As China’s property crisis grows, can nationalisation help rebalance its economy?
- Developers’ debt crisis raises concerns about health of banks, local governments’ fiscal viability, impact of falling property prices on consumption and economic growth
- China can look to US experience where partial nationalisation of troubled assets, financial institutions helped restore financial stability, boost economic recovery
The collapse of the decade-long property boom in China – triggered by a government crackdown on overleveraged property developers in early 2021 – has led to a series of defaults by a number of the country’s major developers.
More worryingly, the crisis in the property sector has raised wider concerns over the health of banks that have a great deal of exposure to the troubled developers, the fiscal viability of local governments that have become over-reliant on land sales to finance themselves, and the drag of falling property prices on consumption and economic growth.
All these have affected China’s ability to rebalance its economy towards one driven more by consumption, rather than (real estate) investments.
It is worth highlighting that the debt crisis China is now grappling with is neither uncommon nor surprising. About 30 years ago, Japan was entering a lost decade of slow growth, deflation, and deleveraging as a result of the collapse of a credit boom that had pushed the value of real estate around the Imperial Palace in Tokyo to be higher than that of California.
The Asian financial crisis 25 years ago began as a currency crisis but its underlying cause was also too much debt (denominated in foreign currency), much of which had flowed to unproductive, speculative investments, especially in real estate.
Fifteen years ago, the global financial crisis began with the collapse of the subprime mortgage market in the United States. About 10 years ago, the euro-zone crisis exposed the high levels of leverage in a number of European countries, and how much of that had financed consumption and commercially unviable infrastructure and real estate projects.
What made these crises so damaging for financial stability and economic growth was that they were driven by debt, and that much of this debt was used to finance (unproductive) real estate. While governments may be able to rescue overly indebted financial institutions and stabilise the monetary system, these often come at great economic and political costs – at least in the short term.
But these near-term costs may have to be borne to avoid the adverse long-term consequences of zombie firms and banks, debt deflation and a weak recovery.
Of the four financial crises mentioned above, only the US managed to bounce back relatively quickly from its crash in 2008-2009. What distinguished the US crisis from the Japanese, Asian and euro-zone ones was that the US rescued its troubled financial institutions and rolled out fiscal stimulus measures to boost consumer spending and private investments.
The financial implications of such measures aside, the political costs are the consequence of popular disgust at the idea that greedy bankers (or property developers) should be rescued for causing the crisis in the first place. But such rescues may be necessary, even if they are unpopular.
At the start of the US subprime mortgage crisis, the Federal Reserve cut short-term interest rates and encouraged banks to use its discount window. There was a deep-seated aversion to using taxpayers’ funds to purchase the distressed debt of the financial institutions or to recapitalise those that ran into solvency problems.
This aversion to bailing out heavily indebted banks that were too big to fail ended soon after the collapse of Lehman Brothers in September 2008. US policymakers soon came to realise that to save Main Street, the state needed to save Wall Street.
The Troubled Asset Relief Program (TARP), approved by Congress at US$700 billion, authorised the US government to buy troubled assets (that is, mortgage-backed securities) and bank shares. TARP enabled a partial nationalisation of the distressed assets of banks, if not of the banks themselves. Between 2008 and 2010, TARP invested US$426.4 billion in financial institutions and recouped US$441.7 billion, turning a reasonable profit for the US government.
History may well repeat itself in China. There is an understandable aversion among the Chinese authorities to rescue heavily indebted property developers, especially as they were so profitable until recently. But the measures announced so far – including making local governments take over unfinished projects or extending cheap loans to these developers – may not only be ineffective, they also require the state to incur more costs without any guarantee that the deeper crisis will be resolved. There is also no financial upside for the government.
In contrast, as the US experience with TARP shows, (partial) nationalisation can be a profitable investment when the assets acquired by the state are sold as financial stability is restored and the housing market recovers.
The wider economic contagion that the malaise in the property sector is causing is a second reason for Chinese authorities to consider nationalisation. When the crisis began with Evergrande’s troubles a year ago, few analysts foresaw that the industry’s debt problems would have systemic consequences.
Most believed authorities would have to tread carefully between maintaining financial stability (that is, limiting the financial contagion of property developers defaulting on their loans) and causing moral hazard (which a government-financed bailout of Evergrande would almost certainly cause).
Most analysts also thought that since mortgages in China had not been securitised and spread to the rest of the financial system, there was little risk of a property slowdown causing a financial or macroeconomic crisis.
In recent months, it has become increasingly clear that maintaining financial stability must take precedence, at least in the short term. China’s property developers turned out to be a lot more intertwined with, and connected to, the rest of the economy and the financial system than most analysts had thought.
Not only were the developers highly indebted, the scope of their liabilities was also extensive. These liabilities are owed not only to banks and bondholders, but also to trust companies, managers and employees who bought wealth management products, suppliers who were paid in commercial paper, and customers who bought flats in pre-sales well before construction had even started. In short, to save the common folk, China may well have to save its troubled property developers.
Third, on paper at least, China has no reason to be ideologically opposed to nationalisation. TARP was criticised as being “capitalism on the way up, socialism on the way down”; it was also viewed as evidence of bank profits being privatised and bank losses being socialised.
The Chinese state would not be subject to similar criticisms or constraints; after all, it describes itself as socialist. No one should be surprised that a sector that contributes nearly 30 per cent of economic output might be taken over by the state – particularly if its excesses have now led the country to the brink of a severe financial and macroeconomic crisis.
In short, whether in terms of pragmatic or ideological considerations, there is no good reason for China to rule out nationalisation, in some form or another, of its troubled property developers.
Author: Donald Low, SCMP