More worrying is the scale of the crisis in real estate and other sectors of the world's second-largest economy, and the real dangers if policymakers choose paths that could prolong the recession and the depth of the downturn.
Evergrande is just one part of an even larger real estate collapse that is impacting economic growth, consumer confidence and China's prospects. Country Garden, once China's top-selling real estate developer, is also there default. JP Morgan estimates that property developers responsible for 40 percent of home sales in China have defaulted since 2021.
Given the direct link between real estate values and consumer confidence, and the fact that real estate accounts for 25 percent of the economy, the impact of the looming real estate crisis is shocking to investors and China's policymakers.
08:36
A vanishing fairyland dream: How China Evergrande rose and then fell
A vanishing fairyland dream: How China Evergrande rose and then fell
Professors Atif Mian and Amir Sufi from House of Debt showed us (using the US housing crisis of 2007-2008) that deep recessions are always associated with falling real estate prices. When prices fall, consumers (even those with large down payments) feel poorer and spend less.
This hits an economy and its banks particularly hard; All economies rely heavily on consumer spending and confidence. When spending falls, confidence falls and the economy slows or shrinks. We can see this from the low values Post-Covid consumer spending in China; a hoped-for upswing failed to materialize.
China's policymakers must avoid creating zombie real estate companies that flounder, paying some bills and not others, completing some apartments but not all. Restructure if possible, liquidate if necessary. Selling to buyers who can build on more solid economic footing will be painful, but is part of the solution.
Yes, in the short term the pain is great (as was the case with Ireland's housing crisis in 2000). However, if these companies remain on expensive financial life support in the hope that they will eventually recover, it could result in a drain of resources from the rest of the economy.
This is an important lesson from Japan's housing crisis. Above all, avoid burdening banks with a growing portfolio of non-performing loans. This restricts lending and banks respond by withdrawing other loans and financing to productive parts of the economy. Putting too much strain on banks could increase the burden on the economy. Unfortunately, this can happen in China.
4:50 p.m
Can China learn lessons from Japan’s “lost 30 years”?
Can China learn lessons from Japan’s “lost 30 years”?
Xiao Yuanqi, deputy head of China's National Financial Regulatory Commission, stressed that banks have an “unwavering responsibility.” she urged To provide “strong support” to real estate companies. This means issuing new loans to pay off other loans on the books of distressed real estate companies. The People's Bank of China has also done this reduce bank reserve requirements and called on banks to exercise leniency on real estate loans. While this is understandable, this can bring with it the risk of throwing good money after bad. China should not take any risks “Japanization” its economy and a long period of slow growth and deflation. With property prices in China much higher – 29 times income in 2020 – than in pre-bankrupt Japan, and vacancy rates also higher than in pre-bankrupt Japan, the dangers of a prolonged downturn are real.
China can cope with its real estate crisis. Can the US and Europe say the same?
China's banks should only lend to companies that can recover and restructure their businesses. Risks must be carefully managed. Banks should assume that the economic downturn could continue and not that there will be a sudden economic recovery, which is unlikely. Real estate companies that cannot be saved must go bankrupt and sell their assets. Creative destruction must be allowed.
There is an important lesson to be learned from past housing crises, banking crises and recessions, whether in Ireland, Japan, the United States or China: when a boom is underway and profits are outsized, strict, consistent regulation and supervision is required. During a boom, risk takers always reassure officials that their practices and business models are sound. However, when the boom goes bust, we often find that many companies promised unrealistic returns based on faulty practices.
Avoiding bank overload is not the only problem; banks are the transmission mechanism, the engine of the economy. China's leaders must be careful not to infect the financial world with the real estate malaise, otherwise the downturn could last much longer than many expect and the economic problems could be more widespread and damaging.
William R. Rhodes is President and CEO of William R. Rhodes Global Advisors LLC and former CEO of Citibank
Stuart PM Mackintosh is managing director of Group of Thirty
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