China Bank Stress Test: Looking For The Next Las Vegas

August 5, 2010 by Douglas A. McIntyre

The Chinese government has taken the extraordinary action of testing some of its banks for the effects of property value drops of 50% to 60% in some regions. Previous tests assumed a 30% drop in the same areas of the world’s most populous nation.

The Economist writes “Expectations seem to be for a sharp decline in Chinese property prices over the next two years, with some, and perhaps significant, impact on Chinese banks.”

The idea that the banks could face such a huge drop in property values on which they hold loans seems extreme, unless China has learned the lesson of Las Vegas.

The value of real estate in the US gambling capital has dropped as much as 70%. Cities in Florida, California, and Michigan have had similar real estate problems. These are usually in areas with high unemployment like Merced, Calif., Flint, Mich. and Vero Beach, Fla., where the jobless rates are worse than 15%.

The trigger for a precipitous drop in real estate values in China will likely be because of events which are different from those in the US.  China appears to be able to keep its unemployment in check primarily because so many of the nation’s businesses are state-owned or state-controlled. China’s main problem of property value inflation is due to  the torrent of liquidity it launched into its economy when its 2008 stimulus package rose to $585 billion. The capital probably prevented a sharp drop in GDP. The side effect was likely to have been profligate loan practices at Chinese banks. This easy money in turn caused speculation in the housing and equities markets.

It is hard to imagine that real estate values could drop by 60% in any developed nation  —  that is until the situation in Las Vegas is considered.

Douglas A. McIntyre

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