From the Economist via Bloomberg, the most worrisome news I read today. The gist of the story:
China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets, a person with knowledge of the matter said.
Banks were instructed to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent.
By means of background, Chinese real estate was one of the best preforming sector in the world economy for most of 2009 and early 2010. The cause may have been anything from a lack of space in major cities, a comparative distaste for the volitile Shanghai stock market, or pure bubble mentality. Regardless, prices have increased by about 70% in major Chinese cities (the countryside has largely been exempt from the mania).
In one sense, today’s news is not much of a surprise. The Beijing government has been skeptical of the real estate bubble, and has done its best to jawbone the market down. Indeed, the news may be the dog-in-the-nighttime sense that the banking regulator is ordering a stress test, rather than an selloff of the real estate loans, or raising capital requirements.
That said, the news may be important in several different ways. Anyone not Rip-van-Winkling through the past three years understands how a bursting bubble, particularly a real estate collapse, can devastate a financial sector and the general economy. Indeed, China’s banks don’t stand on a strong reserve of capital (via Marginal Revolution, the incredible admission that 20% of loans to local governments default). It’s not hard to see how this could provide a major source of pressure both for China’s banks, and for the central government which implicitly underwrites them.
Nonetheless, even the best case scenario of China muddling through the property woes may well be a worse case scenario for the global economy. Broadly speaking, a major challenge for the next couple of years is lack of demand in the global economy. Thanks to the past decade, the American consumer and government alike need to pay down debt, rather than engage in consumption. Europe is demographically in the process of retirement and asset liquidation. The idea that Asia needs to consume more is neither innovative nor particularly insightful. Yet it remains the world economy’s best hope for growth ahead. If the real estate fallout means a slowdown of China’s growth, Americans can expect this Great Recession to become even greater.