Evergrande Already Liquidating
The story out of China and what is sending markets down is the potential default of Evergrande. This is the largest developer in China and has over $300 Billion worth of debt. The company has assets totaling around $200 Billion, leaving it with a shortcoming.
What is worse is that most of their assets are real estate. This is a rather non-liquid situation which makes it tough to raise cash. It is one of the main drawbacks to real estate. Couple that with the fact that many of their properties are still under construction and we can see the bind they are in.
There are many challenges that are being faced here. We will go through a few of them.
Liquidation Already Begun
This is not something that is getting a lot of attention from the financial media yet it is taking place. Reuters was able to uncover that investors in their wealth fund are being repaid in real estate. It shows that we are seeing the process unraveling before our eyes.
Investors obviously do not put money into a wealth fund to acquire real estate. Of course, when given the option of that or nothing, it is an easy choice.
The challenge is that the company is having to discount the properties to get people to accept. Another issue is that many properties being distributed are still not finished. This means that the market for them, on resale, is small.
Of course, discounting of a reported 25% plus the fact that investors want to dump them only helps to accelerate the decline of all other properties in that area. This is something that is going to keep happening as we can presume that Evergrande is going to have to keep increasing the discount rate to make it attractive for investors.
What Does The CCP Do?
This is putting the Chinese government in a very tough position.
On one hand, bailing out a bunch of bankers like the United States did a decade ago will not sit well with the Chinese population. As hard as it was for Americans to swallow, the idea of wealth inequality due to these types of overleveraging is totally unforgiveable. Thus, the government has to be very convert about things.
Of course, the government could just let the company fail. This all started because they wanted to tap the brakes on the overheated housing market. Well, it seems they were slammed. Not surprising that government intervention does not go as planned. Naturally, this is not exclusive to China since we see this each time government has the brilliant idea to meddle in the economy.
Regardless, having their real estate market completely collapse is not an enviable option for the CCP. While they wanted to cool things, the idea of obliterating it will crush the economy. This is not something they will allow happen.
Who Has Exposure?
Here is one of the biggest issues, both for the Chinese government and global markets. In situations like these, nobody is sure who has exposure.
We know there are a lot of Chinese banks involved. This is one reason why the government has to seriously consider stepping in. However, what about those who are outside the country?
This is a great unknown. It is also what many in the markets are fearing. Obviously, companies that have massive exposure are not going to go on television and announce to the world they are holding a lot of this debt. Instead, they will try to remedy the situation quietly. Sadly for them, it is not likely to stay that way for long.
We might not know who but we can presume there are a lot of other companies, outside China, holding this debt. They are facing large risk of default, making their holdings essentially worthless.
This could have a major impact on markets as companies that are hit by this have to sell other assets to cover the losses. Here we see the domino effect.
Debt In USD
This debt is in USD, not CNY.
When a company in the United States issues debt, it is obviously in dollars. When a company outside that nation does it, it have the option of doing it in their native currency or using the USD. Evergrande opted for the later.
Here is where the speculation comes in. Naturally, if one feels the USD is going down against the CNY, issuing debt in USD when paid in CNY makes sense. Effectively, the debt gets reduced due to the currency.
It is also where the government is backed into a corner. If they bail out Evergrande by backing the debt, they could devalue the currency, making it more expensive to cover. This would force Evergrande to raise more Yuan to become whole.
We also see the who else is in the same boat question. If other companies followed this same strategy, how much more could the CCP be facing? There could be hundreds of billions more ready to roll over and face default.
We can presume that Evergrande is not the only company in this position.
The government could get with the banks and work out an arrangement. They will get the debt extended, with government backing, yet no connection be released publicly. This allows the government to look like it is hands off but alleviate collapse.
It could also then leave the foreign investors, i.e. Westerners, out to dry. Call it a win on both fronts if this route was taken.
Of course, we would still see considerable damage to the global situation. Depending upon who is exposed, there could be more than $100 billion in foreign entities that is basically worthless. That is going to hurt any institutions balance sheet.
If it is American banks and insurance companies, it will hurt. Nevertheless, it will not take down the system since those entities are rather strong. The European banking system is not on firm ground however. Them being exposed could be fatal to some of those institutions.
A backdoor deal would alleviate some of the present pressure but it would also harm China a great deal internationally in the medium term. The fact that foreign institutions were hung out to dry would make other investors hesitant to get involved. Ultimately, that country could see capital inflows starting to dry up.
This is no minor issue and there is no "soft landing" on it. We are going to see a hard crash somewhere along the line. The Chinese government cannot successfully navigate this without some fallout. At this point, it is only a question of where it will hit.
We need to watch this situation closely over the next few months. There is likely going to be a lot more to the story.
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