The Chinese real estate giant Evergrande is threatened with collapse. Experts fear that other Chinese corporations could also get into trouble. However, comparisons with the 2008 financial crisis go too far.
Evergrande is the second largest real estate developer in China and has accumulated debts of the equivalent of more than 300 billion dollars (256 billion euros). Investors fear a default.
The troubled corporation has to raise money to pay banks, suppliers and bondholders on time. The company is so large that some experts fear a “risk of contagion” for the Chinese economy and beyond. The most important questions and answers:
How could this happen?
Corporations like Evergrande have grown rapidly in the past ten years because real estate prices in China have risen sharply and there has been a construction boom. However, it was a thorn in the side of Beijing that the industry’s indebtedness continued to grow. Now the government is enforcing strict rules. Beijing has shown the corporations “three red lines”. The ratio of liabilities to assets must not be more than 70 percent. In addition, the net indebtedness should not be more than 100 percent. The third “red line” concerns the ratio of liquid funds to short-term liabilities of the company, which must be greater than a factor of one.
Why does it hit Evergrande so hard?
The group was particularly aggressive on the market. Land purchases were financed with loans, new apartments sold at low margins to drive sales up. Evergrande not only built houses, but bought a football club in 2010 and invested in other industries from mineral water to baby milk to electric cars. His stand at the Shanghai International Auto Show in April was one of the largest, although the company hasn’t even really started building cars yet. In the first half of the year, the e-car division alone posted a loss of the equivalent of 630 million euros.
Will the Chinese Government Rush to Help?
Investors are eagerly awaiting how Beijing will position itself. In the past, when major economic failures threatened, the government usually rushed to help to prevent upheaval. In the case of Evergrande, however, the situation is different. After all, the Chinese leadership wants to use the new rules to ensure order. An example could therefore be made of Evergrande. The rating agency Standard & Poor’s warned in a statement on Monday that the government could not assume that the group would be bailed out. Beijing would only be forced to intervene “if there were widespread contagion that would result in the collapse of several large construction companies and pose systemic risks to the economy,” the agency said.
How do the stock exchanges react?
Concerns about an expansion of the crisis are affecting sentiment on stock markets around the world. At the beginning of the week things went down significantly. The German benchmark index Dax fell to its lowest level since May. “The fear of the next real estate crisis is currently great,” is how market expert Christian Henke from trading house IG describes the situation. The Chinese government does not seem ready to help Evergrande. “The concern now is that more corporations from this sector will be torn into the depths and that a new real estate crisis may develop from this. Memories of the bankruptcy of the US bank Lehman Brothers in 2008 are awakened. “
What were the consequences of the Lehman bankruptcy?
At that time, the real estate bubble financed on credit had burst in the USA. Junk loans bundled by financial jugglers into obscure securities turned out to be largely worthless. Because of the global networking of the financial markets, the problem, initially limited to the USA, grew into a global banking crisis no later than the bankruptcy of the US investment bank Lehman Brothers on September 15, 2008. Financial institutions had to cope with losses in the billions, trust in business partners eroded, and many institutions were saved from collapse with billions in taxes. The upheavals in the financial system plunged almost all economies into recession in 2009.
Is Evergrande’s location comparable to Lehman’s?
Should a colossus like Evergrande go bankrupt, creditors would have to expect defaults. “The difficulty is always the systemic risk,” said China expert Horst Löchel from Deutsche Welle’s Frankfurt School of Finance and Management. “Banks can get into trouble as a result, and in the worst case scenario, this creates a negative pyramid scheme. If that happened, the upheavals would of course be enormous. “
However, Mirko Wormuth from the German-Chinese fund Awesome Capital considers the comparison of Lehman and Evergrande to be “not at all appropriate”. Evergrande has 90 percent of its business in China and is therefore “a nationally limited credit risk,” said Wormuth to the business magazine “Capital”. For most medium to large banks, loans were not a large part of the total. The Deutsche Bank fund subsidiary DWS points out that “the direct involvement of foreign bondholders in Evergrande seems to be relatively modest”.
What do experts expect for the Chinese banking sector?
Landesbank Helaba experts do not rule out a “Lehman effect” in China. According to DWS, even among the Chinese banks, “the commitment should be fairly broadly diversified, and the high level of debt has likely already led to high write-downs, which could perhaps limit further imbalances”. However, Chinese banks and financial institutions are also heavily involved with Evergrande’s suppliers, so that domino effects cannot be ruled out, writes the DWS.
Standard & Poor’s believes the Chinese banking sector could digest a possible collapse of the real estate giant without major turmoil. According to S&P calculations, Chinese banks had about 400 billion yuan (52.6 billion euros) in the fire with the company at the end of June. “A collapse of Evergrande as such would not destabilize the banking system,” says the agency’s assessment. If, however, other large, highly indebted real estate developers should get into turmoil as a result, this could result in a “challenging situation”.
Jane Stock is a technology author, who has written for 24 Hours World. She writes about the latest in technology news and trends, and is always on the lookout for new and innovative ways to improve his audience’s experience.
