Not all housing bubbles crash equally

As China’s home prices soar to record highs and well beyond the reach of ordinary citizens, the world watches closely as many wonder if the housing market might eventually crash. The global economy is still recovering from the financial crisis triggered largely by the collapse of America’s housing market, and it’s easy to see why investors and economists would worry that a similar boom-and-bust scenario in China could deepen the lingering slump.

Such concerns, though, are premature at best. Is there a bubble in China’s housing market? It’s possible, especially in major cities, such as Shanghai, Beijing, Shenzhen, and several provincial capitals. But China’s economy is far different from America’s; should a real estate bubble in China suddenly burst, the following differences could temper the risks of another global disaster:

Declining home prices erode what’s called the “wealth effect.” If home prices drop, theoretically homeowners feel less wealthy so they consume less, which in turn, leads to an economic slowdown. The U.S housing crash in 2007 damaged the wealth of countless Americans, but such spillovers likely won’t be as deep in China because the country saves far more than most other countries.

Most Chinese don’t enjoy the kind of retirement plans and other social safety nets that most Americans do. So they tend to rely on savings and their children for financial security. In addition, they also save to help their children in their competition for marriage partners. As the ratio of males and females in the youth cohort rises due to gender-selective abortions, the competition for brides is getting fiercer for families with a son, and the competitive savings have risen in importance relative to the precautionary savings. Because of these factors, Chinese households save a greater fraction of their incremental wealth than most other countries.

As home prices rise, incremental consumption as a share of incremental wealth in China is smaller than in the U.S. For the same reasons, if home prices were to fall, the decline in consumption as a share of a decline in housing wealth may also be smaller than in the U.S.

A housing bust could also disrupt input-output linkages — when home prices collapse, the ramifications could ripple across the construction industry, leading to reduced demand for steel, cement, and appliances. China isn’t immune, but the government’s ambitious affordable housing program could cushion the blow to the wider construction industry. This program is meant to help address income inequality. To build these houses, you need cement, steel, and eventually furniture. To the extent that a price correction occurs in the normal housing market, the construction of low-income housing will at least partially offset any potential negative effect.

As we saw in the U.S., a collapse in home prices nearly destroyed the nation’s financial system as loans to real estate developers and homeowners turned sour.

In China, loans to real estate developers and mortgage loans to homeowners altogether account for about 20% of all bank loans. Suppose 20% of these loans go bad, which is an aggressive assumption given that subprime loans in the U.S. accounted for less than 20% of all banks’ loans during the subprime crisis of 2007-2008 (and not all subprime loans went bad); this will produce 4% of bad loans.

While this is not negligible, China’s banking sector should be able to work itself out, perhaps with the government’s help. The fact that China’s government debt burden is much lower than the U.S., Europe, or Japan is important here. After all, the Chinese banking sector got itself out of a far more serious bad loan problem a decade ago.

Chinese government policies are not fixed either. In the last few months, the country’s central bank has tightened its expansionary monetary policies used to counter the global economic slowdown. It did so because it made a judgment that risk in the housing market was not very big. If it sees signs of a housing price correction and a potential negative effect on the overall economy, it can reverse course.

Bubbles are an inevitable byproduct of a market economy, especially when the underlying asset is hard to sell short (such as housing in China). However, even if a housing price correction comes, it won’t have the same impact on the overall economy that we experienced when the U.S. and European markets collapsed.


About thenoelteam

As a Broker with RE/MAX Alliance, I work energetically for my clients whether they are a buyer or seller. I help you achieve your goal of owning a home or getting the best price for your home in the shortest time possible. After graduating from UCLA with a degree in communications and finance, I was licensed in 1977 and since then I have sold over 3600 properties amounting to over $1 billion in sales. I currently rank in the top 10 in home sales for Colorado. I offer the same quality of service and superior communication to all clients, ranging from starter homes to multi-million dollar estates, commercial and income properties, relocations and foreclosures My goal is to provide you with the best representation possible whether you are buying or selling. Over the years, one of the things that I've discovered is that there is a difference in the way individual Realtors do business. For me, I have always felt that honesty and personal integrity are the foundations upon which a successful business and career are built and sustained. I have an extensive background and knowledge base in real estate, including financing, which has enabled me to provide outstanding, quality advice and service not found with many agents today. My commitment to communication creates a positive relationship between my client and myself that results in a successful property sale or purchase. My passion for real estate, commitment to my clients and personal integrity has helped me to achieve success placing me in the top 1% of all brokers in nationwide. In my career, I have earned a number of awards and received considerable recognition for my success but the most significant recognition comes from the fact that over 75% of my business comes from past clients. My success is a true measure of my client satisfaction.
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