AUTHORITIES BEGAN TO tighten their regulation of China’s property sector last year, fearing real estate developers’ debt was the country’s most significant systemic financial risk.
A slowing economy has only further exposed the property bubble and the extent of its over-leverage. The sector now faces a crisis that is coming to a head with the fate of one of its largest property developers, Evergrande, which has been offloading its properties at firesale prices to meet the new regulatory requirements.
According to the National Bureau of Statistics, home sales (by value) fell 20% year-on-year in August, while new homes prices rose at the slowest rate this year.
Evergrande, which faces defaults on some of its $300 billion of debt owed to its bankers this week, is widely considered on the verge of bankruptcy. Its scramble to sell assets fast enough to raise the cash to avoid defaults only pitches the property market into a vicious cycle of falling prices that risks bring down even more developers.
Evergrande’s share price has fallen by approaching 90% in the past six months, and global credit rating agencies have downgraded the firm’s bonds deep into junk territory. Yet Evergrande is ‘too big to fail’ both economically and politically.
A bailout of some kind is all but inevitable. The open questions are how it will be dressed up to reduce moral hazard and assuage widespread outrage — beyond the collapse in home values, more than a million people face losing deposits on unfinished homes — and who will foot the bill?
Secured creditors like bondholders account for one-third of Evergrande’s liabilities. Of the remainder, It owes about $147 billion in trade and other payables to suppliers. The risk of the impact rippling through the real economy is significant. Authorities may still be grabbling with quite how extensive and risky those supply chain linkages are.
A way will be found to move Evergrande’s bad debt into official hands, albeit, to mix metaphors, through gritted teeth. The scale of the required rescue is greater than anything experienced with Anbang and other over-extended corporate casualties. The political will also feels weaker, though it will be stiffened as needs be.
Authorities will also have to adjust the expectations of those who invest their savings in a home in the belief that property values never go down.
This all has some of the feeling to it of both the collapse of Japan’s property bubble in the 1980s and the Lehman Brothers bankruptcy in the United States in 2008. Evergrande is systemically important, and its failure would reverberate across the economy with unintended consequences, perhaps for years.
The policy decision to be made is a very high-stakes one. Beyond avoiding a corporate credit crunch, there is the question of whether the potential impact on local authorities is fully understood. Is there reliable data on which to make that assessment?
This Bystander expects a cautious forced restructuring with the bad debt being buried, not resolved. Some executives will undoubtedly be labelled corrupt, official fingers of blame will be pointed at ‘speculators’ and punishments, arbitrary or otherwise, doled out.
Other official fingers will be tightly crossed, hoping to get through the crisis without triggering the economic conditions that befell Japan in the 1990s or the political tensions in the United States that have followed the 2008 global financial crisis.