Is China stumbling into its own mortgage crisis?

It is spreading like wildfire. Homebuyers in China are refusing to pay the mortgage on properties they've bought but that their financially strapped developers can't finish. Some say that they will only resume payments when construction restarts.

The protest involved more than 100 delayed projects as of 13 July , up from 58 projects just one day earlier. The frustrated buyers accuse the developers of misusing sales proceeds and the banks of failing to safeguard their loans.

China has never seen anything like this. As in the US — until the 2007 subprime crisis — the possibility of troubles in the mortgage market was vanishingly small. 

But this mortgage strike isn't entirely unpredictable. Homebuyers have every reason to be angry. Most of the projects were begun by developers who have defaulted. China Evergrande Group led the pack, accounting for an estimated 35% of the total projects that faced mortgage revolts, data compiled by CLSA shows. One such project in eastern Jiangsu province was launched before the Covid-19 pandemic. Construction has been suspended since last August, while property values in its neighborhood has come down by about 10%.

In other words, not only did the affected households see their wealth dip, they can't move in and enjoy their new apartments either. Over the years, with consent of local governments, the likes of Evergrande and Country Garden Holdings Co. fed the residential housing boom through a so-called pre-sales model: Apartments are bought long before they are completed. Now the builders don't have money to finish these projects.

Granted, developers' debt woes were met with protests in the past, from suppliers, employees, all the way to hapless retail investors who had bought their wealth-management offerings. But this new development is something entirely different. It opens a Pandora's box and poses direct threat to the stability of Chinese banks. The Ministry of Housing and Urban-Rural Development met with financial regulators and major  banks this week to discuss the mortgage boycotts, Bloomberg News reported Thursday.

Unless President Xi Jinping's government stops this stampede, a collapse of the banking system on the scale of Lehman Brothers Holdings in 2008 is very much in the cards. China is unprepared for such a big chunk of its bank loans to go sour.  

According to Autonomous Research, banks have about 62 trillion yuan ($9.2 trillion) of exposure to the property sector. More than half is in the form of mortgage loans. At China Construction Bank Corp., one of the world's largest banks, mortgages account for more than 20% of its total assets.

Until this week, China's middle class were excellent customers, dutifully paying their monthly bills. The government's social credit system — a national credit rating and borrowing blacklist — has worked well; bad credit can even hamper one's ability to take high-speed rails. But what if some are just fed up and willing to walk away from their obligations? 

Prime Customers
Chinese banks' property sector exposure is mostly through mortgage loans.

We're not talking about one or two delinquent developers. In the past year, 28 of the top 100 developers have defaulted or asked their debtholders for extensions, data compiled by CLSA shows. Collectively, they account for about 20% of China's total property sales. Money is even tighter now. In the first half, property sales plummeted 72% from a year ago, further eroding their cash flow.

A CLSA monthly survey on the current status of Evergrande projects gives us a glimpse of how many unfinished sites there are across China. As of June, over half of Evergrande's projects were under construction halts. The broker reckons that about 840 billion yuan in mortgages are tied to abandoned sites across China.

It is worth asking how we even managed to get to this point, especially for a government that is obsessed with stability.

All we have seen is policy inertia. Developers have been in distress for more than a year now, but there has been no progress in restructuring their finances. Local officials have been unwilling to make difficult decisions, write off bad debt and reach resolutions. Unable to shed financial burdens, builders can't focus on operations. They become zombies, and their construction sites turn into ghost towns.

In 2008, I worked at Lehman Brothers in New York and witnessed first-hand how the subprime mortgage crisis dragged down the venerable bank — and threatened the entire industry. This environment is starting to feel eerily similar. 

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. A former investment banker, she was a markets reporter for Barron's. She is a CFA charterholder. @shuli_ren

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.