Despite bouncing back today, Chinese stock markets have been in crisis and banks are warning that if efforts to put a floor under the market don’t stick then the turmoil could get as bad as the US crash in 2008 and the debt crisis in Europe in 2012.
The main Shanghai Composite collapsed over 30% in the last month, despite repeated attempts by the government to put a floor under prices. Most people believe Chinese stocks have been in a bubble for months, and now it is bursting.
Bank of America Merrill Lynch (BAML) warned in a note to clients on Thursday that China’s falling markets could escalate into a full-blow financial crisis on the scale of the US subprime mortgage disaster of 2008, saying:
If the market continues to fall sharply, stock lending related losses could run into Rmb trillions, of which, banks and brokers may have to bear a meaningful share. These potential losses can be especially dangerous to brokers whose capital base is less than Rmb 1 trillion. Even more important, the opaqueness of China’s financial system and the lack of clear definition of risk responsibility mean that contagion risk is high, similar to the subprime crisis.
Credit Suisse echoed this warning in a note sent to clients Wednesday, saying China’s central bank, the People’s Bank of China, must copy the US Federal Reserve and the European Central Bank and do “whatever it takes” to stop share prices collapsing
The bank says the market slump could put a halt to rising consumer sales but just like BAML, Credit Suisse’s biggest worry is the effect it could have on the country’s financial sector.
On top of a brewing financial crisis, Credit Suisse say that if the People’s Bank of China can’t stop the slump the country risks a breakdown in “social stability.” The Chinese government strenuously puts down social rebellions inside its borders, and public protests are rare. So if the collapse in stocks morphs into some kind of larger breakdown, it’s unlikely to be pretty.
Analyst Dong Tao and his team say:
China has one of the world’s highest retail investor participation rates in the equity market. With the drastic fall in share prices recently, we think social stability is clearly at stake.
China’s stock market crash has been caused by the millions of ordinary Chinese who have invested in the stock market by borrowing more money than they have to invest in stocks. When share prices dipped, brokerages asked them for more cash to cover losses. The investors then sell sales to raise cash to meet this “margin call”, but the wealth of sellers pushes down prices.
It’s bad enough for the government that millions of ordinary Chinese citizens are losing money, but Credit Suisse also points to anecdotal evidence of some wild west market activity that could really undermine “social stability.”
Here’s Tao: “Some companies and shareholders of companies mortgaged their shares to leverage up to invest in the stock market. Some homeowners mortgaged their house to invest in stocks.”
That could lead to home repossessions, just like we saw in the US after 2008. If that kind of activity is widespread, and Credit Suisse admits its very hard to tell, then it’s easy to see the current slump turning into China’s subprime crisis.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.