Mortgages saddle three generations in China

22 March 2010

China should avoid repeating the collapse in the property values in the United States and many European countries, which helped lead to so much financial and economic damage.

In a symposium held at Peking University on March 10, finance professor Xu Xinzhong of the university’s Guanghua School of Management warned China might be inflating a real estate bubble. The symposium was jointly organized by Wharton business school.

Wharton real estate professor Susan M. Wachter said she saw the warning signs of a bubble, but suggested that China might be taking steps to prevent a major disruption.

While the United States undergoes the most severe contractions in housing prices since the Great Depression, the housing market in China, with prices soaring, appears to be the mirror image of the US.

Prices were climbing swiftly in China’s housing market despite a brief slowdown in country’s economy over the last year.

“Last year, China suffered heavily as in other countries,” said Xu. However, “two industries still did very well indeed – one is online gaming, and the other is the property market.”

Today, Xu said, house prices in Beijing and Shanghai “are comparable to London and New York. If you compare property prices in Manhattan with those within Beijing’s second ring road, they are only about 3 percent different.”

Given that per capita GDP in China is far below that of the UK and US, this makes housing unaffordable for most Chinese.

“In the US, you have 3-year mortgages,” said Xu. “In China, you have three-generation mortgages: Yourself, your parents and your grandparents. Because of the one-child policy, you have five families covering one mortgage.”

What is more, local governments in China have every incentive to drive property markets and push up prices. “By most estimates, land sales and taxes account for between 40 percent and 60 percent of local government revenues now,” said Xu.

In order to reduce the upward pressure on house prices, Xu recommended localized urbanization. “China’s cities become larger every year and we say we want to create international mega cities,” he observed.

The problem this creates is that people only want to live in the mega cities where quality of life is better, and so there is a rush to purchase housing in places like Beijing and Shanghai. That is why China needs to revive its small cities and stop promoting mega cities, Xu said.

Another way to increase housing affordability, according to Xu, is to make property taxes progressive so that middle and lower income homeowners will pay less tax.

Finally, housing should be provided to the poorest citizens in society, Xu noted.

But there are too many institutional players with an incentive to keep prices high. In addition to local governments, there are others with vested interests in holding property values up.

Banks provide 40 percent of their loans for the property market, for example, and they would be hurt if property prices fell. Yet, if a bubble is growing, the consequences for banks could be far worse.

Following an epic collapse in property prices in the US since 2007, the US real estate market remains gloomy. Some 2.8 million US homes were repossessed in 2009 and there is a surfeit of bank-owned foreclosed houses going for rock-bottom prices.

The US bubble was not unique and many banking crashes have been triggered by real estate bubbles before, Wachter pointed out.

She believes the key cautionary signal is when asset price increases are not correlated with economic fundamentals, but are correlated with a decrease in the cost of debt. As the debt premium charge decreases, the asset bubble increases.

“Clearly in China, there are cautionary signs,” she warned. “We have lessons to learn from the US. Regulation has a role to play and undermining regulation in a way that allows risk to spread unchecked is unhelpful.”


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