By Wolf Richter, editor of Wolf Street. Originally published at Wolf Street.
Foreign investors piled into the property sector over the years, buying hundreds of billions of dollars in bonds, including dollar bonds issued by China’s property developers. They bought those bonds because they liked those yields, in some cases over 10%, thinking that the Chinese government wouldn’t let those companies default, that it would bail out the bondholders as it bailed out so many bondholders before, and surely it would do it again, given how crucial the funding of the property sector is to the Chinese economy.
And now just about everything has gone wrong for these foreign investors. For months, there has been a massive crackdown by Chinese authorities on liquidity-driven inflows into the housing sector.
Authorities cracked down on overleveraged property developers. They targeted mortgage approvals and interest rates for first-time buyers. They tamped down on rental growth. They pushed banks to reduce their lending to homebuyers. A national property tax has been put on the table.
And this was topped off with an increasingly strained relationship between the Chinese government and the United States government, that includes major steps by the US government to crack down on speculation by Chinese entities in the US stock markets.
China’s crackdown on property speculation is guided by the official mantra that “housing is for living, not for speculation.”
That massive amount of speculation and leverage has for years posed enormous risks to financial stability. And the government is now trying to defuse those risks – and it looks like at the expense of foreign investors that have bought those hundreds of billions of dollars in bonds.
Those foreign investors are suddenly realizing that they’re no longer sacred and that the government may not bail them out.
Bailouts had been taken for granted, given how important the property sector is to China’s economy, and foreign investors whose money was needed to fuel that property speculation, had felt secure in their thinking that China would bail out those bonds if push came to shove.
Now push is coming to shove.
Evergrande Group, the second largest property developer in China, and the property developer with the most debt in the world, owes banks, shadow banks, other companies, investors, its suppliers, contractors, and home buyers $305 billion, according to Bloomberg.
It hasn’t been able to sell a single dollar bond since January 2020, and has no prospects of doing so as foreign investors have gotten the message.
On August 31, it said that work was suspended on a number of real-estate projects after it delayed payments to its suppliers and contractors. It warned that it may default on its debts if it can’t raise new money.
If it was difficult to raise new money before, it became impossible after that announcement – unless the government steps in, and that hasn’t happened yet.
On September 7, Moody’s and Fitch downgraded Evergrande Group and a number of its entities deeper into deep-junk, to ratings that indicate that a default is imminent with little recovery for investors in those bonds.
Moody’s said that the downgrade reflects the company’s heightened liquidity and default risks given its large amount of debt that will mature over the next 6-12 months.
Since Evergrande does not have enough cash to pay off the debt that matures over the next 12 months, it has to raise new money to pay off those old investors. If it cannot raise new money, either by issuing new bonds, or by borrowing from banks, or by selling assets that are not already leveraged to the hilt, it will default on those maturing bonds.
Fitch, when it downgraded Evergrande on September 7, said that “a default of some kind appears probable.” It based this on tight liquidity, declining sales, pressure to address delayed payments to suppliers and contractors, and little progress on asset sales.
On September 8, Evergrande told two banks that it would suspend interest payments on bank loans, according to financial intelligence provider REDD, which cited four sources briefed by bankers.
Evergrande has already suspended interest payments to several trust firms, and may suspend all payments to its wealth management products, according to REDD. This would rile up retail investors that put their money into those products.
On Friday, so September 10, Evergrande said that its contracted sales of properties in August, including sales to suppliers and contractors in exchange for money it owed them, dropped 26% compared to a year ago.
In Shanghai, trading of its bonds that mature in 2022 and 2023 was suspended last week after they collapsed. Evergrande’s bonds have been blacklisted and can no longer be used as collateral.
Evergrande’s shares, which trade on the Hong Kong Stock Exchange, have spiraled down since late 2017, and on Friday closed at the equivalent of about 45 US cents.
Evergrande’s dollar bonds have collapsed. On Friday in Hong Kong, its dollar bond due in 2025 traded at 29 cents on the dollar. In May, those bonds still traded at 80 cents on the dollar.
But it’s a whole industry. Evergrande just has the most debt.
Four other major Chinese property developers are now teetering. The dollar bonds have collapsed, on fears by international investors that those bonds cannot be refinanced when they mature, which would mean a default. These fears further limited the ability of those property developers to issue new debt to raise new money to refinance those maturing bonds and pay off existing investors.
This is the vicious circle that overleveraged companies find themselves in when investors belatedly get cold feet after having eagerly swallowed all the hype and hoopla for years. And then suddenly, the endgame starts, with everyone wondering what might be left for them when it’s time to poke through the debris.
The four property developers are Fantasia, China South City Holdings, Guangzhou R&F, Xinyuan Real Estate Co. Their bonds have fallen below 60 cents on the dollar, and in some cases below 50 cents on the dollar, indicating a high probability of default.
Other property developers have already defaulted. So far this year, property developers have defaulted on $6 billion in debt, about five times as much as over the prior 12 months combined, according to Morgan Stanley, cited by Bloomberg.
This includes China Fortune Land Development Co., which has nearly $10 billion in bonds outstanding, including $4.6 billion in dollar-bonds. In March, it defaulted on $550 million in dollar bonds. Last month, Ping An Insurance Co. disclosed that it wrote down its investment in the developer by $5.5 billion.
For now, developers that are less leveraged and have credit ratings that are less deep into junk, are faring better.
So will the collapse of these overleveraged property developers cause a financial crisis in China?
It could. But some of the biggest losers are foreign investors that bought those bonds, and not Chinese banks; and for a financial crisis to happen it would have to sink China’s banking system.
And then, China has some unique tools to ward off a classic financial crisis.
The government controls nearly everything, including the central bank, the big four state-owned commercial banks which are the largest banks in the world, the bad-banks which absorb the bad loans, big asset managers, and most of the largest companies, and much of the media, including the social media, specifically with regards to financial stories.
In other words, the government controls the money, the lenders, the borrowers, the buyers, the markets, and the message.
The government can order the big four banks to exchange defaulted loans for equity stakes and forget them. It can tell the central bank, the People’s Bank of China, to do whatever it takes. It can tell state-owned asset managers and pension funds to buy shares and bonds to prop up prices and to fund companies. It can tell the bad banks to buy bad debt from commercial banks.
The government has a long history of bailing out bondholders. And it has a history of bailing out investors in risky schemes that have blown up – including regular folks chasing after the latest bet, such as Evergrande’s wealth management products and apartments in unfinished buildings.
When enough of these folks start protesting in Beijing because they lost oodles of money on some mass-scam they’d fallen for, including property investments, the government, fearing social unrest, steps in and takes care of it. That’s how it has done it in the past.
And the holders of dollar bonds have been counting on it.
This property debt that is now blowing up has funded years of economic expansion and huge projects and millions of jobs. And foreign investors were fairly sure they’d get bailed out when push comes to shove.
So far, these special tools have helped the government to avoid a financial crisis.
But now it looks like the government is forcing a brutal deleveraging on the property sector to bring down risks and tamp down on rampant speculation and price increases. It looks like an effort to rebalance the economy away from property development.
It looks like investors are invited to eat the costs of this forced deleveraging. It looks like the government is teaching them a lesson, namely that they might not get bailed out, and that the flood of liquidity into the property sector was misguided and needs to end.
And it looks like the government is willing to take the risks of spillover effects into the broader economy and credit markets. And if, in fact, the government refuses to bail out bondholders, and allows a large-scale bloodbath among investors, particularly foreign investors, to occur in order to deleverage the economy, that would be a sea change for investors in China.
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the real reason why we get no infrastructure, extended unemployment and housing moratorium, let alone any stimulus? its because nafta billy clintons wall street has to be bailed out again from their disastrous investments in nafta billy clintons free trade utopia communist china
LENIN must be giddy in his grave; FREE TRADE IS FOR LOSERS:)
I think the link to the original article is bad, it gives a 404.
This version seems to work:
https://wolfstreet.com/2021/09/15/what-a-collapse-of-chinas-evergrande-would-mean
It looks like the Chinese government has been listening closely to Michael Hudson and is going to squeeze some of the rentiers and cut-off a big chunk of their unearned income. If that’s what they’re doing I say, good for them.
I do wonder if there is a way to bail out the small-time investors who put money into the wealth management products that Evergrande and others issued and if the government might be considering this.
I don’t see how the ChinaGov could act with such selectively surgical precision. If they are going to let Evergrande collapse and let that collapse collapse the money of foreign speculator investors, they will probably view the ” involuntary little guy losses” you speak of as regretable but acceptable collateral damage.
If any of my pension is tied up in ” China investments”, I am prepared to lose that part of it in order to see the predatory rich investors lose every part of what they invested. Perhaps such a loss spread across millions of involuntary pension-forced micro-investors will poltiically poison forever the concept of “investing in China.”
Every American who volutarily invested their own un-coerced money into China deserves to lose every bit of what they invested. I hope they lose it all. The broad American public will come to view Communist China rather more favorably than now if we actually get to see Communist China destroy several trillion “dollars” belonging to people who deserve to have those dollars destroyed.
Yep…
Now do hedge funds/private equity in America and we might be getting somewhere.
#20yearsafterOccupyWallStreet
“housing is for living, not for speculation”
Splendid idea!
I feel so sad about those poor foreign investors…
As a doctor, you should be willing to treat sickness wherever it occurs.
And sometimes the only good treatment option is amputation.
China’s crackdown on property speculation is guided by the official mantra that “housing is for living, not for speculation.”
Sounds pretty reasonable to me.
Their recent crackdown on tech monopolies didn’t seem too off the mark either, and even though I took a hit on paper last Spring, I’m sticking with the long game when it comes to the China portion of my meager portfolio.
Imagine if in the USA we saw some of this Chinese medicine applied to Wall Street: no more speculation in residential real estate, no gouging in health care, no bundling student loans into investment vehicles… Hell, I’d happily wave my Little Red Book and join a choirs of “L’Internationale” while skipping down the street in a hot pink tutu!!! OK, maybe not the last part.
Who might be our American Mao Zedong? Whoever you are, hurry up, the Revolution awaits!
” America has stood up! ”
Would those words not be delightful to hear?
So it always seems to go like this. Why can’t governments channel the constructive use of money in the first place so that it doesn’t go into real estate speculation? Building excess commercial and residential real estate must be the easiest way to stimulate an economy. But a disaster for the environment. It’s a little surprising to see the PBOC crack down on investors because there are still millions of people in China who need decent housing. Did they just open up China to all that speculation in order to maintain trade with other countries? Of all countries, you’d think China would have accomplished building the needed housing. But instead China deferred to investors and speculators. So will there be a future for investing as we know it? Something tells me that is the question. The problem with channelling all the investible money into the MIC is that it is (has been) the most destructive industry in history. Funny how all that destruction created a circular scheme that kept the FIRE industry in business. Like a subsidy chain. And now what? What shall we subsidize next?
Epsilon Theory have been on this for some time – this article gives a brief but good long term overview of how China has gotten to where it is now (one credible estimate is that Evergrande debt could amount to a whopping 3% of China’s GNP). The company has been in serious trouble for well over 4 years – their bonds have been trading at a discount since around 2017. Anyone buying or selling the bonds since then – unless they are complete idiots – were looking at it as a high risk gamble. The FT have been writing about it for some time, so nobody will have been too surprised.
Evergrande also isn’t alone – there are at least four very big property companies likely in similar trouble. They are symptoms, not the cause. The housing market in China accounts for as big a chunk of the economy in China as it did in Ireland and Spain pre 2017. By some estimates it is far bigger.
Ultimately, China has three choices:
1. Let the company go down, and put in place as much support as it can for small domestic creditors to minimise the overall damage, while gradually deflating the bubble.
2. As above, but do it badly, causing chaos.
3. Do what they’ve been doing the past 10 years or more, which is bailing out companies like this, passing on the cost to regular bank savers (because its the State owned banks that usually end up with the bad loans). Kick the can down the road for another year or so.
No.1 is undoubtedly the most sensible option. The problem is that property interests have become so embedded in the system that it may be institutionally very difficult to make the hard decisions on who loses out and who gains. Its noticeable that none of the top people in Evergrande have been made visible scapegoats, unlike the tech billionaires who stepped out of line.
There is, incidentally, and almost complete black out on all mention of Evergrande in mandarin media. There is apparently not one mention of it in Chinese domestic media of any kind today.
“There is, incidentally, and almost complete black out on all mention of Evergrande in mandarin media. There is apparently not one mention of it in Chinese domestic media of any kind today.”
Probably because there’s not going to be any news. It’s Mid Autumn Festival time from the 19th to the 21st.
Nice play-by-play on the construction of a complex and elaborate house of cards. The real estate sector incorporating industries downstream and upstream make up 29% of GDP. Ouch! The description of the development of a large rentier cohort is priceless. One can only hope that the government does not respond with Keynesian militarism to support aggregate demand. And the grinding screw will be delivered to municipalities when this tidy source of income disappears.
Thanks again, PK, for (another) outstanding precis.
Caixin just published How Evergrande Could Turn Into China’s Lehman which gives some hard numbers on the size of this beast:
(digested for readability):
1. Evergrande’s liabilities are equivalent to about 2% of China’s GDP. Its activities create 3.8 million jobs every year through some 8441 upstream and downstream companies.
2. The company has more than 800 projects under construction, over 500 of them now halted due to its cash crunch. Several hundred thousand units have been presold and not delivered. It needs at least 100 billion yuan to complete construction (USD:CNY about 6.5:1)
3. Chinese lenders often require personal investments from the developers’ executives as a risk-control measure. Evergrande would have internal fund-raising campaigns, selling “Chaoshoubao” (“Super Return Treasure”) promising 25% annual interest and redemption of principal and interest within two years. Buyers actually received an actual annualized return of 4% to 5% in four years and principal was finally repaid only to current executives (90%).
4. About 40 billion yuan of Evergrande WMPs are now due.
-> WMPs sold to the public mostly offer a return of 5% to 10%, higher than WMPs typically sold at banks.
So many of Evergrande’s 200,000 employees bought them and persuaded their families and friends to invest.
-> Evergrande would require construction companies to buy WMPs of about 10% of their receivables.
-> Evergrande property owners were also WMP buyers.
5. Evergrande relies heavily on commercial paper to pay construction partners and suppliers, mostly six-month notes with annualized interest rates of 15%–16%. Now most carry interest rates of more than 20%.
Since May 2021, the few Evergrande notes that could still be resold have been discounted as much as 55%.
6. From July 1 to Aug. 27, Evergrande sold properties to suppliers and contractors to offset a total of 25 billion yuan of debt.
In addition to the 571.7 billion yuan of interest-bearing debt on its books, it’s not a secret that developers like Evergrande have huge off-balance sheet debt. The total is not known.
7. Evergrande’s partners in local development projects were paid 30% down to acquire them, but the rest has not been paid by the project subsidiaries as sales from the projects have been transferred to the parent.
8. Evergrande has sold equity in subsidiaries to strategic investors and promised to buy back the stakes if certain milestones can’t be reached in the future. Such equity sales are actually a form of borrowing.
9. Evergrande has been frantically selling properties at discounts this year. As of June 30, Evergrande had 778 land reserve projects with a total planned floor area of 214 million square meters and an original value of 456.8 billion yuan. Potential buyers say that while some of Evergrande’s projects look good on the surface, there are complex creditors’ rights that make them difficult to dispose of.
10. Some of its offshore bonds carry interest rates as high as 15%, a person close to the Hong Kong capital market said. UBS estimates that $19 billion of Evergrande’s liabilities are made up of outstanding offshore bonds.
…. So sorry, NC pitchfork and tumbrel enthusiasts: $19B doesn’t seem likely to blow up Soros or anyone else outside China-HK. It’s the contagion that outsiders need to watch.
As an astute commentator once said on WolfStreet back wayyyy back in 2019:
“What is about to unfold in China will not stay there but will quickly ripple around the globe. We are not looking at a 2008 scenario but something much more akin to Enron x 50 but this time with with a major economic power at the center of the issue.”
Thanks for the great detail.
I think your final point 10 is very important. The direct financial exposure outside China is peanuts, nobody big in financial markets is likely to be directly hurt by this unless someone, somewhere has been really stupid and put a big high risk bet on the Chinese housing market continuing to expand. I would not mind guessing that many of the bonds have already been sold at a discount to Chinese insiders who are confident that they’ll be able to be part of a recovery deal.
The bigger picture for the rest of the world is the effect of China having to restructure its economy. How exactly it impacts depends almost entirely on which direction Beijing picks for recovery, and thats anyones guess.
Yup, that’s the fog I am squinting into at this very moment, as one of many bourgeois stooges whose living depends quite directly on where things go next….
My best guess at present is that to cover the “Enron x 50” losses — and have no doubt, China will find some way through, albeit with a good bit of can kicking — Beijing has absolutely no choice but to double down on its supersized export model to keep its own seat on the Groaf tiger (and not become lunch).
That was, and remains, the original engine for China’s original emergence from under the heavy boot of Mao. But while China has more or less resumed its ‘natural’ historical share of about 30% of world GDP, that next slice is going to be *much much* harder to win and keep in this skeptical and disillusioned stage of the neolib world Hype Cycle©.
…. Problem is, having treated so many foreign partners so shabbily and disdainfully for so long (oh the war stories I could tell), China’s relationships and alliances are purely cash-and-carry these days. Quite simply, I have never heard of a Mainland counterparty or vendor any foreigner ever went *back* to for any reason other than rock bottom prices. Yes, it’s that awful. And it’s not that they can’t perform, they just choose not to.
(And I won’t even mention the Wolf Warrior posturing that has been just like whisky to a drowning MIC)
…. So the million dollar question (YMMV) is: how long can Beijing keep buying book for its industrial machine overseas while sorting accounts at home?
And bonus question, which will give no joy to old school Reds here still rooting for the “World Socialist Great Wheat(and Sickle) Hope”: What happens if China’s own national champions use this urgent mandate for Groaf to go truly multinational, and squirm out from under the thumb of the Party?
(hint: that’s happening already. VOC, East India Company, Royal Dutch Shell, United Fruit, Anaconda anybody? Plus the individual example of pretty much every Chinese who actually got out of China)
The mountains are high and the Emperor is far away
Wonder if the Fed will convince itself it must get involved in this.
The Fed vs China.
That’s a movie I’d go to see and I haven’t gone to a movie theater since I can remember.
The Fed will be begging China to take as many dollars as it needs. Anything to stave off the inevitable.
I wonder what the american financial landscape would look like today, had the u.s. government / “federal” reserve taken even a fraction of that disciplinary tact in 2008 instead of falling all over themselves to cash in for, literally, years.
We’ll never know, but we’re sure finding out what living in that deep greed hole they dug for us feels like.
The western civilization would have ended as we know it.
So said Bernank and Paulson.
I am so thankful for such great leaders.
Top of the class talent.
Our “Great Financial Helmsmen.”
Personally, I’d like to see them swim across the Potomac river near Arlington, much less the Yangtze river (at Wuhan no less.)
The Best and The Brightest!
Which reminds me, why hasn’t SoftBank stepped in yet? What are they waiting for? An investment opportunity like this has their name all over it.
Yep we’ll never know. What could’ve been.
They had a toolbox that worked after the S&L debacle. It was the called RTC, and it was fairly effective or believe I had read that.
I’ve long suspected the FED, and FDIC, feared a broader systemic failure of the US payments systems. The intricacy of the modern clearing, payments and ACH is a compelling subject, one I am not equipped to explain.
I’m absolutely certain there were / are / will be a torrent of “lessons learned” books “analyzing” the destruction of the american financial system / economy.
Trouble is, they’re only written to make the authors money, and only the Chinese give enough of a shit to read them.
In the long run, China will be a much better place for this action.
Certainly some smaller, less well off investors will lose their investments. However, an economic system built on speculative assets does not add real value. Speculators are not funding scientific research, productive capital investment, improving labour through training or education, and not interested in the common good.
They are buying assets in the hopes that they will be able to get a capital gain through flipping properties and possibly create a passive income stream.
What is good for investors and finance is bad for society. It has led to real estate bubbles, contributed to housing crises by making housing prices unaffordable, and when bubbles pop, as the 2008 financial crisis demonstrates,, can result in a significant recession.
In other words, the government controls the money, the lenders, the borrowers, the buyers, the markets, and the message.
Financial blogger crackdown leaves China investors scrabbling for data
Wolf is always–always–wrong about China, as this image demonstrates:
https://i.imgur.com/JQIyrn9.png
What’s more:
1. China’s debt-to-GDP ratio in Q4 2020 was the same as the US and the EU (with much lower shadow banking exposure): around 273% of GDP, according to the Bank for International Settlements.
2. China’s economy is growing 300% faster than the US economy–and growth eats debt.
3. China’s debt is 98% domestic.
4. China’s asset to debt ratio is 3.8:1
5. China’s debt is self-liquidating, backed by high quality, productive assets. The Three Gorges Dam, for example, repays its construction costs every 42 months.
6. The Keynesian multiplier of Chinese debt is 200-300%, according to a US Federal Reserve study.
7. 95% of Chinese trust their government, and debt is a measure of trust.
I want to see a run down of what was actually built while all of that money was sloshing around.
Sounds like they got less interested in actual building as time went on. Then the paper trading and ponzi scheming became the central business.
The bile comes due: https://www.youtube.com/watch?v=7ehETntF6QI. I suspect the Landesbanks and Pension Funds (etc) are being lined up right now to enter into the losing side of Abacus-type deals as the big houses try to reduce their DV01 to the sector. Should make for interesting reading in 5 years when the details of the deals start reaching the media.