China’s real estate market has been reeling from a crisis for two years now, and the ripple effects are leading to a larger financial crisis looming on the horizon. Recently, Chinese Vice Premier and head of financial oversight, He Lifeng, issued a warning about the urgency of the situation: “We must firmly guard against the bottom line of avoiding systemic financial risks in the near and medium term, and face the hidden risks in the financial sector.”
“This time, the top echelons of the Chinese Communist Party are very anxious! In reality, the severity of the situation has far exceeded the so-called hidden risks of systemic financial risks. It is now a financial collapse,” said Chinese-American economist Li Hengqing, speaking to Dajiyuan. “The collapse and collapse of the financial system closely connected to the bursting of the real estate bubble is unfolding before our eyes.”
On May 21, the Chinese Communist Party held a meeting of local party committee financial directors, where Premier of the State Council and Director of the Central Financial Commission, Li Keqiang, emphasized the need to “firmly guard against systemic financial risks.” He Lifeng, Director of the Office of the Central Financial Commission, also warned about the intertwining of three major risks, stating: “Currently, we must coordinate efforts to strictly prevent and control the risks intertwined in real estate, local government debt, and risks of small and medium-sized financial institutions.”
A recent report from the China Index Research Institute shows that from January to April, the sales area of newly built commercial housing was 2.9 billion square meters, a 20.2% decrease year-on-year. During the same period, the sales of newly built commercial housing reached 2.8 trillion yuan (approximately 386.6 billion dollars), a 28.3% drop year-on-year. In April alone, the sales volume of commercial housing was 671.2 billion yuan (approximately 92.7 billion dollars), a 30.4% decrease compared to the previous year.
Moreover, data released by the National Bureau of Statistics of China for April indicates that the decline in sales prices of commercial residential buildings in various cities is widening both year-on-year and month-on-month. Out of 70 large and medium-sized cities, only six showed a monthly increase in new house prices, including Shanghai, a decrease of five compared to March. There were 64 cities where new house prices decreased on a monthly basis, an increase of seven compared to March.
The steep decline in the real estate sector is directly impacting the fiscal revenue of the Chinese government. Official data shows that from January to April, the tax revenue of the Chinese government was 6.6938 trillion yuan (approximately 916.9 billion dollars), a 4.9% decrease compared to the same period last year. Among the government budget revenue (such as revenue from state-owned land use rights, tolls, lottery public welfare funds, etc.) related to real estate, revenue from state-owned land use rights amounted to 1.0536 trillion yuan (approximately 145.9 billion dollars), a 10.4% decrease year-on-year.
Li Hengqing explained that among the three major risks mentioned by He Lifeng, real estate is the core risk. “The current crisis triggered by the bursting real estate bubble is right in front of us, the ‘gray rhino’ is at the doorstep, the ‘black swan’ flies outside the window every day, and the grim reality is making the top leadership of the CCP anxious!”
Regarding the risks of small and medium-sized financial institutions, Li Hengqing stated that the recent incident of the Henan Village Bank, involving the life savings of 400,000 depositors and a total of 40 billion yuan (approximately 5.5 billion dollars) that could not be withdrawn, is just the beginning. With over 4,000 similar small banks in China, events like the Henan Village Bank incident will continue to unfold, ushering in a Chinese version of a Lehman moment in seconds.
North American investment advisor Mike Sun told Dajiyuan, “The process of crisis propagation usually starts from village banks to local small banks, then to joint-stock banks, and finally to large state-owned banks. To avoid the crisis, state-owned banking giants have begun issuing bonds to replenish capital this year and have recently started issuing Total Loss-Absorbing Capacity (TLAC) bonds.”
Recently, some of China’s largest state-owned banks have started issuing a special form of loss-absorbing bonds for the first time, with the aim of preventing a recurrence of the 2008 Lehman financial crisis.
On May 20, the Industrial and Commercial Bank of China (ICBC) announced the issuance of 40 billion yuan (approximately 5.5 billion dollars) of so-called “Total Loss-Absorbing Capacity” (TLAC) bonds. On May 23, the Bank of China also initiated the pricing of TLAC bonds worth 30 billion yuan (approximately 4.2 billion dollars).
TLAC bonds are designed to address the “too big to fail” problem of banks. The Financial Stability Board in 2015 set TLAC capital requirements for globally systemic important banks (G-SIBs) to prevent potential systemic financial crises in the event of their bankruptcy.
When a bond-issuing institution faces a major operational or bankruptcy crisis, bonds can be reduced in face value or converted into equities through contract or statutory mechanisms, which may lead to partial or complete bond write-offs, cancellation of interest, conversion of bonds into equities, and modifications in bond terms, such as maturity dates, interest payments, or suspensions of interest distribution.
Mike Sun remarked, “They [the top CCP leaders] do not want to repeat Japan’s path after the bursting of the real estate bubble, in the short term, they can rely on issuing bonds to tackle the crisis; however, in the medium to long term, internal demand is still crucial. The current measures are merely postponing the crisis and cannot solve the root problem of the crisis eruption.”
On the other hand, small and medium financial institutions in provinces like Guangdong, Sichuan, and Shanxi are attempting to strengthen their financial capacity to cope with the crisis through mergers and reorganizations.
Recently, the Chengdu Bank released a statement announcing the approval of the proposal to acquire certain shares of its subsidiary, Sichuan Mingshan Jincheng Village Bank, to convert it into a branch in Ya’an.
The Dongguan Rural Commercial Bank will convene a shareholder meeting on May 30 to discuss the proposal to merge two of its village banks, Huizhou Zhongkai Dongying Village Bank and Dongguan Dalang Dongying Village Bank.
The Shanxi Bank’s board of directors will hold a shareholder meeting on June 6 to review the proposal for the establishment of a branch through the acquisition of four village banks, including Yangqu County Huimin Village Bank Ltd.
Over the past 20 years, the real estate and related industries in China have been crucial pillars supporting GDP, accounting for 25%-30% of China’s GDP after 2010. The World Bank estimates that real estate investment in China accounts for 13% of GDP, and when considering supply chain inputs, the real estate industry contributes approximately 30% to China’s GDP.
Since 2010, the real estate and related industries have been essential pillars of China’s GDP. This is linked to the large-scale investments in real estate introduced in 2013 with the initiative known as “shantytown” renovation (“shantytown reform”). In June of that year, the State Council of China decided to renovate 10 million households of various types of shantytown areas over the following five years.
The term “shantytown” refers to areas with concentrated housing that are structurally simple, with many safety hazards and inadequate infrastructure, which were prevalent in cities across China in the past. “Shantytown reform” began in 2005, with the government providing direct financial compensation to residents who were displaced, allowing them to purchase homes in the commercial housing market. After 2010, shantytown reform became an important tool for stimulating the Chinese economy, but it also gave rise to the real estate bubble. Faced with massive real estate inventory, the CCP expanded and increased the scale of “shantytown reform” to absorb the surplus, further inflating the real estate bubble.
Li Hengqing asserted that the CCP has missed several opportunities to address the real estate bubble. The game of passing the buck has reached its limits. Now, with the financial system crisis triggered by the real estate collapse and the looming crisis of local government super-debts, the CCP only has two choices: a “hard landing” or a “soft landing,” both of which would lead to the downfall of the CCP regime.
“A ‘hard landing’ would involve swiftly clearing debts through legal procedures, but it would have a huge social impact, likely causing social panic. Simultaneously, the CCP regime and its leaders would face accountability, and CCP rule would lose its legitimacy,” Li Hengqing explained. “A ‘soft landing’ would mean delaying the crisis, finding opportunities to solve it slowly, often reliant on Europe and the United States. For example, if China-US trade returned to its previous state, revitalizing the economy through exports could slowly resolve the bubble. However, the likelihood of this is almost zero.”
Taiwanese macroeconomist Wu Jialong told Dajiyuan, “The current political and economic situation in China is highly similar to the late Qing Dynasty, with crises looming. Any conflict event could potentially become an opportunity for the CCP regime to fall. He Lifeng’s emphasis on safeguarding against systemic risks essentially aims to protect the party and the CCP regime, providing only a temporary lifeline.”
With the financial storm gathering strength in China, the full extent of the impact is yet to unfold, and both domestic and global markets are closely watching how the situation will evolve going forward.