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Everything You Need To Know About the Chinese Evergrande Crisis (So Far) - How Money Works - YouTube
Channel: How Money Works
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Evergrande is China’s largest
property development company
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and was (up until recently) one of the
most valuable companies in the world.
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However most analysts are now
predicting that this company
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is on the verge of insolvency and won’t
be able to meet its mountainous debt
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obligations without direct government
intervention within the next few weeks.
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For those of you who are not already aware
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this has the potential to be far more than
a run of the mill corporate bankruptcy.
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The company employs over 200,000 people directly
while also providing work for as many as 4 million
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subcontractors who work to erect thousands
of buildings for the company every year.
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Beyond just job losses, the company is also
holding deposits for 1.5 million properties
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that may not be delivered to regular Chinese
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citizens who were just looking for
a home or an investment property.
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Now loosing a home is terrible in ANY
country, but perhaps nowhere more so
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than in China. The value of these properties
compared to the incomes of people buying them
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is astronomical, and it often takes multiple
family generations to save up for a deposit.
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Because of this, real estate has become basically
the only thing that most people invest in,
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and over a million people losing that investment
will have massive knock on economic impacts beyond
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just putting people out on the streets
(as is that wasn’t bad enough already)
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Despite these social issues and the apparent
threat to the national and global economy
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the Chinese government has said that they
are not prepared to bail out the company.
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Why? Well politics… but there
are a few things that you need
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to understand about this crisis as
we watch it play out in real time.
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The first is how this collapse actually
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started in what looked like an
otherwise very healthy company.
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The second is how bad could this get
if the government DOESN’T step in.
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And the third is, Will this all be contained?
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Or could this leak out and cause an economic
collapse in countries outside of China?
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Well it’s time to learn how money works so
you can have a better understanding about
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what all of these alarming headlines really
mean. This is video was brought to you by
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the channels patrons and channel members. If
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Alright, so many people are
calling this China’s Lehman moment,
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in reference to the American investment
bank Lehman Brothers which was allowed to
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go bankrupt in 2008 effectively kicking
off the 2008 Global Financial Crisis.
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There are a lot of similarities here.
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Both of these companies are very large, they both
have a lot of debt on their books, that debt is
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being offset with assets that may not be nearly
as valuable as people might think, and finally
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they both look to have been left for dead by their
governments which have decided to let them fail.
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Now of course Evergrande is not a bank,
it’s a property development company,
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but in China that’s almost worse.
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Property is basically the only thing
that average citizens invest in
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so it’s as if you took the us financial
market and housing market and rolled
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them all up into one for people to
speculate on… sort of like in 2008.
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Now the regulators knew this, and
they saw the problem of an asset
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price bubble having the potential
to cause major economic factors.
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It’s because of this, that the
story of Evergrande’s problems
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actually start more than a
year ago in august of 2020.
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Property is never “owned” in China, it is leased
from the government for a set amount of time
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most commonly 70 years. These land leases are then
purchased by property developers like Evergrande.
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The property developers will then design apartment
buildings and pre-sell the units they designed to
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regular investors who will put down a deposit and
wait for the buildings to actually be finished.
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The developer can then take this money and use
it as a down payment to borrow even more money
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to either buy up more land leases, or to use on
the actual construction of buildings on that land.
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This system works very well for rapid expansion
and it is in theory a win-win for everybody.
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Evergrande and other developers were able to buy
up more 70 year leases and build more houses,
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regular investors were able to get access
to properties that were far cheaper than
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existing apartments for sale in china, and the
banks and non-bank lenders were able to give
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money to an institution that was offering
good returns on a secured line of credit.
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Most of these lenders figured that in
the extremely unlikely scenario that
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a company like Evergrande defaulted
on it’s debt’s they could just yoink
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the properties they had on their books
and easily cover all of these loans.
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Now… Evergrande had seen that properties in China
were appreciating at a rate of about 10 – 15%
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per year so they wanted to
push this limit to the extreme.
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They wanted to borrow more money, buy up
more land rights, presell more apartments
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all in an attempt to grow as fast as possible.
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This DID work well, the company was highly
profitable, it always had more assets than
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liabilities and continually gave consistent
returns to both equity and debt investors.
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But all good things must come to an end and that
brings us back to August of 2020 when the Chinese
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government introduced new laws in to control the
amount of debts that developers could take on, and
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also how the money that companies like Evergrande
were getting of pre-sales could be used.
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This was a big problem because it
radically altered the high growth business
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model that the company had become reliant on.
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The company basically needed a constant stream
of new money coming in from property buyers to
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keep the whole operation running,
but it did have a backup plan.
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If this money ever slowed down
the developer could just lower
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the prices on their pre-sales
to attract more buyers and prop
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up the system again. Sure they wouldn’t make
as much profit, but it’s better than nothing.
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In a worst case scenario the company just kept
certain properties on their own books as real
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estate assets. This meant that they could borrow
even more against the value of these finished
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properties and never need to realise a loss by
selling a property for more than it cost to build.
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This was not a bad strategy considering
property price growth in China meant
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that the company only ever needed to
hold onto these properties for a few
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months at most before market forces
made them profitable to sell again.
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However these new regulations meant
that the company was forced to hold
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onto more and more existing properties
while also needing to sell off their
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new developments at increasingly steep
discounts to keep the money flowing in.
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This caused two problems, for starters it
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undermined all of the holdings that
they had to offset their liabilities.
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I said at the beginning of this video that the
company had more assets than it did liabilities,
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and that is technically true, but only if you
accept that HUNDREDS OF BILLIONS OF DOLLARS
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worth of residential real estate holdings
are worth as much as the company says it is.
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Even if we ignore the propensity of Chinese
companies to… “massage”… their figures a bit, this
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is an alarming number because these assets are
NOT liquid… which leads us to the next problem.
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The new regulations have made it harder for
the company to borrow money to complete the
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projects it was working on. This has meant that
they company has had to sell more presales to
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fund existing projects which are in turn
going to be even harder to get funding for.
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The questions raised about the true value
of the companies real estate holdings has
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meant that the company has had to seek finance
from not one or two banks like most companies,
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but from over 128 different banks and
hundreds of other non-bank lenders.
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This started to raise alarm bells
with individual property investors
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who were waiting on their homes to be finished.
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Potential investors were starting
to see these massive real estate
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development projects (that used to
sell out within a matter of hours)
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were now being discounted over and
over again to try and attract buyers.
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Even if their overall attitude towards
the real estate market was bullish,
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it only made sense to sit back a bit and see if
they could snag themselves a bigger discount.
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This closed the faucet on the cash injector that
kept everything going causing bigger discounts and
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bigger question marks over how much the companies
inventory of property was actually worth.
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Now the company is in a situation where it
lacks the funds it needs to pay for day to day
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operations beyond the next few weeks. Of course it
could sell off these existing real estate assets
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as a last ditch attempt to free up some cash flow
but it would now be at a massive discount given
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the bad press and the fact that they wouldn’t
really have time to negotiate too hard on price.
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Now that leads us onto how bad this could get.
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…
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If the government did not intervene at
all the company would go into liquidation,
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the 1.5 million people that have paid
their deposits for homes that have not
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yet been built would lose that money
and the properties on the companies
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books would be sold off as quickly as possible
flooding the market with properties for sale.
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Even in a company as hungry for real estate as
China this would inevitably drive down prices.
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It would simultaneously put more eyes on the other
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property development companies who would
inevitably be in a similar situation.
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If property prices fall then their
inventories are going to be worth less too,
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meaning they will have less assets to secure
loans against, which means more difficulty
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completing projects, which means more trouble
paying off loans which means more liquidations.
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If you replace the words “Chinese
Apartments” with “Mortgage Backed
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Securities” it is easy to see why
people are calling this a Lehman Moment.
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Which leaves just one final question…
Will this impact markets in the west?
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The GFC quickly spread from the US to Europe
and then on around the world. China is the
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second largest economy in the
world so it’s not unreasonable
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to be a little concerned with the
same thing happening here right?
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Well yeah, we should all be
cautious of what this could mean,
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but I wouldn’t be overly worried just
yet. China’s markets by design are very
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closed off to the outside world which means
that they are much less interconnected with
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American markets than say American
markets are with European markets.
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What’s more is that it’s hard to believe
that the Chinese government would let it
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get quiet that bad. The strength and
unfaltering growth of the Economy has
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been the linchpin of the current government.
If they were to loose that they would not only
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have to deal with an economic catastrophe,
but also widespread civil unrest as well.
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As I said, this is a developing situation so
your guess about what comes next is just as
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good as mine, but at least you know the nuts
and bolts of the problem that they are facing.
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Now if you want to learn about something a little
bit more light-hearted go and watch my video
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on why jellyfish have secretly been used as a
global reserve currency for the past few decades.
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A regular video will still be coming at some
point this week, so this one is just an extra
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to keep you all up to speed on this situation.
These video’s are made possible by my amazing
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channel members and patreon supporters. If you
enjoy these video’s please consider supporting
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