering on the edge of a global recession, only two years after the last one.” The global economy rebounded 6.1% in 2021, but is now being hampered by rising interest rates designed to combat runaway inflation, likely to hit 8.3% year-on-year in Q4 2022.