[Global Finance History] China's Real Estate Crisis Resembling the '2008 US Mortgage Crisis'

US Federal Policy Fully Supports Home Ownership
No Borrower Suitability or Property Value Checks
Bank Failures from Defaults Trigger Global Economic Collapse

China's real estate crisis in 2023 is becoming increasingly serious. The crisis in China resembles the 2008 subprime mortgage crisis in the United States. It is a moment to implement proper policies based on historical experience.

Throughout 2008, signals of a severe financial crisis were steadily flashing. The phrase "since the Great Depression" appeared twice as often in the New York Times during the first eight months of that year. On September 15, the catastrophe finally erupted and was dramatically revealed to the public. Hundreds of stunned Lehman Brothers employees poured out onto Manhattan's 7th Avenue. They struggled to explain the shocking situation to the gathering reporters. News of Lehman Brothers' bankruptcy quickly became the latest front-page headline. The investment bank, a bastion of Wall Street with a 158-year history, went bankrupt due to the subprime mortgage crisis that caused the real estate bubble.

At that time, policymakers in Washington were also at a loss about what went wrong and how to respond. Instead of analyzing the cause of the crisis, Treasury Secretary Henry Paulson simply stated, "The U.S. financial system can survive after the Lehman incident. We will not bail out risky financial firms." Then-President George W. Bush had little to say other than words of encouragement. The American financial system, corrupted by greed, was intricately intertwined globally, and the U.S. financial crisis ultimately triggered a worldwide economic collapse.

The biggest problem with the U.S. financial system at the time was that the American Dream was sold on too easy credit. The 2008 financial crisis began in the housing market, which had been a symbolic cornerstone of American prosperity for generations. Federal policy had fully supported the American Dream of homeownership since the 1930s when the U.S. government began supporting the mortgage market. After World War II, the GI Bill provided veterans with affordable home loans. Policymakers aimed to fill undeveloped land around cities with new homes, new homes with new appliances, and new driveways with new cars. They believed this would prevent a return to the pre-war depression. All these new purchases meant new jobs and security for the next generation.

It did not take long until the mortgage market exploded. According to the final report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, mortgage debt increased as much from 2001 to 2007 as all previous debt combined. Almost simultaneously, home prices doubled. Nationwide, mortgage salesmen emerged, rushing Americans to borrow more money for homes, even borrowing for future homes. Salesmen could make these deals without investigating the borrower's suitability or the property's value. Mortgages became increasingly risky investments.

Lenders continued to sell these mortgages. Bankers bundled them into securities and sold them to yield-hungry institutional investors. Mortgage owners were often thousands of miles away and unaware of what they had bought. They only knew that credit rating agencies said these were safe, as homes had always been since the Great Depression. Banks converted mortgages into securities and sold them like derivatives to increase returns. After the September 11, 2001 terrorist attacks, the Federal Reserve, the central bank, adopted low interest rates to avoid a recession. Since then, ordinary investments yielded little, so savers sought better returns. To meet this demand for higher yields, the U.S. financial sector developed securities backed by mortgage payments.

Credit rating agencies assigned high credit ratings equivalent to U.S. Treasury bonds to processed mortgage products. Financial institutions trusted decades-old data and trends. Americans had almost always paid their mortgage costs in the past, and banks relied on this data and trends. The problem was that U.S. laws and regulations had changed. The financial environment in the early 21st century resembled pre-Great Depression America more than post-Great Depression America. Strict banking regulations after the Great Depression gradually disappeared. President Franklin Roosevelt protected commercial banks and savers through the Federal Deposit Insurance Corporation (FDIC). Then, the 1933 Banking Act (Glass-Steagall Act) separated commercial and investment banks. However, in the late 1970s, politicians seeking to revitalize the stagnant economy pushed for deregulation. The Glass-Steagall Act's substantive provisions gradually vanished. The core provision separating commercial and investment banks was repealed by a 1999 law, and investment banks took on excessively risky investments. Congress also eased regulation of over-the-counter derivatives through the 2000 Commodity Futures Modernization Act.

Investment banks were able to make huge short-term profits by betting on the continuous rise in real estate values through bundled mortgages and others. They sold more debt than they could handle and even collateralized temporary assets. When defaults began, mortgage securities lost their AAA credit ratings, and banks went bankrupt.

In March 2008, the investment bank Bear Stearns was rescued from near collapse. The U.S. Treasury and the Fed brokered and partially funded JP Morgan Chase's acquisition deal. In September, the Treasury announced it would bail out government-supervised mortgage insurers. President George W. Bush was a conservative Republican who believed in the virtues of deregulation along with most of his appointees. However, when the crisis hit, Bush and his aides, especially Treasury Secretary Paulson and Fed Chairman Ben Bernanke, decided not to gamble by leaving the market free. Senator Jim Bunning of Kentucky called the bailout "a disaster for the free market system" and essentially "socialism."

Banks, mortgage lenders, and insurance companies suddenly became an unreliable financial system. A series of bankruptcies and mergers followed, and timid investors withdrew money from high-yield investments seeking safe havens. Fearful financial workers bought Treasury bonds with their liquid funds. After decades of trying to push the U.S. government out of banking, it turned out that the U.S. government was the only institution bankers trusted. The capital- and credit-starved economy staggered into a long recession.

Baek Youngran, Head of History Journal