Currently (as of late October, 2014) the Chinese housing market is at a historic high, yet housing prices have increased only modestly this year. This got me to thinking, could the booming Chinese housing market be at a turning point, and is perhaps already on a road to decline? Recently, I have read that some in China have begun to starting selling their houses, and that those who sells it the most are those with government connections. Perhaps they have some insider information on the Chinese government’s attempts to curb this housing bubble, or that they know something the rest of people in China do not? In terms of policy, I believe the best way to do this is through tightening the credit market, and raising interests rates. Its been well known that the government have been trying to do curb the proliferation of non-performing loans and easy money that is circulating in the country, and if the central bank indeed decided to raise the interest rates, the effects could be extremely profound, not only for the housing market, but for the entire economy. The construction boom occurring in China is fueled by the essentially free-loans that real estate developers have been getting through state-owned banks, many of these using their political connections. And now the housing supply have far outstripped the demand for housing, yet the price remains artificially high, with most of the new buying coming from speculators. In this situation, a crash is inevitable. Many have warned that crash is impending for many years now, yet the market took the warning in stride, perhaps factoring in the risk. Yet investors still believed that the boom is sustainable. In such a situation, even the slightest sell-offs can induce a panic.

Let’s look at a hypothetical situation. Going back to the central government’s actions. If the central bank (People’s Bank of China) had raised interest rates, the money fueling the construction would dry up, speculators would not be able to gain the necessary funding for them to construct new homes and further speculations in the market can no longer be financed. In this case, the housing will tumble investors leave the market en masse. The non-existent demand would not be able to prop up the price or to slow the decline. A fall in housing price will likely mark the beginning of a general slowdown in the Chinese economy for several reasons: firstly, the housing sector and construction is one of the largest sector in Chinese economy and much of the economy is tied to real estate in one way or another. The housing sector stimulated demands for steel, concrete, etc, and provided employment for millions of migrant workers coming into China’s cities each year. A fall in construction would result in overall lower aggregate demand in the economy since it is such a major component. Secondly, many companies uses real estate as asset to back their loans, and with a rise in interest rate as well as a fall in the housing prices, more loans would be much harder to get and the companies will get less of it because of the decline in their property values. As cheap loans have been at the basis of Chinese economic growth for years now, it is reasonable to expect that as this cheap loans dry up, the Chinese economy (which is driven by new investments) would slow as well. Non-performing loans, especially at the provincial and municipal levels in China would inevitably further exacerbate the crisis. Many state-owned-enterprises are burdened by high amounts of loans and a rise interest rates would cause them to become financially insoluble, a risk the Chinese government simply cannot take.

Of course, these risks have passed through the mind of the government officials as well, and especially since many government officials have ties to the commercial world, they would not be likely to push for legislations that would damage their commercial holdings. (On corruptions in China, click here). No one wants the housing market to decline, since everyone has so much tied into it. A decline in housing is not likely, or at least the government will sought to delay it as long as possible. However, the need to curb the wild growth in the market is needed. Once again, as many commentators have stated before, the Chinese economy needs structural reforms in order for it to sustain the levels of growth. The deep and complicated ties between political bodies, regulatory agencies, banks, developers, speculators, etc. causes the rise in property values in the first place, and now it has grown to an unsustainable level. The task before the government is therefore to curb the wild proliferation of loans without damaging the rate of economic growth and find a solution that is acceptable to all parties involved. A herculean task indeed! It remains to be seen how the government will be able to manage this crisis.