Evergrande and the Story of why China is the Better System

Evergrande, China’s second largest real estate developer, recently filed for bankruptcy at the beginning of December. Since the start of 2021, the company has reported extensive financial trouble with an overleveraged portfolio and has been unable to pay its debt to both overseas investors and its employees. This has led to a huge sell off of the company’s stocks, protests against management and the Chinese government intervening with mandates to protect economically vital assets within the company.

Should Evergrande declare bankruptcy, this can directly impact the 200,000 Evergrande employees and thousands of upstream and downstream companies that rely on Evergrande for business. In other words, the success or failure of Evergrande can impact more than 3.8 million jobs

This fiasco begs the question as to:

How has Evergrande gotten into big trouble?

Evergrande borrowed heavily from banks in order to acquire land and investment in new projects in a debt-fueled expansion. Eventually, the interest acquired outweighed the payoff for these investments as it heavily relied upon on increasing real estate prices.

They also engaged in a number of activities that were similar to the Lehman Brothers bank during the 2008 financial crisis. The company owed extensive debt to their own executives at 25% interest over 2 years and sold Wealth Management Products to the public at a ‘guaranteed’ 5-10% interest rate. That’s not to mention another unknown subset of liabilities including off the books debt, WMPs to construction partners and even presale cash before projects began.

In other words, the company took on a large number of high risk, high interest loans in order to fuel a rapid expansion and depended upon high real estate prices for the return on the investment. Sound familiar? It might, because this was roughly the model that led to the 2008-2009 financial crisis or great recession in the U.S. Essentially large Wall Street banks offered hundreds of high-risk low-entry barrier loan packages (NINJA loans) that were then packaged into collectivised debt obligations (CDO). These were then speculated upon at almost a 100 times their value by financial institutions.

Given that there are so many similarities between the Evergrande crisis and the 2008-2009 financial crisis, shouldn’t we expect the same sort of financial meltdown in China?

The answer is not necessarily and increasingly not likely because there are some key differences between the two scenarios.

Evergrande owns more assets than liabilities particularly when it comes to land. Unlike that of the Lehman Brothers who owned primarily financial assets that all crashed during the great recession, Evergrande primarily owns physical assets including hundreds of millions of acres of land, properties and even their profitable energy sector. The only reason why they recently defaulted on their debt is because the CEO Xu Jiayin said at an emergency staff meeting on September 10, that “in China land is the most valuable assets…this is Evergrande’s biggest asset and last resort.”

In other words, he refuses to sell off land in order to pay back their immediate debt which indicates, at least for now, he is either trying to calm the angry investors and/or believes in the long term viability of the company.

The type of debt structure is also dissimilar as Evergrande owes financial institutions, while during the 2008-2009 financial crisis regular people owed the majority of the debt.

Another major difference is the early governmental response. Unlike the 2008 financial crisis where the government ratings agencies were paid off by the banks to give the CDO’s high marks on their underlying value, the Chinese government has taken a series of precautionary measure to protect against economic fallout. They have increased foreign exchange reserves and ordered evergrande to prioritize land developments. They have actually issued travel bans for certain executives in case they try to just dump their assets and leave the country.

Furthermore, China has prioritized the 3.8 million upstream and downstream jobs over the WMP investors, which is why many of the projects that were previously halted due to liquidity crunches have since restarted. It is because of strict and early government intervention that the fallout will likely to be softened. This is contrast with the 2008-9 financial crisis in the U.S. where the large stimulus given to the banks were primarily used to pay the executives large bonuses and write them off as business expenses.

The Chinese government has also indicated that it will not bail out the company but will only ensure that the least harm is done to the wider Chinese economy. In other words, they have have endeavored a series of long term measures in order to stopgap any potential fall out.

But perhaps, the biggest difference between the two and the reason why Evergrande is not going to be China’s ‘Lehman Brothers moment’ is because of the priority of it’s very different political system. Although China suffers from corruption, because it is not capitalist the bosses are not the titans of industries as much as they are the people. China's capitalists are not special citizens with the right to do whatever they see fit with virtually no consequences. The country regularly executes large numbers of billionaires for crimes like larceny, murder and organized crime.

The U.S. despite the apparent corruption has never executed anyone with significant wealth and status. Money can allow you to get away with crime because of the worship of capital in the U.S. whether it’s rape like with Brock Turner, or the systematic molestation of little kids like with Epstein.

Killing capitalists when they commit horrible crimes is an amazing deterrent from them exercising their power as though they were god’s and thus reminds them that they are human and can be humbled to our level at anytime.