The Regulatory and Financial Crises of Evergrande’s Real Estate Investments in the Chinese Economy: “Three Red Lines”
The Chinese government launched a program known as the “three red lines” in early 2020 to deleveraging the real estate market. Recognizing that this sector was overheated, Beijing placed restrictions on how much it could borrow.
Judge Linda Chan said Monday it was appropriate for the court to order Evergrande to wind up its business given a “lack of progress on the part of the company putting forward a viable restructuring proposal” as well as Evergrande’s insolvency.
China’s economic boom was driven by real estate but developers borrowed heavily to create apartment and office towers. It has helped to push corporate, government and household debt to the equivalent of over 300% of economic output, a high for a middle-income country.
Financial markets were rattled by the fear of an Evergrande Liquidation. But Chinese regulators said the risks could be contained. Only a few billion dollars of Evergrande’s debt was owed to foreign creditors.
Evergrande’s Hong Kong-traded shares were halted from trading at the start of the day. But Hong Kong’s benchmark Hang Seng index was up 0.9% and some property developers saw gains in their share prices.
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There is no relevant purpose for the court to adjourn the petition because there is no restructuring proposal that will garner the majority of the creditor’s support, Chan said in remarks published online Monday.
She lambasted the company for putting out only “general ideas” about what it may or may not be able to put forward in the form of a restructuring proposal. The interests of creditors would be better protected if Evergrande is wound up by the court, she said.
He said the group’s domestic and overseas units are independent legal entities. Siu said Evergrande will try to keep smooth operations and deliver properties to buyers.
He said that if affected, they will still make every effort to ensure smooth advancement of risk resolution and asset disposal.
The fallout from the property crisis has also affected China’s shadow banking industry — institutions that provide financial services similar to banks but operate outside of banking regulations, such as Zhongzhi Enterprise Group. Zhongzhi, which lent heavily to developers, said it was insolvent.
China is going to be producing a lot of goods that they need to sell, and they are going to be selling them on the cheap. I would think that could be a deflationary force.
Roberts sees similar concerns. The U.S. is entwined with China and most top U.S. companies have a substantial amount of their revenues and profits in China.
At first glance, that would seem to benefit consumers buying Chinese-made goods. Instead, it’s more likely to mean that U.S.-based competitors will need to lower their prices to compete with a flood of ever-cheaper Chinese products.
China is a huge economy and should be on the American’s radar. “If China is having severe deflation at home, pretty much the only choice left would be [for it] to export deflation.”
Beijing has realized that China’s model of an export-led economy doesn’t work forever, and that it has been trying to encourage domestic consumption to take up some of the slack.
Although Evergrande’s demise is unlikely to have an immediate impact on U.S. consumers, it is yet another indicator that China’s economy — which makes up about 20% of the world’s GDP — is undergoing a painful period of slowdown, and that could result in slower global growth down the road.
Diana Choyleva, a senior fellow on China’s economy at the Asia Society, says Evergrande’s investors — both foreign and domestic — will see the biggest impact from Monday’s ruling in Hong Kong.
The drawn-out liquidation of Evergrande means ordinary investors who just wanted to buy an apartment and larger institutional investors “are going to need to stand in line, and the courts are going to have to figure out who is going to be at the head of that line and get paid,” Kennedy says.
Some Chinese households have 70% of their assets in their apartments. Roberts says that the collapse of Evergrande comes as a blow to some.
“At some point, you may not be able to actually complete all of that housing. … Eventually projects get bogged down and your financing situation gets worse,” Kennedy says.
In the last 6 years, Evergrande was selling apartments to the middle and upper-income Chinese. The company was listed as the world’s most valuable real estate company. It was on the edge of financial ruin three years later. China’s economy faces a number of near-term obstacles, including slowing growth, increasing debt, and a declining workforce, which have become symbolic of Evergrande.
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The dramatic fall of Lehman was due in large part to millions of risky mortgages propping up an unstable financial system. Homebuyers with mortgage payments they couldn’t afford defaulted on their loans, sending shock waves through Wall Street and leaving those borrowers vulnerable to foreclosure.
“It worked,” says Dexter Roberts, director of China affairs at the Mansfield Center at the University of Montana. “Evergrande has been the biggest victim of that policy.”
Roberts is a senior fellow at the Atlantic Council’s Global China Hub as well as author of The Myth of Chinese Capitalism.
Scott Kennedy, who is a senior adviser and Trustee Chair at the Center for Strategic and International Studies, agrees with others that Evergrande’s collapse shouldn’t be a surprise to its investors.