A collapse in housing prices could have a harsh effect on the economy, given that 80 percent of urban homes are owned by private citizens. The value of housing loans awarded in China stands at nearly $450 billion so far this year.

Yi Xianrong, a finance and banking researcher at the Chinese Academy of Social Sciences, a government-affiliated research institute, worries that China's subprime mortgage problem is worse than that in the United States because banking laws are still being written and a credit rating system doesn't exist.

"Both good and bad consumers can get into the real estate market. Many buyers are investors, using forged documents to get money from banks to speculate on the domestic real estate market," Yi said.

In China, mortgages are not pooled and securitized as they are in the United States. That's both good and bad. While it means that the risk is isolated to the lending institutions, banks are the sole source of financing for the vast majority of Chinese corporations. If many people begin defaulting on their mortgages, the banks may have to scale back their lending, which could cripple growth, or may have to ask for a government bailout, which may lead to inflation.

Until recently, gambling in the real estate market was a popular pastime in Shenzhen, the southern city where China's foray into capitalism began.

Once just occupied by fisherman, Shenzhen was designated a special economic development zone by the Chinese government in 1980. Attracted by the tax breaks, cheap labor and lax environmental controls, companies and people flooded in. The experiment was such a success that China began opening up the rest of its economy.

Today, Shenzhen and its sister, Dongguan, are the richest cities in China. Factories churn out everything from glass panels to toys. Wal-Mart Stores, which sends $18 billion of Chinese goods to the United States each year, maintains its purchasing headquarters here.

By January of this year, new home sales reached the dizzying rate of more than 300 per day, according to the Shenzhen Municipal Bureau of Land Resources and Housing. In Wan Qu, or the Bay Area, a trendy neighborhood next to a bay that overlooks Hong Kong, two-bedroom apartments were being bid up to well over $1 million.

Thanks to lax lending policies by state banks, investors had been able to get low-interest mortgages for second or even third homes with zero down. While China officially requires home buyers to pay 20 to 30 percent of the price of a new home up front, real estate agencies said contracts were manipulated to erase any need for the purchaser to put any money down.

Investors regularly bought and flipped new properties. Liao Kai, 29, a senior manager at World Union Property, describes the real estate market as akin to the stock market, with investors often making decisions that defy logic. "If it's popular, everyone wants in," Kai said. "If it's not, no one wants it."

In August, the price of newly built houses in Shenzhen had jumped 17.6 percent from the same period a year earlier, beating price increases in Shanghai and Beijing. The average year-to-year increase nationwide was 9.9 percent in 70 major Chinese cities surveyed by China's National Development and Reform Commission.

But at the end of this summer, many of China's state-owned banks, a legacy of a command-and-control economy, abruptly stopped issuing new loans, stating they had surpassed their quotas. For the few banks still offering loans, the government increased interest rates and down-payment requirements for second homes. Police raided a number of black-market banks that had been used to finance speculation in the property market, cutting off a major source of financing.

By October, daily sales in Shenzhen had dropped as much as 80 percent, to as few as 60 a day. The slowdown was reflected in the falling stocks of publicly listed real estate developers like China Vanke and Poly Real Estate Group.

Kai estimates that at many of the new properties in Wan Qu the vacancy rate is 30 to 40 percent.

Still, he says, repeating government officials' mantra about the tightening measures: "I'm not even a little worried. This is the first time we've experienced such a market correction. It's just like the stock market. Without dropping, how can it recover stronger?"

"It makes the market more orderly," agreed Chen Peng, 25, an agent with Shihua Real Estate. His monthly salary, which is based on commissions, has dropped from about $7,000 to $1,000 from August to September, but he remains optimistic that the tightening measures will be good for the economy in the long term.

Real estate agencies in Shenzhen have resorted to sending fleets of agents to the street with signs to try to encourage people to buy. Xiao Fan, 24, and his friend Li Gang, 31, often stand outside for eight hours at a time. Their sign says: "Shenzhen-Hong Kong Properties -- Already Constructed -- Inquires Welcome." In recent years, the property market had been so hot that units were purchased before they were built.

The dramatic effect of the new government policies on the real estate market in Shenzhen and other large cities like Shanghai and Beijing, however, may be the exception to an economy that continues to grow at a blistering pace.

In China overall, "tightening measures did not stop the surge of broad money supply in September, which could mean mounting macro risk in the economy," Huang Yiping, an analyst with Citigroup in Hong Kong, wrote in a report last week. "It could add fuel to the already high asset prices in both the property market and equity market."

But Peking University's Huo warns that this isn't nearly the end of the government's readjustment of macroeconomic policies.

"China is learning to be a big country," Huo said. Stakeholders should take heart, however, in that while "many policies made by the Chinese government are not in accordance with textbooks, its performance is not bad on the whole."

http://www.washingtonpost.com/wp-dyn/content/article/2007/10/17/AR2007101702217_2.html