Will Evergrande Cause A Market Crash?

A variety of factors contributed to the 2008 global financial crisis, beginning with serious misses in real estate lending policy and regulation that went on for years.

By April 2007, the United States’ largest independent subprime lender, New Century Financial, declared bankruptcy. Global investment bank Bear Stearns narrowly avoided the same fate with a desperate sale to JP. Morgan Chase (JPM) in March 2008. 

Then, in September 2008, the investment bank Lehman Brothers collapsed. Investors were terrified – with good reason. The entire US stock market immediately crashed, setting off a global recession. 

The crippling repercussions of that dark time in economic history are still fresh in the world’s collective memory. It’s no wonder, then, that the prospect of default by China’s Evergrande – a massive real estate developer – has everyone on edge. 

Will Evergrande default? Will Evergrande go bankrupt? And most importantly, will Evergrande cause a market crash?  

Evergrande Collapse: A Story Of Leverage

Whether it is a list of the best companies to work for in the United States or a ranking of the world’s richest people, Fortune keeps close track of wealth and business success. Its Global 500 lists the biggest companies on the planet by revenue. In its most recent report, Evergrande was number 122. For context, that is one place higher than the entire United States Postal Service. 

Evergrande has more than 200,000 employees on its payroll, but it is credited with sustaining as many as 3.8 million jobs.

In addition to owning at least 1,300 real estate projects in 280 Chinese cities, the company has investments in sports, theme parks, food and beverage businesses, and electric vehicles.

Its reach stretches into dozens of aspects of daily life for Chinese citizens, which makes the prospect of its collapse downright chilling. The problem? In a word, leverage. 

All of those projects, whether real estate or otherwise, require cash, and Evergrande borrowed with abandon. It is now notorious for being the most indebted developer in China, with liabilities totaling more than $300 billion. 

Investors and industry experts have been concerned about Evergrande’s debt for some time, and their concern was well-placed. In recent weeks, Evergrande alerted investors and the larger marketplace to cash flow issues.

Worse still, Evergrande’s management warned that it might default on certain debts if it doesn’t realize an influx of cash right away. To date, it has been unable to sell certain assets due to a lack of interest from prospective buyers. 

There is a lot of discussion about how Evergrande got into such a mess, and as with any complex financial issue, it can be traced back to a combination of intertwined factors. The consensus is that, when put as simply as possible, Evergrande erred by getting involved in too many industries that were unrelated to its core business. 

Of course, the whys aren’t especially important just now – at least not for those whose livelihoods and assets depend on Evergrande. At the moment, stakeholders need to know whether Evergrande can recover – and if not, what that means for their own financial futures. 

Will Evergrande Default?

Year-to-date, Evergrande shares have lost 85 percent of their value as the company dropped hints that all was not well.

Things came to a head in September when credit rating agencies signaled they had lost faith in Evergrande’s ability to resolve its cash flow issues. Fitch Ratings went so far as to say that the agency views “a default of some kind as probable.” 

So far, Evergrande has missed two large payments – one for $83.5 million on September 23rd and another for $47.5 million on September 29th. Once those payments are 30 days past due, the company is considered to have defaulted. 

Evergrande leadership has outlined some of its attempts to get back on track, including the sale of portions of its electric car business, parts of its real estate servicing business, and its multi-billion dollar office tower in Hong Kong.

So far, the company has been unable to find buyers.

Is default a certainty? Not quite yet – but Evergrande’s window of opportunity to resolve this crisis is rapidly closing. 

Will Evergrande Get Bailed Out?

When massive US financial institutions began to teeter during the 2008 crisis, the U.S. government passed the Emergency Economic Stabilization Act of 2008. It is often referred to as the Bank Bailout Act because it allowed the government to buy hundreds of billions in distressed assets from troubled financial institutions for the purpose of stabilizing the economy. 

The Act led to a new term in the national conversation: too big to fail. In other words, taxpayers had to foot the bill for poor decisions by private-sector corporations because the failure of those corporations would cause too much damage to the nation’s economy. 

The size and scope of Evergrande – and the potential for catastrophic consequences if it fails – has the world talking about too big to fail companies again. In the Chinese media, there is a lot of discussion on the prospect of a government bailout. The general sentiment is that pouring money into Evergrande is akin to sending cash into a black hole. 

With that in mind, the Chinese government has shown interest in certain limited forms of intervention. Specifically, there don’t appear to be any plans for bailing Evergrande out directly, but there have been steps taken to limit the fallout if Evergrande should default on its debt. 

For example, it appears that the government is likely to ensure that individuals and families who have purchased homes from Evergrande will be made whole, and there has been an effort to “limit contagion” by purchasing Evergrande’s stake in a key financial institution.

At the opposite end of the spectrum, there is no indication that the government intends to protect Evergrande’s bondholders, which could create another set of problems. 

Will Evergrande Go Bankrupt?

Most experts agree that if Evergrande remains on its current path, some type of bankruptcy and restructuring is practically a certainty.

The company strongly disputes this projection, and its leaders have stated unequivocally that they will find a workable solution to prevent total collapse. 

The debate around will Evergrande go bankrupt is far from settled, and there are still a few pieces that may fall into place in time to prevent default on debts. However, the window is closing rapidly, and if nothing intervenes in the coming weeks, bankruptcy is the only possible outcome.

That could be an issue for investors in every part of the globe – and there may be larger ramifications to the world economy. 

Will Evergrande Affect The US?

Market analysts are torn in their evaluation of how an Evergrande bankruptcy would affect the United States. Most believe that there are enough protections in place to prevent the chain of events that followed Lehman Brothers’ collapse, but that doesn’t mean a complete lack of consequences. 

If Evergrande goes down, there will be an impact on the Chinese economy. It is fairly certain that the Chinese government will intervene to prevent this type of fallout, but international bondholders – including those in the United States – will see losses. 

Most analysts are recommending that U.S. investors avoid Chinese stocks and Chinese companies listed on United States exchanges for now, as an Evergrande collapse could keep the Chinese economy stagnant for some time.

However, on the chance that there is global economic fallout from an Evergrande bankruptcy, investors would do well to review their portfolios now. Diversification is key in a widespread financial crisis. 

How Evergrande Crisis Affects Mining Stocks

Finally, as analysts and economists examine the potential ramifications of an Evergrande bankruptcy, there has been quite a bit of attention paid to mining stocks.

China is the world’s largest consumer in terms of certain metals and minerals. A decline in the Chinese economy could create substantial drops in demand for those commodities, which will ultimately affect companies and shareholders on a global scale. 

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.