“Contagion” is the four-dollar term economists use to describe what happens when a calamity in one market or economic sector drags down other markets or sectors—a process also known to many as “stuff” rolling down hill.

China has become a textbook example of contagion as the real estate crisis that largely began with Evergrande’s serial defaults has now spread to a full on debt/mortgage/banking crisis, a factory output crisis, and an industrial crisis.

The most visible sign of contagion is the collapse in July of home sales.

Sales at the country’s top 100 property developers fell 39.7% in July from the same period last year to the equivalent of $77.6 billion, or 523.14 billion yuan, according to data released Sunday by CRIC, a Chinese real-estate data provider.

July sales were down 28.6% from June, ending a two-month recovery in month-to-month sales growth. Apartment sales showed increases in May and June from the previous months, as activity picked up following Covid lockdowns in Shanghai and other Chinese cities earlier this year.

A 40% drop year-on-year and a nearly 30% drop month-on-month is no minor correction. This is a correction on the order of the US housing bubble collapse between 2005 and 2010—a true collapse of Chinese residential real estate.

Mortgage Boycott Fueling Banking Crisis

The drop in home sales represents the second part of a double-whammy for China’s banking sector. The drop in home sales equates to a drop in mortgage lending by banks and financial institutions—while at the same time the mortgage boycott that is catalyzing the sales decline is adding default stresses to those same banks. With approximatel 38 trillion yuan in outstanding mortgage debt, already some 2.4 trillion yuan of that amount is at risk of default due to the boycotts, and the amount of exposure grows as the boycott movement spreads.

In a worst-case scenario, S&P Global Ratings estimated that S$492 billion, or 6.4 per cent of mortgages, are at risk while Deutsche Bank AG is warning that at least 7 per cent of home loans are in danger.

So far, listed banks have reported just 2.1 billion yuan in delinquent mortgages as directly affected by the boycotts.

To illustrate the magnitude of the banking problem, with just a 10% drop in real estate investment, banks face a loss of 17% of their earnings.

A 10 percentage-point slowdown in real estate investment growth translates into a 28 basis-point increase in overall bad loans, meaning a 17 per cent decline in their 2022 earnings, Citigroup analysts led by Judy Zhang estimated in a July 19 report.

Unless there is a quick rebound in home sales, the banks are facing an earnings drop multiple times that 17% figure—furthering the parallels with the 2008 financial crisis here in the US.