Credit crisis begins to cripple Chinese cities

Shenmu, and nearby cities like Ordos and Fugu, are at the leading edge of broader troubles that are beginning to afflict the entire Chinese economy. Across China, growth has slowed. With the slowdown have come rising defaults on loans made outside the conventional banking system, chronic overcapacity in many industries like coal mining and steel production and, in particularly troubled cities like Shenmu, a sharp decline in previously debt-fueled prices for real estate and other assets.

The cracks are showing in many sizable cities like coastal Wenzhou, where informal lending, a big part of so-called shadow banking, has dominated for a quarter-century. Cities with economies linked to commodities with falling prices have also been affected, as more people have defaulted on loans. The biggest, most economically diverse metropolitan areas like Beijing and Shanghai seem considerably less affected, but also have many small and medium-size businesses that depend on informal lending.

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Although changes are being slowly introduced, state-owned banks have long been allowed to lend only at low, regulated rates barely above the inflation rate, with the total value of loans controlled by quarterly quotas. All over China, these loans go overwhelmingly to large state-owned businesses, government officials and politically connected individuals, who then relend the money at much higher interest rates to small and medium-size businesses in the private sector that need money to grow.

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The popping of the real estate bubble has been the most serious blow to the local economy. Real estate prices had soared in cities across China. In Shenmu, 1,200-square-foot apartments that sold for less than $20,000 a decade ago reached $330,000 by last winter.

Local real estate brokers say that they are advising sellers to avoid price cuts of more than 10 percent. But local business owners who buy and sell apartments say that deals are now being done for as little as $115,000 for a 1,200-square-foot apartment, a decline of 65 percent.