Investors have been on a hair trigger for any hints of weakness in China's property sector even as housing prices continue to climb at double-digit rates.
On Feb. 24, shares of major property developers dropped sharply following reports that two major state-controlled banks had stopped issuing real estate loans due to credit risks.
The scare started after Shanghai Securities News reported that China's Industrial Bank Co. and other lenders "may have stopped extending loans to property developers," according to Reuters.
Reports also cited an internal memo to Bank of Communications branches, ordering a suspension of real estate lending, the official English-language China Daily said.
The banks issued denials, but the market reaction had already begun.
Major stock indexes in Shanghai and Shenzhen fell by some 4 percent over a two-day period, while shares in the nation's leading developer China Vanke slid 8.2 percent.
Confidence was also shaken by reports that a developer had offered deep discounts for unsold apartments in Hangzhou, the capital of eastern Zhejiang province, sparking protests from angry residents who had invested at the full price.
The news raised alarms among analysts, who have been on guard for signs that the long runup in real estate prices has finally peaked.
"Property prices are at a high level, and the industry may enter a correction period," said West China Securities analyst Wei Wei in comments cited by Bloomberg News.
"Given the fact that the property industry is a pillar of China's economy, growth will lose steam once the industry suffers. That's also bad for global growth," Wei said.
In the days that followed, state media veered between warnings and reassurances.
"Many are pessimistic about the industry and some even speculate that the country's property market is heading for a crash," said the official Xinhua news agency on Feb. 26, quoting Vanke founder Wang Shi as saying that "the situation is bad."
But in another report on the same day, Xinhua said it had received assurances from all of the state's "Big Four" banks that there had been no change in loan policies, "helping [to] calm the somewhat panicking property and stock markets."
In a separate commentary, Xinhua also tried to dispel concerns about slowing economic growth that "aroused concerns and market jitters," arguing that "doomsters" have "over-estimated the risks while focusing their attention on digits."
The market scare coincided with mixed reports on housing prices, which the government has been struggling to keep from rising too fast.
On Feb. 24, the National Bureau of Statistics (NBS) reported that new home prices in January rose in 62 of 70 major cities from December.
The result was seen as a "cooling" in the property sector because prices fell in 6 cities, compared with only two a month before.
But the evidence of a downturn was almost infinitesimal, with an average monthly price increase of 0.49 percent compared with 0.51 percent in December.
In a 100-city survey by the China Index Academy, prices rose 0.54 percent in February compared with 0.63 percent a month before.
But on an annual basis, new home prices have jumped 18.8 percent in Beijing and 20.9 percent in Shanghai, China Daily reported.
In yet another commentary on Feb. 26, Xinhua said "predictions of an imminent property bubble burst and economic crash are premature."
Since taking power last March, China's new leaders have tried to slow property price hikes, which have made housing unaffordable for millions moving to cities under the country's urbanization drive.
In his work report to the National People's Congress on March 5, Premier Li Keqiang cited housing as one of the "many problems which people are unhappy about."
Despite reports of cooling in the market, China Daily complained on Feb. 21 that the rules on property speculation issued by the State Council, or cabinet, a year ago "fail to quench home fever."
Pilot programs in Shanghai and Chongqing to impose property taxes on larger and more expensive apartments to curb speculation had produced "meager results," the paper said on Feb. 19.
Financial reform 'essential'
The slew of contrasting reports in state media point to the importance of the property issue to China's economy, while also suggesting extreme sensitivity and conflicting expectations.
Markets appear poised to overreact if housing prices keep rising and also if they do not.
But the stakes for China's economy are high, since many developers have turned to the vast and unregulated "shadow banking" sector for high-interest loans.
Shadow banking also supports development-linked industries like steel and cement, which are on a tight leash for traditional bank loans because of the government's campaign to cut industrial overcapacity.
The connections may explain why China's markets have been so twitchy over reports of possible tremors.
Harvard University economics professor Dale Jorgenson sees the volatility as part of the mix between short-term and long-term issues related to real estate development.
"There are certain areas where there's already evidence of excess supply, but in major cities like Beijing and Shanghai, it's pretty clear that there's still excess demand," Jorgenson said.
The speculative market is motivated by the price increases that the government is trying to control, creating a volatile environment. Those with household wealth to invest in multiple residences may be swept along on an increasingly bumpy ride.
"I think that underlines the fact that some kind of financial reform is essential," said Jorgenson. "People have to have alternative investment vehicles."
Chinese families are heavily invested in home values, making them sensitive to fears of a decline, said a study by Southwestern University of Finance and Economics in Chengdu, the capital of southwestern Sichuan province.
The study found that China's households have 66 percent of their assets in their homes, The New York Times said.
Savers in traditional banks get little or no return, driving them into property investment. Shadow banks have offered high-yielding instruments, but demand has outstripped the supply, keeping the focus on property and upward pressure on prices.
In his work report, Premier Li vowed to "curb demand for housing for speculation and investment purposes," suggesting new moves to dampen prices may be in the works.
But Jorgenson sees the potential of risk to the financial sector as overblown.
"As to whether there's going to be some kind of grand collapse that will wipe out the financial sector, that's not a realistic possibility," he said.
One reason is that much of shadow banking is only unregulated financing through alternate windows of the mainstream banking system.
In a pinch, investors are betting that the big banks or the Ministry of Finance would step in to keep defaults from spiraling out of control.
That assumption may have been tested last Friday after the government and state banks refused to bail out a heavily-indebted solar cell manufacturer as it defaulted on an interest payment for a 1-billion-yuan (U.S. $163-million) bond.
The missed payment by Shanghai Chaori Solar Energy Science & Technology Co. marked the first onshore bond default in China, raising questions about how far the government will go in making investors share risk.
"It's an important test to see the workout process and what losses will be incurred by domestic investors" Hans Stoter, chief investment officer at ING Investment Management Co., told Bloomberg. But Stoter said he expects "limited spillover effects."
It is unclear whether the tougher stance toward the fledgling bond market will be reflected in credit policies for housing developers, but state banks are still seen as well-prepared to backstop the financial system.
"The Big Four banks supply the funds ultimately that go through the shadow banking system, including investments by developers in real estate projects," said Jorgenson.
"The question is what kind of shape are the banks in? The answer is the banks are in unbelievably great shape," he said.
The big gap between decontrolled lending rates and controlled deposit rates has made the banks "very, very strong," said Jorgenson, calling China's system "a license to print money."
In December, the former chief economist of the National Bureau of Statistics (NBS) made a now-famous comment on the ease with which the banks have enriched themselves.
"With this kind of operational model, banks will continue making money even if all the bank presidents go home to sleep and you replaced them by putting a small dog in their seats," said Yao Jingyuan, as quoted by the South China Morning Post.
Such a system may reduce the risk of defaults on runaway development from spreading through the financial system and the economy, but it may also provide little relief from price hikes that have made homes unaffordable for would-be buyers.