Without government intervention China Evergrande, one of the country's biggest property developers, will be forced into a bankruptcy reorganization.
The company used promises of above market returns to raise billions in
financing from individual investors through unregulated money management
products. Now protesters daily storm the company's offices as Evergrande
falls further and further behind on payments to more than 70,000 investors.
Construction of unfinished properties with enough floor space to cover
three-fourths of Manhattan has come to a halt and a million homebuyers are
stuck having made payments to Evergrande but without homes to show from
their cash.
The housing ministry told Evergrande's main banks this week that the
developer won't be able to make interest payments due September 20.
Just by itself Evergrande's problems would be a big deal.
But Evergrande's problems threaten to be contagious.
First, the entire real estate sector–already under pressure from the
government's efforts to damp (again) speculative buying–is reeling and the
need for developers beyond Evergrande to raise cash to pay down debt is
pointing toward a wave of fire sales that will further depress real estate
prices. "As a systemically important developer, an Evergrande bankruptcy
would cause problems for the entire property sector," Shen Meng, director
of Chanson & Co., a Beijing-based boutique investment bank, told Bloomberg.
"Debt recovery efforts by creditors would lead to fire sales of assets and
hit housing prices. Profit margins across the supply chain would be
squeezed. It would also lead to panic selling in capital markets."
But the contagion doesn't stop there.
Second, once again, a crisis in the black financial markets, the home of
unregulated investment products and sky-high leverage, has demonstrated
just how fragile China's financial system continues to be. The Evergrande
crisis is a replay of the crisis at bad-bank China Huarong Asset
Management. And before that in bad debt at conglomerate HNA Group. And
before that, it was the regional lender Baoshang Bank.
Despite years of trying the government does not seem able to root
speculation and leverage out of the financial system and the system as a
whole remains dangerously exposed to a collapse if the failure of one big
company can't be limited to that company by government intervention.
Besides the drop in Evergrande stock, the crisis has also sent yields on
China's junk bonds to the highest level since March 2020.
Evergrande's total liabilities come to somewhere around $300 billion. Of
that 54% is secured bank and other borrowing and 17% is unsecured bank and
other borrowing.
In réponse to the crisis some banks have begun hoarding yuan at the highest
rate in almost four years, Bloomberg reports. That's a sign of fear of a
liquidity squeeze in the financial system.
The long-term problem that the Evergrande crisis reveals is that every time
the government moves to crack down on dangerous levels of leverage or to
attempt to reduce speculation in the financial markets, some big Chinese
company that has built up a dangerous level of leverage, as Evergrande has,
goes into crisis. And that forces the government to choose between
continuing the policies that it knows the financial system needs or
patching up the system one more time. Which results in a dangerous lurch
from crisis to crisis.
To date the government has not indicated whether or not it will allow a
major debt restructuring or bankruptcy at Evergrande. Senior officials at
state-owned banks have told Bloomberg that they're still waiting for
guidance on a long-term solution from top leaders in Beijing.
With President Xi Jinping in the midst of a potentially politically
sensitive extension of his tenure in office, I think it's unlikely that the
government will roll the dice and risk a larger crisis.
Again.
Which just leaves the problems of bad debt, over-leverage, and unregulated
speculation to continue, until next time.
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