Ying Zhao

Financial Crisis Is Highly Unlikely in China

Editor's Note: As the financial crisis in the United States spreads around the world, China appears to be safe. With government-owned land, higher quality mortgages, a closed financial system and huge foreign exchange reserves, the country is unlikely to face a similar economic crisis.

As the financial crisis in the United States spreads around the world, investors are scrambling for a safe place to dock their money. They can at least find one -- China, where a similar financial crisis is highly unlikely for several reasons.

First, slumps in real estate values, which directly triggered the current credit crisis in the United States, aren't likely to occur in China.

Unlike most countries in the world, in China, the government owns the land. That means Chinese homeowners spend the majority of their income paying for a house on land they don't actually own. A homeowner simply buys the right to use the land for a certain period of time -- 70 years in the case of residential properties.

The government benefits the most from a booming real estate industry by selling and re-selling land, and it will lose the most if the housing market tumbles. Revenue from auctioning land surpassed 900 billion yuan ($132 billion) in 2007, according to the Ministry of Land and Resources, or nearly 20 percent of the country's fiscal income last year.

That explains why China has seen several stock market crises in the past 10 years (the most dramatic one is happening now), but not one single crisis in the housing market. It doesn't mean, of course, that China's house prices will rise indefinitely, but it does mean that the government has strong incentives to intervene in the market.

The government has powerful means. The most obvious one is a limited supply of land. China has 1.3 billion people living in an area as big as the United States. Over the past few years, new cities have been built and more people have moved to urban areas. But the majority of the Chinese still live in rural areas, and their demand for better housing will provide strong support for the property market.

Spending within their means

Another reason why China won't suffer the same fate as the United States: Mortgage assets owned by Chinese banks are of a much higher quality. House buyers usually shell out a down payment of 30 percent for their first apartment, and the government requests that buyers of a second home pay 40 percent down. Sub-prime mortgages with zero-down payments are now allowed in China.

And unlike the United States, Chinese homebuyers tend to prepare enough savings for a monthly mortgage payment before they decide to buy an apartment. Allowing spending to surpass savings is seen as an embarrassment in China. The Chinese take advice from their elders seriously: never spend beyond your means.

High down payments and low loan default rates have enabled China's banks to keep their troubled mortgage assets under control. Troubled mortgage loans in the Industrial and Commercial Bank of China, the nation's biggest bank, stood at 1.84 percent in the first half of the year, according to Xinhua, China's official news agency.

Indeed, in China most bad loans come from government-guided lending to state-owned companies. By some aggressive estimates, bad loans could stand above an average of 20 percent in China's biggest four banks. But an implosion of big banks is also very unlikely. The government has already used its massive foreign reserves to help bail out bad loans for big banks. Allowing its banks to fail, which could create havoc in Chinese society and even endanger the ruling of the communist party, is the last thing the government wants to see.

Ammo for the financial system

Finally, a similar crisis won't happen in China because the country has a closed financial system and $1.8 trillion in foreign exchange reserves.

The 1997 Asian financial crisis didn't spread to China because the country maintained its fixed foreign exchange rate. It used its reserves to guarantee that speculators wouldn't succeed in betting that China would de-peg its currency.

Ten years later, China's foreign reserves, the biggest in the world, are giving the country more ammunition to fight a similar crisis. In fact, the country is facing a very different dilemma compared with that of most developed countries: a stronger currency instead of a weakening one, and foreign capital inflows instead of massive outflows.

So while China is not likely to see a similar financial crisis, the country has to fight a different set of challenges -- how to control inflation when foreign capital is flooding the country as foreign investors bet that the yuan will keep rising -- and how to maintain a robust exporting sector when the rest of the world is slowing.

But no matter what happens in China, a credit crunch probably won't be a concern.

In fact, the country has too much money, and it doesn't know how to spend the money in a more profitable way. The value of China's holdings of U.S. bonds is declining, and its initial attempt to direct investments to foreign equities, such as BlackStone, has been a total failure.

U.S. Treasury Secretary Henry Paulson, who is set to look for buyers for the new $700 billion debt, should approach China before that country finds something better to do with its money.

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