Whereas international investors crave for China’s economic development, it has been claimed that its economy is decelerating. In 2013, China’s economy, which is the second largest in the world, grew at a yearly rate of about 7.7%. According to the latest Organization for Economic Co-operation and Development’s (OECD) report, China’s economic growth will decrease to about 7.3%. On the other hand, the growth rate of the United States’ economy is expected to increase by about 1%. Apparently, the Chinese industrial production gains in August 2014 slowed to their lowest point since 2008. The country’s retail growth sales have been decreasing by a few percentage points each year. Most importantly, China’s recently prices of homes only increased by 2.5% in July 2014, after an increase of about 10% at onset in 2014. The concept of housing crisis in one of the largest economies, more than three times the size of French economy, reminds economists the 2008 US subprime mortgage crisis. A bubble in property value in the universe’s second largest economy would result in international effects. However, some economists have also pointed out that the global effects of property bubble in China might not be bothersome as those caused by the US housing collapse in 2008. Consequently, this paper discusses the possibility of housing crisis in China, and its similarities with US housing crisis.
Effects of Housing Crisis
The impacts of housing crisis in the US can be used to project the impending crisis in China in event of housing crisis. Deng, Shen & Wang (2011) proposed four impacts of the US housing crisis. Firstly, the crisis elevated poverty, which Deng, Morck, Wu, & Yeung, (2011) referred to as “slumburb.” The crisis caused a rush of home foreclosures, which left several regions that were once successful suburban in economic disrepair. Because of the foreclosures, the rates of poverty have increased more rapidly in suburbs than in the cities.
The second impact of the crisis was higher unemployment. The resent rate of unemployment is at 9.6% after an increase beyond 10% in 2009. Several economies have argued that the unemployment rate is gradually declining. However, unemployment will be US’s perpetual friend for at least several future years.
Thirdly, most Americans had a comparatively weak credit capability. Unlike in the past when anybody could acquire credit card or get approval for a home loan, presently, people are facing difficulties acquiring credit despite qualifying. Approximately 1 out 10 persons are approved for home loans.
Fourthly, the crisis abridged savings among millions of Americans, specifically the middle class. Figures indicate that 60% of Americans live from paycheck to paycheck, compared to the 49% and 43% in 2008 and 2007 respectively. Approximately 1.4 million Americans filed for insolvency in 200.
House Down Payment
The high availability of home loans coupled with very low down payment accelerated housing crisis in the US. Most people were attracted to take high housing mortgages because of the low down payment offering by financial institutions. Unfortunately, the prices decreased sharply lowering the value of houses that had already been acquired. An individual could acquire a house at higher price because of the low down payment, and later realize that the prizes had fallen sharply. Housing prices decreased by 20% from their 2006 peak, with the future housing market indicating further 30% decline. The 20% decline translated to a decrease from US$ 13 trillion home equity to about US$ 8.8 trillion by mid-2008.
Economists have started giving warnings that China might be approaching the foreclosure moment, which is driven by underwater mortgage loans. The speculative increase will suddenly witness a debt accumulation that overtakes cash flow. However, unlike in the US, China seems not to be worried by citing the 30% down payment obligation on real estate acquisition. The US witnessed low down payment, which attracted many buyers who eventual became victims of foreclosures. China seems to cut the number of victims by using a higher down payment for acquiring real estate. If down payment has a critical effect in influencing foreclosures, then China might not witness the impacts of housing crisis. The 30% down payment reduces the demand for real estates. With the less demand, contractors are limited to supply houses to the market, and thereby eliminating the chances of excess supply, which causes decline in prices. Prices decrease if supply outgrows demand, and prices increase if demand outgrows supply. The figure below depicts this situation.
The likelihood of underwater mortgage loans and foreclosures happening in China depends on how an individual views the 30% Chinese down payment on property. For instance, Deng, Shen & Wang (2011) argued that 30% down payment on real estate might be low for China. As a result, it might deter people from securing mortgage loans or reducing demand. In fact, it increases demand for properties. With a likelihood of excess demand, supplier will provide more houses to the market, which will devalue houses. This is not likely to happen, but might happen in the case of the US, where people were lured by the low down payment to secure mortgage loans.
Subprime Loans and ARMs
The US housing crisis was caused by subprime lending with high rates interests, coupled with Adjustable-Rate Mortgage. The Central Bank of the Republic of China defines ARM as mortgage rate paid based on floating benchmark rate plus a particular mark-up. Unlike the US housing market, China does not exhibit the large magnitudes of subprime lending and ARMs, though all residential mortgages ARMs. Once the Chinese Central Bank announces a rate adjustment, the new rate applies to all existing mortgage loans, with a term longer than one year. Most Chinese are hesitant to have a debt, unlike their American counterparts. According to studies, at least 75% of Beijing residents are aware of the subprime loans and ARMs, but less than 10% of them apply for them. This implies that motivation among borrowers of prepayment in China is different from what was observed in the US during the housing crisis.
Unlike the United States, the cash remittance for owning a house happens essentially in the early stages of purchase. In the event that an individual prefers owning a home through mortgage, the official minimum deposit, as mentioned in the previous question, is 30%, and it is accompanied by an interest rate of 6.6%. It is true that both China and US financial institutions use fancy ARMs and low interest mortgage loans to attract homebuyers, but the Chinese are not falling for the lucrative deals that plunged the US in housing crises.
Presale is a common practice in the Chinese housing market. Consequently, homebuyers might take certain risks if home developers fail in the delivery of properties as stated in the presale contracts. Majority of Chinese mortgage borrowers utilize mortgages as an instrument for sharing the presale risks with the bank. If the mortgage borrower is satisfied with the property, he or she might decide to pay off the debts as soon as they can. In the case they are unsatisfied, borrowers have an alternative to default the mortgage loan. In simple terms, the borrower has an alternative of selling the poorly constructed house to the bank at the price set by the remaining balance of loan.
Oversupply of Houses
Homeowners and home developers speculations have been cited as a contributory factor of the subprime mortgage crisis. Speculations about prices of houses have a significant effect on suppliers. In the US, housing constructions companies speculated that prices would increase. As a result, they took the risk and oversupplied the market resulting in excess supply of buildings, which locals could not afford. On the other hand, if construction companies speculate that price would decrease, they are less likely to develop houses, resulting in shortage. China and US both witnessed speculations concerning house prices. In the US, oversupply of houses is common along west coast, in cities such as Florida, CA.
In China, oversupply can be examined in cities where defaults have occurred. Because of speculations about increases in home demand, home prices in Chinese major cities have skyrocketed. These cities include Wuxi, Jiangsu Province; Hangzhou, Zhejiang Province; Ningde, Fujian Province; and Xinyi, Jiangsu Province. However, unlike the US government, Chinese central government is not particularly concerned about the defaults arising from the inability of people to pay their mortgages, or bankruptcies. The government is concerned about unemployment, which will result from the collapse of privately funded construction. The government of China learned from the US, which experienced the increasing rate of unemployment due to housing crises. The diagram below shows how oversupply of houses arises.
Financial Sector’s Large Exposure in China
China has upheld high economic development rate over the past three decades. Since the introduction of reforms in 1978, China’s economic development has been around 10% and inflation has remained comparatively passive. China financial sector has also growth expansively and rapidly in order to achieve financial diversity. The lending to household, despite being low in comparison to other nations, has picked up because of the housing sector.
China has made considerable progress in moving towards commercially oriented financial sector. Reformed that comprised of the recapitalization of banking sector created new capital markets, introduced a wise regulatory regime, opened the financial sector following accession to the World Trade Organization, and took attempted to reform interest rates and the exchange rate systems. The nation’s financial reforms are capable of handling the insinuated housing bubble by economists.
The anticipated impacts of housing crisis in China include unemployment, weakened credit capability, elevated poverty, and reduced savings. The high availability of home loans coupled with very low down payment accelerated housing crisis in the US. Different from the US, China’s housing market does not show the large magnitudes of subprime lending and ARMs, though all residential mortgages ARMs. Speculations about prices of houses have a significant effect on suppliers. In China, oversupply can be examined in cities where defaults have occurred. Examples of the cities include Wuxi, Jiangsu Province, Hangzhou, Zhejiang Province, Ningde, Fujian Province and Xinyi, Jiangsu Province.