Real Estate Development and Financial Crises

This report represents an international, comparative, empirical study of the relationship between financial crises and real estate development—with a focus on Japan, Hong Kong, the U.S., some OECD countries, and China. It mainly consists of two parts of analysis: qualitative and quantitative. In the qualitative analysis, we focus on an international comparative study and particularly look at the way nine variables related to real estate and financial sector development change during a crisis, and the way real estate crises develop into financial crises (considering that most recent financial crises actually trace their origins to real estate bubbles). We summarize the similarities and differences in major crises around the world from 1980 to 2013, demonstrating the linkages between real estate bubbles and financial crises. We also look at China’s current economic situation and identify potential threats to the country’s economic development by comparing its current situation with other countries’ historical experiences. We further explore the deep-seated underlying Chinese systemic causes and characteristics that explain why China’s economic bubble has yet to burst. Historical heights in nine variables in particular, used to predict economic bubbles, foretell an upcoming burst in China’s bubble economy. Our findings of qualitative analysis suggest that a financial crisis often emerges from a weak financial system which is too closely linked to the country’s real estate sector. These linkages allow real estate crises to mushroom into financial crises. In turn, these financial crises balloon into macroeconomic crises. China’s current situation is extremely alarming, though the country shows remarkable resilience to crisis. The government seems to possess the tools and capacity to avoid a hard landing. We particularly draw parallels between modern-day China and the pre-asset bubble period in Japan. These two experiences resemble each other in many ways—and such resemblance should sound a clear warning to China’s policymakers.

In the quantitative study, which is part of a larger qualitative study, we further intended to devise a model which would allow economists and policymakers to predict the collapse of a real estate and financial asset price bubble. We developed a stock-flow model in the first of the report for the qualitative overview of the Chinese property markets and financial markets which could predict the onset of a macroeconomic crisis. We found the impact of exogenous changes in property prices to changes in Chinese GDP from our quantitative modelling—and showed that roughly a 30 percent drop in property prices would cause recession in China.