Unlike the rescued Fannie Mae and Freddie Mac, sound liquidity means China’s property market doesn’t need life support.
By Hu Shuli - Caijing Magazine 17 September 2008
The U.S. Treasury Department finally stepped in September 7 and took over Fannie Mae and Freddie Mac, the country’s government-sponsored mortgage companies.
It was the largest government rescue operation of its kind since the Great Depression of the 1930s, and could cost an eye-popping US$ 200 billion. In addition, the decision was a policy move with a lot of implications for China, which holds Fannie and Freddie mortgage bonds worth hundreds of billions of yuan. It is comforting to know China’s rights are protected.
Meanwhile, the U.S. bailout has inspired fantasies among some in China who look to this U.S. experience as an example. They wonder whether similar help should be extended to the Chinese property market, which has its share of troubles. They also wonder how such a rescue could be executed.
Here, correctly reading and understanding the U.S. bailout is paramount. To be sure, the bailout has been endorsed by many observers. Fannie and Freddie, although not state-owned, are financial institutions backed by the government that provide loans for the bulk of the U.S. housing market. Their health can affect the stability of the U.S. and global financial markets. Without the latest bailout, a subsequent financial meltdown could have triggered a crisis more serious than the Asian financial storm of 1997.
Fannie and Freddie hold a combined US$ 5 trillion worth of mortgages, or 42 percent of all housing loans. Of the bonds they’ve issued, more than US$ 3 trillion worth are held by U.S. financial institutions and US$ 1.5 trillion are controlled by foreign institutions, mainly central banks. If Fannie and Freddie tank, the financial fallout would spread rapidly. Not only would U.S. institutions fall victim to systemic risk, but foreign investors also would face huge losses. Very likely, such an event would affect global capital flow, causing the U.S. dollar to lose value and triggering a currency crisis. If this dire scenario for the U.S. financial market and the dollar plays out, the devastation would dwarf any regional financial crash of the past.
The bailout will bring relief to the hard-pressed U.S. housing market. Analysts expect mortgage rates to ease slightly and offset the pain caused by sliding property values. However, Treasury has repeatedly said the decision was not a market intervention move but a macroeconomic policy step. There is no evidence that the government intends to boost the housing market, which is cyclical. Excessive leveraging on the U.S. market in recent years pushed risks over the limit. But since a bubble burst could have catastrophic consequences, the government decided to put Fannie and Freddie on life support. The next step could involve buying mortgage securities. These are desperate steps with very high costs.
Quite obviously, the U.S. bailout has nothing in common with a wished-for shoring up of the Chinese property market. The Chinese financial situation is relatively stable. There are no signs that property market risks are spreading to other institutions. Residential housing loans account for a low percentage of financial assets. Loans to property developers are limited. Even if some become non-performing loans, the system would not be imperilled.
Moreover, housing loans in China are structurally sound, which underscores the importance of risk prevention over remedial action. Currently, Chinese mortgages are concentrated in large and mid-sized cities in coastal regions where housing demand is high. Chinese people customarily live within their means and, in fact, mortgages contribute to economic stability. If capital costs are too low and housing prices rise too fast, investment demand will crowd out effective demand and turn housing into a purely speculative vehicle. Speculative investments rely more on leverage (and, to be sure, leveraging tools are still limited in China), and the magnified risk will lead to worrying consequences. Thus, it is necessary to use appropriate macroeconomic policies to dampen speculation.
Technically, the bailout of Fannie and Freddie focuses on market liquidity, which should also guide China’s macroeconomic fine-tuning. At the end June, household savings totalled 19.8 trillion yuan, up 14.6 percent year-on-year. The rate of savings growth rose 5.1 percent. In the first half of the year, 2.2 trillion yuan was added to savings accounts, compared to 1.4 trillion yuan in the same period last year. Term deposits rose by 1.5 trillion yuan.
Bank deposits are a key source of liquidity for China’s financial system, while medium- and long-term credit turnover is relatively low. The numbers for the first half of 2008 suggest household savings pumped into the system more than four times the 460.2 billion yuan borrowed from banks. In view of this ample liquidity, the central government and central bank have neither reason nor need to rescue the housing market by easing credit or any other means.
Symptoms of the ailments facing the U.S. financial system may improve in the wake of the bailout of Fannie and Freddie. But it remains to be seen whether the move will have long-term effects. And the rescue itself comes at great cost, such as tangible costs for taxpayers and intangible moral hazards.
For China, lessons can be learned. For example, it’s apparent now that some macroeconomic policies concentrate financial risks, and that institutional formation of government-sponsored housing enterprises can carry hidden risks. These are lessons to keep in mind while we watch the bailout process unfold.
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The Mortgage Bailout That Doesn’t Apply
Unlike the rescued Fannie Mae and Freddie Mac, sound liquidity means China’s property market doesn’t need life support.
By Hu Shuli - Caijing Magazine
17 September 2008
The U.S. Treasury Department finally stepped in September 7 and took over Fannie Mae and Freddie Mac, the country’s government-sponsored mortgage companies.
It was the largest government rescue operation of its kind since the Great Depression of the 1930s, and could cost an eye-popping US$ 200 billion. In addition, the decision was a policy move with a lot of implications for China, which holds Fannie and Freddie mortgage bonds worth hundreds of billions of yuan. It is comforting to know China’s rights are protected.
Meanwhile, the U.S. bailout has inspired fantasies among some in China who look to this U.S. experience as an example. They wonder whether similar help should be extended to the Chinese property market, which has its share of troubles. They also wonder how such a rescue could be executed.
Here, correctly reading and understanding the U.S. bailout is paramount. To be sure, the bailout has been endorsed by many observers. Fannie and Freddie, although not state-owned, are financial institutions backed by the government that provide loans for the bulk of the U.S. housing market. Their health can affect the stability of the U.S. and global financial markets. Without the latest bailout, a subsequent financial meltdown could have triggered a crisis more serious than the Asian financial storm of 1997.
Fannie and Freddie hold a combined US$ 5 trillion worth of mortgages, or 42 percent of all housing loans. Of the bonds they’ve issued, more than US$ 3 trillion worth are held by U.S. financial institutions and US$ 1.5 trillion are controlled by foreign institutions, mainly central banks. If Fannie and Freddie tank, the financial fallout would spread rapidly. Not only would U.S. institutions fall victim to systemic risk, but foreign investors also would face huge losses. Very likely, such an event would affect global capital flow, causing the U.S. dollar to lose value and triggering a currency crisis. If this dire scenario for the U.S. financial market and the dollar plays out, the devastation would dwarf any regional financial crash of the past.
The bailout will bring relief to the hard-pressed U.S. housing market. Analysts expect mortgage rates to ease slightly and offset the pain caused by sliding property values. However, Treasury has repeatedly said the decision was not a market intervention move but a macroeconomic policy step. There is no evidence that the government intends to boost the housing market, which is cyclical. Excessive leveraging on the U.S. market in recent years pushed risks over the limit. But since a bubble burst could have catastrophic consequences, the government decided to put Fannie and Freddie on life support. The next step could involve buying mortgage securities. These are desperate steps with very high costs.
Quite obviously, the U.S. bailout has nothing in common with a wished-for shoring up of the Chinese property market. The Chinese financial situation is relatively stable. There are no signs that property market risks are spreading to other institutions. Residential housing loans account for a low percentage of financial assets. Loans to property developers are limited. Even if some become non-performing loans, the system would not be imperilled.
Moreover, housing loans in China are structurally sound, which underscores the importance of risk prevention over remedial action. Currently, Chinese mortgages are concentrated in large and mid-sized cities in coastal regions where housing demand is high. Chinese people customarily live within their means and, in fact, mortgages contribute to economic stability. If capital costs are too low and housing prices rise too fast, investment demand will crowd out effective demand and turn housing into a purely speculative vehicle. Speculative investments rely more on leverage (and, to be sure, leveraging tools are still limited in China), and the magnified risk will lead to worrying consequences. Thus, it is necessary to use appropriate macroeconomic policies to dampen speculation.
Technically, the bailout of Fannie and Freddie focuses on market liquidity, which should also guide China’s macroeconomic fine-tuning. At the end June, household savings totalled 19.8 trillion yuan, up 14.6 percent year-on-year. The rate of savings growth rose 5.1 percent. In the first half of the year, 2.2 trillion yuan was added to savings accounts, compared to 1.4 trillion yuan in the same period last year. Term deposits rose by 1.5 trillion yuan.
Bank deposits are a key source of liquidity for China’s financial system, while medium- and long-term credit turnover is relatively low. The numbers for the first half of 2008 suggest household savings pumped into the system more than four times the 460.2 billion yuan borrowed from banks. In view of this ample liquidity, the central government and central bank have neither reason nor need to rescue the housing market by easing credit or any other means.
Symptoms of the ailments facing the U.S. financial system may improve in the wake of the bailout of Fannie and Freddie. But it remains to be seen whether the move will have long-term effects. And the rescue itself comes at great cost, such as tangible costs for taxpayers and intangible moral hazards.
For China, lessons can be learned. For example, it’s apparent now that some macroeconomic policies concentrate financial risks, and that institutional formation of government-sponsored housing enterprises can carry hidden risks. These are lessons to keep in mind while we watch the bailout process unfold.
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