Just about everybody in the world has been saying for years that the world’s overheated property market was a rising risk. China’s Evergrande is scaring the hell out of the property and credit markets. The group has $305 billion in debt. It’s behind on debt payments. A turgid litany of headlines is looking increasingly doom-laden.
These gigantic debts are currently “assets” to Evergrande’s lenders. Some or all of the $305 billion is on balance sheets as assets. Remove a few billion in assets from your balance sheets, and you get a mess. So a lot of major credit providers may lose those “assets” soon enough. The current bond deal scramble is just one debt, but there are many more. This issue isn’t solved, and non-payments aren’t resolved, either.
This practice of leveraging debt and borrowing against debts owed isn’t exactly new. Global markets borrow and lend on this basis. Everyone borrows and lends to everyone else. When it gets to $305 billion vanishing into thin air, however, in a volatile, all-sectors-affected market like property, the ramifications are enormous. Other companies may default. Property prices could crash.
In China, the property market is worth about 25% of the entire economy. Evergrande is the second top company in the market. A lot of Chinese and foreign finance is sunk into Evergrande, directly and indirectly.
We’re not talking about theoretical money here. The impact will be felt in hard cash, worldwide, if Evergrande collapses. A crash in the Chinese property market also has truly global reach:
- Hits to property stocks could and probably would trash the related investment markets.
- “Collateral damage”, in the form of reduced general trade, goods, construction etc., simply due to the impact of lost money. You don’t lose six figures and rush out spending.
- A lot of lost jobs for future projects across the property spectrum. Another direct physical cash hit on the real economy.
- General and possibly large losses to investors and property owners due to depressed property prices. (This typically affects property market borrowers, making their credit issues a lot worse.)
- Possible runs on financial institutions as investors try to bail out of risky investments or get cash to manage their commitments.
- Interest rate rises due to a credit squeeze.
Much more to the point – Chinese investors in foreign markets would have to reposition to manage risk in China. The Chinese property market could be absolutely smashed.
This in turn could (and almost certainly will) mean dumping properties on the market around the world, crashing their prices. Chinese property portfolios are huge, and directly affect local property markets. (Australia is a case in point, where Chinese money helped to fuel a pretty steep range of price increases, particularly in the higher end of the market.)
The big question – What will China do about Evergrande?
China’s position in relation to Evergrande isn’t anything like as simple as it may seem. Sending in the firing squads isn’t the instant option, however well deserved. China has no reason to be pleased that one of its big corporate kids has made a dog’s breakfast out of itself. A few bullets might do a bit of aesthetic good, but don’t solve the larger problems.
The much bigger picture is all about China’s economic management as a top investor.
China makes very big money as an investor in foreign markets.
The Evergrande situation simply should not have happened.
It’s unclear whether the Chinese Shadow Banking Curse is involved. (Shadow banking is off the books banking; it’s pretty much illegal, and rife. Nobody knows how much money is involved, but this would make a bad situation a lot worse, if loans to Evergrande have been spirited away into the shadows.)
The debt levels are to put it very mildly, absurd. The usual process for a property group to go bankrupt is to overborrow and mismanage capital. All else follows.
That said – The sheer scale of this debt would have been visible to a first-day trainee accountant with a 5-second attention span. How do you not notice $305 billion in debt sneaking up on you?
There are ways, and none of them reassuring. You can upvalue your property portfolio above the debt level, and assume nobody on Earth can read, for example. You can borrow on the shadow market so nothing goes on the books and assume that won’t occur to the authorities.
One way or another, someone must have made a lot of money out of Evergrande’s debt. Third parties in particular would have done quite nicely. How much of this vast amount of money actually translated into credible hard assets doesn’t seem to be known.
…So China has a lot of complex issues to manage here. The credibility of the market defines investment and capital issues. The legal issues, however, are stupefying, even when a bullet is an option. Whom does one shoot? Is one shooting the right people? Will it have any effect on the third parties? What is an effective deterrent?
More to the point, in so many ways, is the future. How will the property market manage capital in this environment? Who’s at risk of going broke and “spreading the joy” to the wider market with more defaults? How will the Chinese finance sector cope with the train wreck?
Also relevant: How much of this money waddled out of China in the debt binge? It’s highly unlikely this exceptional level of debt was incurred on a charitable basis. There had to be something in it for someone. There’s a real possible stench in this area, and Chinese authorities know it all too well. A bit of corruption can go a long way, powered by big money.
How do loans get approved? Who benefits? Where does the money go, when the debts are generating cash? It’s unlikely Evergrande wasn’t paying its debts previously, so where did all that money go? Obvious questions, and no answers are likely for quite a while.
Modern “creative accountancy” prides itself on its complexity. Stupidity would be a better word. Most white collar criminals leave an audit trail behind them, so cleverly hidden that a not-very-interested schoolkid, let alone a forensic accountant, could find it. Any out of synch debt management will stick out very conspicuously at some points. The trouble is that there could be so much of it that it might take years to find it all.
Alternatively, and if the shadow banks are involved, it’s very likely, the money could simply vanish in the global black economy. That’s a lot harder to trace, and also not a lot of use as evidence against even the dumbest financial mis-managers.
Meanwhile, the world is about to find out what happens when a Chinese property giant goes bust. Don’t expect too much cheering. This could get very nasty.
