A guide to China’s as­ton­ish­ing stock mar­ket crash.

The Washington Post Sunday - - BUSINESS - BY ANA SWAN­SON ana.swan­son@wash­post.com

In China, lo­cal stock mar­kets, which rose to dizzy­ing heights over the past year, plum­meted back to Earth last week. They then re­bounded sharply on Thurs­day and Fri­day, as the Chi­nese gov­ern­ment worked to re­store faith in the mar­kets.

It has been called the big­gest stock mar­ket bub­ble since the dot-com boom, and some say its ef­fects could be big­ger than the cri­sis in Greece. China rep­re­sents more than 16 per­cent of the global econ­omy, af­ter all, while Greece is merely 0.38 per­cent. A guide to what’s un­fold­ing:

1 What’s hap­pen­ing now?

China’s stock mar­kets ended the week by re­bound­ing strongly, with the Shang­hai mar­ket ris­ing 4.5 per­cent on Fri­day.

But China’s two main stock ex­changes are both down sig­nif­i­cantly since hit­ting a peak June 12. The Shang­hai Com­pos­ite In­dex has lost 25 per­cent of its value in less than a month, while the Shen­zhen Com­pos­ite In­dex has fallen 35 per­cent.

Al­to­gether, more than $3 tril­lion in share value has evap­o­rated since mid-June — more than the value of France’s en­tire stock mar­ket.

Still, both mar­kets are up more than 80 per­cent from mid-2014. But the slide was enough to spook in­vestors, com­pa­nies and the gov­ern­ment alike.

2 How has the gov­ern­ment re­sponded?

The Chi­nese gov­ern­ment de­nounced the mar­ket move­ment as panic selling.

In re­sponse, it cut in­ter­est rates for the fourth time this year, paused new ini­tial public of­fer­ings, capped short selling, changed the rules to al­low pen­sion funds and the so­cial se­cu­rity fund to in­vest more in stocks, and or­dered state-owned com­pa­nies and con­trol­ling share­hold­ers not to sell their shares. It changed the rules so in­vestors can, for the first time, use their houses as col­lat­eral to bor­row money to buy stocks.

Most sig­nif­i­cantly, it used a state-owned se­cu­ri­ties fi­nanc­ing com­pany to lend $42 bil­lion to 21 bro­ker­ages so they could buy blue-chip stocks — on top of $20 bil­lion that bro­ker­ages said they would buy over the week­end. As Gwynn Guil­ford of Quartz notes, taken to­gether, China’s re­sponse was big­ger than TARP, one of the U.S. gov­ern­ment’s prime re­sponses to the fi­nan­cial cri­sis.

3 How­did we get here?

In just 12 months, China’s stock mar­ket climb cre­ated $6.5 tril­lion in value — enough to pay off Greece’s debt 20 times over. No other stock mar­ket has ever grown that much in dol­lar terms.

The boom has been fu­eled by novice in­vestors rush­ing into the mar­ket. Even Chi­nese farm­ers are giv­ing up tend­ing their fields to tend their stocks.

Although the stock mar­ket has surged, the Chi­nese econ­omy has be­gun to slump. The Chi­nese econ­omy grew 7 per­cent year over year in the first quar­ter, its slow­est pace since 2009. Im­ports plum­meted 18.1 per­cent in May.

4 What role does lend­ing play?

One way money has flowed into the stock mar­ket is through mar­gin lend­ing, where bro­kers lend their clients money to buy stocks. The rise in mar­gin lend­ing has deeper roots: the huge ex­pan­sion in money in China af­ter years of in­ter­est rate cuts and easy mon­e­tary pol­icy.

As Scott Kennedy of the Cen­ter for Strate­gic and In­ter­na­tional Stud­ies has noted, “Over a quar­ter of China’s stock mar­ket cap­i­tal­iza­tion is now sup­ported through mar­gin fi­nanc­ing, turn­ing an eq­uity mar­ket into a de facto debt mar­ket.”

5 What about the prop­erty mar­ket?

Prop­erty has long been a pri­mary store and gen­er­a­tor of wealth for the Chi­nese mid­dle and up­per classes, be­cause the coun­try’s un­der­de­vel­oped fi­nan­cial sec­tor of­fers few in­vest­ment op­por­tu­ni­ties. Selling land to prop­erty de­vel­op­ers has also been a pri­mary source of fund­ing for most city and vil­lage gov­ern­ments, which mostly don’t have the au­thor­ity to levy their own taxes or is­sue bonds. McKin­sey has es­ti­mated that, ex­clud­ing the fi­nan­cial sec­tor, al­most half of China’s debt is di­rectly or in­di­rectly re­lated to real es­tate, about $9 tril­lion.

When the prop­erty mar­ket started to slump in late 2014, it put much of the coun­try’s wealth at risk. Mor­gan Stan­ley Economist Andy Xie com­pared the Chi­nese stock and prop­erty mar­kets to a hor­ror movie: “Peo­ple like towatch, but don’t want to be in it.”

6 What are the risks?

An­a­lysts say that the Chi­nese gov­ern­ment’s re­peated pledges to boost the mar­ket and sub­se­quent fail­ures to do so could dam­age its cred­i­bil­ity and lead to a cri­sis of con­fi­dence.

Some in­vestors will lose their sav­ings. Be­cause for­eign­ers own such a small per­cent­age of stocks, the pos­si­bil­ity of con­ta­gion out­side the mar­ket is low.

The big­ger risk lies in the debt that in­vestors and com­pa­nies have bor­rowed. A dip in prices in China could spark an even big­ger sell-off, as in­vestors sell stock to pay their bro­kers. Some Chi­nese com­pa­nies have even pledged their own shares as col­lat­eral for bank loans — mean­ing that, if their share price falls enough, they may de­fault. This lever­age could threaten the sta­bil­ity of banks and bro­ker­age firms.

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