Sub-Prime Comprehension

Interesting cultural details come up when I give my students exams. I had a question about sub-prime mortgages on my biz ethics exam, and the majority of students lost a lot of points.

Why? They defined a sub-prime loan as a loan to "the poors" (i.e., poor people), or to "people who cannot pay it back." In some cases, their description of a sub-prime loan made it sound as if the banks were seeking out bums on the street to give loans to. The answer I was looking for was simply that a sub-prime loan was one given to a person with a relatively low credit rating, but fewer than 1 in 10 got that right.

The reasons for this failure to comprehend were very interesting.

First of all, the American system of credit is quite alien to China. Most people have never heard of a "credit rating" (though a banking insider has told me that they have them). So when you say someone has a "low credit rating," that has no real meaning to my students. Understandably, they unwittingly translate that to "not enough money to pay." Never mind that America has plenty of people who could pay their debts, but choose not to.

Herein lies the second alien concept. China doesn't have much of a credit economy. Almost no one carries a credit card. Even a bill for services is essentially unheard-of in my part of China. The hospital is cash-only, and you pay *before* you get treated. You get loans for two things in this country: a condo, and a car. And the idea that someone would intentionally default on either of those is utterly incomprehensible to most Chinese people.

A car is an enormous status symbol, often possessed as much for bragging rights as for transportation. So if one month you're driving a fancy car, and the next month it's gone, repossessed, you suffer tremendous embarrassment. You would only do that if you suddenly found yourself poor.

A condo is an even more ironclad obligation. In America we call owning your house a key part of the "American Dream." Here it's not a dream, it's a necessity.

As I've mentioned before, social custom dictates that a young man literally cannot get married unless he owns his own condo. No woman worth her salt will think of marrying him. And so, to have a condo and default on the payments is worse than a shame. It would be tantamount to divorce, bankruptcy, and social suicide. No one would do it unless it was absolutely, 100% unavoidable.

With that background, you can see how my students equated sub-prime mortgages that didn't get paid back, with wildly reckless "loans" to bums on the street. Even if they understood the idea of a credit score, the idea that someone with even a modest amount of money would have a low credit rating would enter a Chinese mind like a square peg into a round hole.

If you wonder about the future of the Chinese economy, and especially the housing bubble that many people think exists in this country, one part of the answer lies in my students' inability to understand sub-prime mortgages.

Housing prices will always be sustainably higher relative to personal income in China than they are in the West, because there is so much cultural pressure toward home-ownership. A debt crisis such as hit America in 2008 would happen here only if people's incomes fell dramatically, such that they literally could not pay back their loans. I do think it's possible, or even likely, that this will happen, but it will not happen lightly.

Given that my students seemed to think a sub-prime loan was a loan to someone who literally had no chance of paying it back, my Western mind immediately asked why they wouldn't have asked a question about this seemingly absurd idea. Why would a bank loan money to people it knows can't pay it back?

To be fair, some of my students knew about banks immediately selling the debt upstream, but this really only pushes the question back a step: why would anyone buy obviously bad debt from the banks? I guess in China it wouldn't be unheard-of for a bank to simply lie to upstream purchasers, falsify the loan paperwork, and leave someone else holding their counterfeit loans.

But even more fundamentally, in China one gets accustomed to economic transactions that seem preposterous on their face. It's always someone paying someone else off by accepting a bad deal, or someone moving money from A to B to make B look momentarily better than it really is. It's a political kickback, or stock manipulation, or personal enrichment at the expense of one's company, or whatever. Usually someone — usually the government — sweeps in with some money to prevent the situation from exploding, and the banks and companies stumble forward another day until the next crisis arises or the next bribe is needed. The system has been held together this long, only because of a combination of how universally-accepted it is, and how incredibly crafty the Chinese are at drafting these complicated deals.