The China property crackdown
EDITOR'S NOTE
The first thing to know about the mess with China's Evergrande Group is that it's been a "known known" to markets, so to speak. This is no Black Swan.
The group is so heavily shorted, in fact, that it's been using share buybacks to fight back all year--until it ran out of room to do so. The stock had already slumped 60% back in June, when it was being described as "the world's most indebted developer." It has held that title since at least 2017, when it "pledged" to cut its debt ratio to 70% from 240%, according to Reuters. A decade ago, short-seller Andrew Left was banned from trading in Hong Kong for saying Evergrande was insolvent! (Ironically, the ban expires next month.)
Left warned that Evergrande, one of China's biggest property developers, had been insolvent for years and was relying on junk debt and government bailouts to stay afloat. Back then, in 2012, they had just under $12 billion of net debt. By last year, that figure had reached more than $300 billion, according to this great piece by Institutional Investor last month. "He ran out of friends," said Left of Evergrande's chairman, Hui Ka Yan. "The media has completely turned against [him]."
Why now? Perhaps it shouldn't be surprising that, at a time when Chinese leader Xi Jinping seems to be consolidating his personal power ahead of his expected and nearly unprecedented third-term "election" next year, he ran out of patience with Evergrande. After all, China has been cracking down on one wealthy executive after another for the past year, not to mention celebrities and political figures, too.
There are really only two possibilities with Evergrande's looming defaults here: either China chose to let this happen, or it was caught off-guard and couldn't stop it. The latter seems extremely unlikely in the current environment, and if it were true, would be a huge black eye for the leadership. That's because the Chinese people are large holders of Evergrande wealth management products that they now fear are worthless; they've been thronging Evergrande offices to demand repayment.
This is all why people are drawing the comparison to Lehman's collapse in the U.S. financial crisis of 2007-08. As Bloomberg put it, "The company's complex web of obligations to banks, bondholders, suppliers and homeowners has become one of the biggest sources of financial risk in the world's second-largest economy." Among other issues, "The company has received down payments on yet-to-be-completed properties from more than 1.5 million homebuyers."
So yes, a "messy default" could spawn a bigger crisis in China. But would authorities really let that happen? Especially when they've been specifically cracking down on property developers since at least last August, and authorities themselves have been warning creditors not to expect certain payments from Evergrande this month. From this lens, the property-sector crackdown feels more in line with the crackdown on everything from Big Tech to after-school tutoring to video games in recent months.
Last week, we asked the question, "Where will Xi strike next?" (Recall that Derek Scissors explicitly warned about those "dependent on non-bank financing.") This week, we may have the answer.
See you at 1 p.m!
Kelly
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