2 April 2024
Over the past several years, a wide range of reports have come out surrounding the housing market in the People’s Republic of China (PRC). The most famous case was that of Evergrande, which had been the largest developer in China. It became the most indebted property developer in the world, but as the Financial Times reported, it was far from the only case, with over half of the nation’s former top 50 developers having gone into default. [1] A major crash within the Chinese economy would no doubt cause ripples across the globe in a similar fashion to the 2008 financial crisis, when the U.S. housing market crashed and the wider economy screeched to a halt. These bitter memories mean that experts have become anxious about the precarity of the situation. This state of affairs is clearly unsustainable, leading many to ask: what can be done about this? It is highly unlikely that the PRC will radically alter its governmental strategy, so some options that might be available in other nations are unlikely to be implemented. However, by implementing some modest reforms, the possible fallout of an eventual collapse can hopefully be mitigated or avoided entirely.
It is important not to undersell the severity of the situation. Various examples indicate just how strange the situation has become. The most infamous phenomenon is so-called “ghost cities,” large areas of urban development that were built but never used. [2] This has meant the striking oddity of many large, declining towers and streets devoid of pedestrians. This was due to how hot the market has been and the sheer scale of China’s urban growth. Rather than towns that have been abandoned, these housing accommodations were built with the idea that residents would eventually come to these areas. It was a prediction that ultimately failed. Other instances show things from the economic perspective. Several banks across China have raised their maximum age for allowing mortgages, leading to 70-year-olds being signed for mortgages that will last decades, well beyond the nation’s average life expectancy. [3] The strategy is generally avoided due to the fact that the death of the signatory will likely mean that the debt goes unpaid. All of this is to say that the situation is far from typical. Reforms will most certainly be needed to correct the issues in this market.
The government of China, the Chinese Communist Party (CCP), has taken steps towards alleviating these issues. In 2020, the CCP began to address the problems in this market by cracking down on the amount of debt that developers were allowed to accumulate. [4] For example, the main policy, known as the “Three Red Lines,” set certain parameters that these companies would need to follow, or else they would be unable to acquire further debt. These parameters were: a cap on net debt to equity of 100%, a cash to short-term borrowing ratio of at least one, and a 70% ceiling on liabilities to assets. [5] While all of that may sound complicated, the reforms essentially forced companies to have a level of debt equal to or below the value of their assets. If they didn’t meet these targets, they faced some restrictions, with more restrictions for each “red line” that they crossed. This did, however, put some developers in a tight spot, as they suddenly found themselves unable to keep borrowing to finance existing debts. Yet, the reforms were limited in scope, and subsequent action has lacked significant direction. The CCP is clearly concerned about the issue, but appears hesitant to act, lest any significant shift pop the bubble.
With this in mind, a delicate approach is recommended. A feasible proposal that would fit in with the nation’s espoused socialist principles would be redistribution, specifically of the assets of defaulting companies. When debt needs to be paid, the assets of a business—their money and resources—are used to pay off the groups that made them the loans. Rather than the standard distribution of debt repayment to owed banks, the CCP should instead opt for some deficit spending to allow some repayment to injured investors. The plan should be to subsidize the largest of the current defaults in order to reduce the harm to those who invested in this sector and restore a degree of consumer confidence. By spending some extra resources and giving some money to cushion the average investor, they can help those most affected prepare for the collapse of the market, when their investments will lose most of their value. This should hopefully make the ensuing fallout more manageable and limit the burden on the economy. The property sector accounts for roughly 29% [5] of the nation’s economic output—for reference, residential construction reached a peak of 6.8% of the U.S. GDP in 2005 [6]—so limiting the growing pains of shifting away from it is crucial. This would be a similar tactic as the U.S. bailout in 2008, but would instead be directed towards consumers. “Too big to fail” was the justification given for major bank bailouts in the wake of the 2008 financial crisis. It was clearly a flawed premise. The aim of this method was to limit economic damage by preventing the collapse of some of the major institutions involved. This meant that the taxpayer footed the bit for the recklessness and incompetence of these companies. The Chinese housing market is failing in real time. By diverting resources to affected consumers, the nation can better equip its citizens to weather the potential storm. The exact amount of capital transferred to consumers would be uncertain, but Evergrande alone possessed roughly $340 billion in debt [1]; the total would likely be in the realm of a trillion dollars or more. The funds for this would be difficult to come by, especially given the economic stumble the nation has been facing since the COVID-19 pandemic, but preparing for the crisis is paramount. If the CCP bolsters its current crackdown on these companies while minimizing the consumer impact, it can hopefully start to deflate the bubble over time. The redistribution of resources away from failing companies would allow other firms in better economic shape to fill in the gap left by some of the larger developers, though it is certain that there would still be significant economic hardship as the industry stabilizes and development reaches a more appropriate level. The PRC will no doubt have a great deal of hardship ahead of it. Its declining property market will be one of its greatest hurdles in the coming decade. However, by giving its citizens ample preparation for catastrophe, the nation can hopefully better weather the storm. The deficit spending required would be extremely high, but the alternative would mean personal bankruptcy for the many Chinese citizens that become involved in one of the few markets allowed in China. If the CCP hopes to maintain some semblance of consumer confidence, providing a stipend of sorts to affected parties will be a necessity.
Image via Pexels Free Photos.
Works Cited
[1] Financial Times: “China’s property market slumps as Evergrande struggles to repay debts,” Financial Times, September 20, 2021, https://www.ft.com/content/a387a533-5995-43a9-b472-ce5691969657.
[2] “Where are China’s ghost cities?” World Economic Forum, November 26, 2015, https://www.weforum.org/agenda/2015/11/where-are-chinas-ghost-cities/.
[3] Jethro Mullen, “China’s mortgage borrowers are aging fast. In some places, they’re already 95,” CNN, February 17, 2023, https://www.cnn.com/2023/02/17/economy/china-mortgage-age-95-property-market-intl-hnk/index.html.
[4] Keith Bradsher, “China’s Property Market Slumps, Taking the Economy With It,” The New York Times, August 21, 2023, https://www.nytimes.com/2023/08/21/business/china-economy-real-estate-crisis.html.
[5] Emma Dai, “What China’s ‘three red lines’ mean for property firms,” Bloomberg, October 8, 2020, https://www.bnnbloomberg.ca/what-china-s-three-red-lines-mean-for-property-firms-1.1505582.
[6] Dean Baker and Aimee Josephs, “Is There a Bubble in the Housing Market?” Center for Economic and Policy Research, September 2018, https://cepr.net/images/stories/reports/housing-bubble-2018-09.pdf.
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