Is Evergrande really Lehman Brother’s moment in China?


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As US President Biden recently returned from his trip to Asia, there was one country he did not visit that has significant global economic implications; China. The Great Recession and the Asian Financial Crisis are still fresh in many people’s minds and a possible global recession is looming given geopolitical tensions, lockdowns in China due to a global pandemic, coupled with the fact that the Chinese group Evergrande could default on its debt. This month, Evergrande’s onshore unit won approval from bondholders to extend payments originally due May 6 on two yuan notes by six months, according to documents filed with the Shanghai Stock Exchange. The conglomerate will unveil a debt restructuring proposal to its creditors by the end of July, but the reputational damage is already done.

One can’t help but wonder “Is this another Lehman Brothers moment?” While defaults by Evergrande, Shimao and other property developers could lead to an economic slowdown and the loss of over 250 million Chinese jobs, there is one more thing that can stop it, the Chinese government. The Chinese Communist Party (CCP) has been able to create a well-planned response and unite people behind a common cause.

In 2008, Lehman Brothers Holdings Inc. officially filed for bankruptcy. Driven by risky investments, wild speculation and the belief that the real estate market could not decline. This singular event catalyzed the Great Recession, responsible for an estimated $10 trillion in lost economic output. The global economy has finally recovered, but many people’s homes and retirement savings are gone forever. Since December 6, 2021, China Evergrande Group has been in technical default. Many fear this will lead to the collapse of China’s property market and wipe out billions of generational wealth. These similarities have led people to call this the collapse of Lehman Brothers in China, but is that really the case?

The US housing crash and economic response can provide important lessons for China. Its response ultimately led to economic recovery and has been the subject of extensive analysis over the past decade. One possible program that could be of significant interest is the Troubled Asset Release Program (TAR

AR
P). Essentially, the Federal Reserve would invest in failing institutions through corporate stocks and preferred stocks with guaranteed dividends. A TARP program in China could have a high chance of success. By targeting loans with the highest probability of default, they could stabilize these promoters. A priority item would be to complete the delivery of the apartments they have already sold, but not yet built.

The Chinese government has provided mixed messages in helping Evergrande. Beijing has been reluctant to offer unequivocal support for fear of a public backlash from individuals who might also want a bailout. However, at other times the CCP has stepped in and taken more control over the Evergrande Group, which it may also do with other developers for fear of public unrest over the housing crisis. China has seen protests, a rare occurrence in China, outside the Evergrande Group headquarters in Shenzhen, underscoring people’s outrage at the situation, and the current lockdowns in China have only fueled that anger. In China, homes can easily account for 45% of a household’s net worth. In some Tier Three and Tier Four cities, it’s closer to 70%, compared to just 27% in the United States.

Where potential defaults could continue is in the $20 billion of foreign bonds. After a group of international investors threatened to go ahead with legal action that could include the liquidation of the company’s assets, several banks decided to seize $2 billion from one of the principal subsidiaries of Evergrande on March 22. This could make the situation even worse, Evergrande has already replied. that they “sincerely request all offshore creditors to grant us more time”. Debts and deliverables to Chinese investors have been prioritized, and foreign investors will either have to wait or possibly write off the losses as bad debts.

Real estate accounts for around 25% of China’s GDP and has been a key driver of growth. Beijing must strike the right balance between supporting Evergrande while avoiding moral hazard in which the government bails out any company that fails to repay its debt. Lessons learned from the US financial crisis will show what works and what perpetuates a corrupt system. While prioritizing the realization of the investments made, the CCP should support companies by helping them restructure debt and promoting better governance and reporting mechanisms. With a focus on common Chinese investors and in line with President Xi’s “common prosperity” theme, Beijing must develop an environment that fosters more trust, transparency and engenders fiscal responsibility.

Earl Carr is founder and managing director of CJPA Global Advisors and publisher of the new book, “From Trump to Biden and Beyond: Reimagining US-China Relations.” Mr. Carr is also an Adjunct Instructor at NYU’s Center for Global Affairs.

Special thanks to James Hinote, Geopolitical Analyst at CGPA Global Advisors for his exceptional research and writing skills, and to Pengyu Lu, Senior Advisor at CJPA Global Advisors, for providing a timeline of events.

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