China’s mortgage crisis could threaten financial stability

China’s growing mortgage boycott is already threatening nearly 1 trillion yen ($148 billion) in home loans, but is rapidly escalating. As a result, it poses a threat to the financial stability of the world’s second largest economy.

The landlord boycott is currently affecting 980 billion yen ($145 billion) in mortgages, according to Standard & Poor’s, which represents 2.5% of all mortgages nationwide. That could reach 2.4 trillion yen ($355 billion) and 6.4% of China’s mortgage portfolio, the rating agency predicts.

The showdown between buyers and developers represents a crisis of confidence. Although the current threat to Chinese banks is contained, the mortgage strike is weakening the strongest pillar of the Chinese economy. It hits 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 house prices, it could threaten financial stability,” wrote Yiran Zhong, senior credit analyst at S&P, in a report. “The government sees this as important enough to rapidly deploy relief funds to deal with the erosion of confidence.”

China is preparing to launch a 300 billion yen ($44 billion) capital-backed fund to ensure that property developers complete the projects they have started, according to Reuters. However, the fund would initially be pegged at 80 billion yen ($12 billion), with backing from the Central People’s Bank of China and China Construction Bank (CICHY) (HK:0939).

The PBOC would support the CCB with money from its on-lending facility. If this plan works out well, the central bank would also support other major Chinese banks, the news agency reports, citing a state bank official.

The initial size of the fund would not be sufficient to stimulate the real estate sector, analysts believe. Such a real estate fund should probably be part of a larger support program. But Beijing has resisted calls to directly stimulate the economy and support struggling developers, as the Chinese government tries to reduce property prices by forcing the residential construction sector out of debt.

Confidence in small rural banks in China is wavering after several ran aground in Henan province. Depositors sparked a run on Henan banks in April after police said they opened an investigation into Henan New Fortune, the major shareholder of four Henan banks. Police accused the owner of Henan New Fortune of defrauding banks by forging loans and illegally transferring funds.

It could be a costly 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 would reimburse depositors with savings of up to C¥50,000 (US$7,400). S&P estimates this will cost the government about 20 billion Canadian yen (US$3 billion).

Even if the mortgages hit by the strike rise to $355 billion, “the large public lenders that are active in mortgages can handle such an increase in bad loans,” says S&P. “However, we see a possibility that the effects will spread. Distressed developers who are not affected by the boycotters could still be targeted by strikes. This would deter banks from granting mortgages to developments, thus halting sales in their tracks.”

S&P calculates that 32 of the top 100 Chinese developers are already in financial difficulty. The worst problems occur in small towns where real estate prices are already falling sharply. The rating agency predicts that house prices in China will fall 6% to 7% nationwide this year.

Homebuyers are taking a considerable risk by refusing to make their mortgage payments. Failure to pay will hurt their credit score, which feeds into a national “social credit” rating that every citizen has. A bad credit score can therefore prevent citizens from buying train tickets, traveling by plane and accessing government services.

Policymakers are thought to be considering offering “payment holidays” so homebuyers can get back on track with their payments without hurting their credit scores. Local governments and the administration in Beijing are likely to push banks and asset managers to work with local governments and public developers to secure the construction of the projects.

The turmoil has already caused a sharp slowdown in real estate transactions. Home sales will fall 28% to 33% this year, according to S&P forecasts, double the decline previously predicted.

The problems in Henan Province have drawn wide attention in China. Five officials from Henan province have been punished after tampering with health codes on the phones of local citizens who traveled to the provincial capital, Zhengzhou, to protest the banks. The protests have spread to developers, whose buyers fear they will not be able to complete the projects if the banks collapse. Actions by provincial officials to try to stop the protests have received wide coverage in China.

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

The local provincial-level issues come as China struggles to sustain growth this year amid a challenging global macroeconomic backdrop.

Presidents Joe Biden and Xi Jinping are due to speak by phone Thursday, according to the White House. But a planned visit by House Speaker Nancy Pelosi to Taiwan in August will overshadow any talk they might have of a thaw in the icy trade war between the United States and China.

Biden’s economics team has been considering lifting some of the trade tariffs put in place on Chinese imports under the Trump administration. With the additional trading duties ultimately passed on to US consumers, their reduction could help dampen inflation, albeit slightly. China is extremely keen to see tariffs lifted.

The Russian invasion of Ukraine 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 ruled island is believed to be higher than it has ever been. Beijing has hinted that its military will react if Pelosi’s visit, a show of support for Taiwan as China continues to make numerous incursions into its air defense zone, continues.

Pelosi would be the highest-ranking U.S. official to visit Taiwan since Republican House Speaker Newt Gingrich made a similar trip in 1997. Biden could show Xi he doesn’t support the visit, but didn’t no authority to stop him.

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

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

And the risks remain firmly on the downside, according to the IMF. “The outlook has darkened considerably since April,” said IMF chief economist Pierre-Olivier Gourinchas. “The world could soon teeter on the brink of a global recession, just two years after the last one.” The global economy rebounded 6.1% in 2021, but is now hampered by rising interest rates to combat runaway inflation, which is expected to reach 8.3% year-on-year in Q4 2022.

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