Chinese Housing Crash Threatens the Economy

Shanghai and Hangzhou are a long way from Detroit and Phoenix, but all suffer from the same trouble: plummeting housing prices. The Chinese cities are offering all manner of perks to try to boost their markets—larger loan limits, help with closing costs and property taxes, extended repayment periods and even guaranteed local residency permits for buyers migrating from the hinterland. None of it is working. Analysts say most potential buyers expect prices to drop 20 to 30 percent in coming months.

Officially, housing prices in China have barely ticked downward nationwide. Anecdotally, however, prices are plummeting in many cities, and year-on-year sales volumes have fallen as much as 60 percent from their peaks in some markets. The crash—a word that's gaining currency among analysts who follow China's real-estate sector—bodes ill for the broader economy at a time when Beijing hopes to ramp up domestic demand. That's because, much as in America, housing in China sets the tone for the economy. It drives industrial outputs like steel, and largely determines final consumption of appliances, furniture and cars. "Everything moves hand in hand," says Scott Laprise, an analyst for CLSA based in Shanghai. "First people buy the home, then they fill it, then they get a car for the garage."

Two crucial sectors already slowing are autos and steel. Laprise calculates that steel rebar and girders for the construction industry compose about 65 percent of China's annual steel output, with much of the rest going to make autos, appliances or electronics. Even factoring in post-earthquake reconstruction in Sichuan and massive new infrastructure initiatives believed to be on the government's drawing board in Beijing, he forecasts that growth in steel consumption and auto sales will descend into the single digits next year, down from double digits this year, even if China's GDP stays above the critical 8 percent growth threshold for a soft landing—a feat by no means guaranteed.

New bankruptcies, higher unemployment and more pressure on profit margins seem unavoidable. Consider as an example FerroChina, an average-size steelmaker. Like most companies in China, it was thriving until very recently. In August it reported that net profits for the second quarter had tripled from a year earlier to $35 million. Then on Oct. 9, it shocked investors by announcing that "due to the current crisis" it was unable to pay $104 million in loans and was seeking outside capital to survive. As a supplier of steel sheets to building contractors, it looked like a sudden victim of the housing slump—and perhaps not the last. "This could be a sign of things to happen," says Kan Shik Lum, head of Equity Capital Markets for Singaporean banking giant DBS. "For others who are subject to similar strains, the cracks may emerge."

China's export sector faces obvious headwind in a global economy lurching toward recession. At home, however, consumption is what matters most. Last week the China Association for Automotive Manufacturers revealed that car sales declined for a second straight month in September, compared with a jump of 17 percent in the first half of the year and 23 percent in 2007. Durable-goods sales, too, are weakening. Consensus forecasts now see GDP growth slowing from more than 10 percent to a pace closer to 8 percent.

Which puts China in a familiar trap. Its slowdown looks set to continue until the housing market finds a bottom. The good news: unlike the United States, where millions of families are saddled with more home than they can afford, demand for better housing remains strong across China even if buyers are now on the sideline awaiting better deals. At issue is how long the market correction might take and what lower home prices would mean for the hundreds of steel-sheet, appliance and car manufacturers with products tethered to the housing market. Laprise says the correction could be brutal, and he cites the example of cars. "In terms of the world market, 7 percent growth isn't bad at all," he says, "but the Chinese auto industry is geared for 30 percent growth, [so] the slowdown is a massive problem." Of the hundred or so car companies currently in production in China, he expects as many as 85 will disappear by 2015. There's only one way to describe that: a pileup.