Crisis Rescue via Direct Purchase: Evidence from China

The state of the Chinese economy holds significant relevance for Australia, given that China is Australia's top trading partner. Local investors and the business community are keenly observing how Chinese policymakers address the current economic challenges, particularly the ongoing real estate crisis.

Recently, Chinese authorities have introduced several measures to stabilize the real estate sector. These include lowering down payment requirements and releasing 300 billion yuan to invest directly in unsold apartments, aimed at supporting developers and revitalizing the real estate market.

Amid these interventions, a crucial question arises: what are the unintended consequences of such direct intervention programs on the broader economy? This question is explored in a recent study published in the prestigious Journal of Banking and Finance by Gaoping Zheng from RMIT and her co-authors, providing fresh insights into the economic impact of government interventions.

The study delves into the Chinese government's unprecedented intervention during the 2015 stock market crisis, highlighting the broader economic implications of direct purchase programs, particularly their effects on market stability and firm behavior. The 2015 Chinese government direct purchase rescue program, which aimed to stabilize the stock market by spending over US$200 billion to buy equities over 1,360 firms, is similar to the current housing market interventions where the government is stepping in to purchase unsold apartments. Both measures reflect direct market interventions to stabilize critical sectors and restore investor confidence. The recent actions, include lowering mortgage rates, reducing down payments, and enabling local governments to buy homes to reduce the oversupply of properties, mirror the proactive approach seen in the 2015 rescue efforts.

"The study reveals that while the government's direct purchase program temporarily halted the market's freefall, it led to a significant decline in market liquidity"

The key findings and insights of this study include:

1. Liquidity and Market Stability: The study reveals that while the government's direct purchase program temporarily halted the market's freefall, it led to a significant decline in market liquidity. Liquidity, or the ease with which assets can be bought or sold without affecting their price, dropped considerably and remained low for several months. This suggests that the intervention had unintended negative consequences on market functioning.

2. Policy Uncertainty: One of the crucial insights from the study is that policy uncertainty played a major role in the observed liquidity decline. Unlike interventions in developed markets, which are typically accompanied by clear communication and guidelines, the Chinese intervention was marked by opacity. Investors were uncertain about the future government actions, deterring trading and contributing to the liquidity decline.

3. Moral Hazard and Firm Behavior: Contrary to concerns that government bailouts might encourage risky behavior among firms, the study finds that rescued firms in China adopted more conservative investment policies post-intervention. This is evidenced by reductions in R&D expenditures and slower asset growth, suggesting that high policy uncertainty brought by the purchase program made managers unsure whether their firms are too-big-to-fail and pushed these firms into a state of “hibernation”.

4. Long-term Effects: The decline in liquidity was not just a short-term reaction but showed signs of being a lasting effect. While there was some reversal of the liquidity drop over the following months, the overall impact was sustained. The government's subsequent trading activities—both purchases and sales—continued to affect market quality adversely, reinforcing concerns about policy uncertainty.

The recent measures by the Chinese government to stabilize the housing market can be seen in light of the findings from the 2015 stock market intervention. This study underscores the importance of transparent communication and clear exit strategies when intervening in markets to avoid exacerbating uncertainty and instability. For policymakers, the lessons from the stock market intervention highlight the complexities and potential unintended consequences of direct market participation.

For the general public, these findings contribute to a nuanced understanding of crisis management tools, moving beyond the simplistic view that government interventions are either entirely beneficial or harmful. Instead, the study advocates for a balanced approach that considers the specific context and potential long-term implications of such measures. Understanding the results of our paper helps gauge the likely effectiveness of current interventions and informs future policy decisions.

Author:

Dr Gaoping Zheng (Senior Lecturer in Finance, RMIT University)

11 June 2024

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