The US sub-prime mortgage crisis which started from August 2007 has been transformed into a worldwide financial turmoil. The slump in housing prices increased the default on mortgages, the negative effect further amplified by asset securitization. Not only were the US banks suffered, nearly all financial institutions around the world were affected because of their investments in Mortgage Backed Securities (MBS). The US Federal Reserves responded swiftly to rescue the market through cutting interest rates and extending financial support to house buyers and mortgage lenders.
The most dramatic action taken by the US government was the takeover of Fannie Mae and Freddie Mac, two of the most powerful mortgage companies in the US, announced by the Bush administration on 8 September 2008. This move is designed to forestall a collapse in house prices that could plunge America into a new Great Depression and trigger chaos on the world’s financial markets (The Independence, 8 September 2008). Fannie Mae and Freddie Mac together are responsible for half for the US mortgage market which is worth over $10 trillion. The seizure of these two companies puts a federal guarantee behind a $5 trillion of outstanding mortgage debt.
In contrast to the rather nervous reaction in the US, the UK and other G7 economies have taken a rather cautious approach by keeping the interest rates more or less unchanged in fear of inflation pressure caused by high oil and food prices. China’s response has been relatively calm; although Chinese share prices have plummeted by almost 70% within a year after reached its peak of 6124 in October 2007.
According to Goldman Sachs, the Bank of China (BOC) was widely exposed to the US sub-prime securities which might generate huge losses (Chen, 2007). However, BOC’s annual reports have showed impressive improvement in its profits. As China’s financial sector becomes more integrated into the world economy, there is increasingly interest in understanding the influence of the US housing crisis on the Chinese banks and its wider economy. To what extent is the Chinese banking sector exposed to the US sub-prime mortgage market? Might such an exposure spillover into China’s financial sector? With the rapid growth in the market for domestic mortgages, is it possible for China to experience a similar housing mortgage crisis in the future?.
This paper aims to answer these questions. The rest of this paper is organized as follows. Section 2 will outline the background of the US sub-prime mortgage crisis and its impact on the US and the world economy. Section 3 will focus on China, analyzing its banks’ exposure to the US sub-prime securities and discuss how such an exposure may affect its economy. Section 4 will assess the possibility of whether China might experience such a crisis. Sections 5 will draw conclusions and discuss policy implications.
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