Zhang Ming is Deputy Director of the Institute of Finance and Banking, Chinese Academy of Social Sciences, Deputy Director of the National Finance and Development Laboratory, and Director of the China Chief Economist Forum
Despite the recent introduction of the "517" new policy, the confidence in the real estate market has not been reversed, housing prices in the core areas of first-tier cities have not stabilized, and a large number of private real estate enterprises are still on the verge of credit default (the white list has not significantly improved the reluctance of commercial banks to lend to the real estate industry). While the current decline in house prices and transaction volume has not posed a serious risk to the financial system, as house prices gradually fall below the margin of safety (e.g., the 30% historical down payment ratio), we should be concerned and guard against the potential risk of a sharp rise in mortgage defaults in the future.
China's financial system, which is dominated by indirect bank financing, is resilient to stock market shocks, but it is vulnerable to the real estate crisis. The lessons of Japan in the early 1990s are clear evidence. We should attach great importance to the possible significant negative impact of the deep adjustment of the real estate market, which may bring about a significant decline in economic growth, the continuous deleveraging of the residential sector due to the negative "wealth effect", the soaring non-performing loans of commercial banks related to real estate and land, and the significant contraction of the comprehensive financial resources of local governments.
As shown in Figure 1, as of May 2024, the cumulative year-on-year growth rate of real estate development investment in mainland China fell to -10.1%, and the cumulative year-on-year growth rate of commercial housing sales fell to -27.9%, both close to the lowest level in history so far. As shown in Figure 2, the data as of May 2024 are all phased low values of the four major first-tier cities in recent years. Shenzhen, Beijing, Guangzhou, and Shanghai had indices of 833, 804, 778, and 522, respectively, and compared with the highest points in their respective cities, the prices of second-hand homes in Shenzhen, Beijing, Guangzhou, and Shanghai fell by 37.2%, 24.4%, 25.0%, and 25.3%, respectively. Compared with history, the second-hand housing price index in Shenzhen has roughly fallen back to April 2017, the second-hand housing price index in Beijing has fallen back to August 2020, the second-hand housing price index in Guangzhou has fallen back to July 2017, and the second-hand housing price index in Shanghai has fallen back to June 2016.
Properly addressing the three major risks in China's real estate market is crucial to preventing and resolving systemic financial risks and achieving high-quality financial development.
Risk 1: The liquidity of the leading private real estate enterprises is tight, and the cash flow is insufficient due to the contraction of real estate sales.
At present, the market is highly concerned about the liquidity of leading private real estate enterprises and the default of bonds and loans. If a leading private real estate company falls, it may trigger a domino effect. In addition, at present, the liquidity crisis of the leading private real estate enterprises has a tendency to spread to state-owned real estate enterprises.
How to deal with this risk?
It is recommended that the provincial government directly participate in the province's leading private real estate enterprises. For example, the provincial government buys a 10% stake in a leading private real estate company. On the one hand, this move will help significantly boost the financing capacity of the top private real estate enterprises, which have become mixed-ownership enterprises with provincial government participation. On the other hand, judging from the experience of real estate rescue in developed countries, there is a high probability that local governments will benefit from this equity investment, because local government investment is in line with the market stability investment behavior of buying low and selling high. At present, except for the head private real estate enterprises in Fujian Province, there are basically 1-2 in each province in other provinces, and the possibility and space for rescue by provincial governments through equity participation are greater.
In the current situation, it is more important to protect the main body of the market than to protect specific projects.
Risk 2: Housing prices in the core areas of first-tier cities have declined significantly.
The trend of real estate prices in the peripheral areas of first-tier cities and second-tier cities is usually highly referenced in the core areas of first-tier cities. If housing prices in the core areas of first-tier cities are allowed to fall, it may lead to the expected contagion, resulting in a sharp decline in housing prices in first- and second-tier cities, which may trigger multiple financial risks.
How to deal with this risk?
The policy of restricting purchases and loans in first-tier cities should be completely abolished, and housing prices should be stabilized by introducing new external demand. This will not only help stabilize housing prices in first- and second-tier cities, but also help boost the sales of leading real estate companies in first- and second-tier cities in major markets, helping them alleviate the problem of cash flow shortages caused by the contraction of real estate sales.
Some policymakers are still worried that if the restrictions on real estate purchases and loans in first-tier cities are fully relaxed, housing prices in first-tier cities may soar again. The likelihood of such concerns being realized is low: first, the demographic shift has significantly changed the expectations of various investors for the medium- to long-term trend of real estate; Second, in the context of the deep adjustment of the expectations of various investors on the trend of real estate prices, it is unlikely that investors will significantly increase their leverage and concentrate their investments; Third, even if housing prices rise sharply, it is not necessarily a bad thing, which will help activate the first- and second-tier real estate market, and second, governments at all levels still have sufficient means to regulate again. The problem is that we can't rule out this policy option outright just because a radical easing of restrictions on purchases and loans could lead to a rebound in housing prices.
The current "toothpaste-squeezing" policy relaxation will make potential home buyers expect that the policy will continue to be relaxed, so it cannot promote the timely entry of stock demand. Therefore, first-tier cities should fully lift the purchase and loan restrictions as soon as possible, and announce to the market that the policy relaxation has ended here and will not continue to be relaxed in the next few years. In this way, we can promote the stock demand to enter the market as soon as possible.
Risk 3: Large-scale backlog of commercial housing inventory in third- and fourth-tier cities.
Since the 2016-2017 wave of shantytown redevelopment, some large developers have stook land in third- and fourth-tier cities and developed a large number of new real estate projects, which have a large backlog due to unsalable properties in the context of high real estate saturation and net outflow of population from third- and fourth-tier cities. If measures are not taken to solve the problem, this may lead to a sharp drop in the price of commercial housing in third- and fourth-tier cities, which may not only lead to the bankruptcy and bankruptcy of relevant developers, but also may have a huge negative wealth effect, which is not conducive to the recovery of consumption and economic growth.
How to deal with this risk?
In third- and fourth-tier cities, considering that a large number of commercial houses cannot be sold, and there is still a large demand for affordable housing in the local area, local governments can consider setting up a fund to buy surplus commercial housing from developers at a lower price and transform it into affordable housing to meet the housing needs of new citizens. Considering that local government finances are mostly stretched thin, such housing funds could be financed by the issuance of special government bonds by the central government.
The above-mentioned practice of local governments purchasing commercial housing at low prices and then converting it into affordable housing has at least three advantages: first, it can prevent the price of third- and fourth-tier commercial housing from plummeting, and avoid large-scale bankruptcy and bankruptcy of developers and cause huge negative wealth effects; Second, it can help local governments complete the goal of providing affordable housing as soon as possible, and contribute to the settlement of new citizens in the city; Third, avoid rebuilding new buildings on a large scale, which solves various resources.
It is proposed that the Ministry of Finance issue special treasury bonds and inject the proceeds into the newly established Real Estate Stabilization Fund, which will buy commercial housing from developers at a reasonable price and then convert it into affordable housing.
The establishment of a real estate stabilization fund with fiscal funding is preferable to the central bank's eventual lending to local governments through PSLs, which will continue to worsen local government debt.
It is better to set up a new fund to acquire commercial housing than to entrust local state-owned enterprises to do so, because the latter will confuse the operating business with the guarantee business, and the result will be either very inefficient or may create new moral hazard.
There are concerns about whether rent-seeking behaviour and moral hazard could arise if local governments buy commercial housing from developers. In fact, this can be solved by introducing a market-based auction mechanism. For example, a local government in a place can say that it will add 1,000 units of affordable housing in the next six months, and this will be achieved through the acquisition of local commercial housing. Local governments can give requirements for the area, house type, community facilities, and quality of affordable housing, and under this premise, local developers are required to quote through bidding, and under an open and transparent decision-making mechanism (media supervision can be considered), the lowest price is selected. This kind of mechanism design can be a good way to curb rent-seeking behavior and moral hazard.