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Is China repeating the Lehman crash ?

05 Aug 2022 By : Coin Gabbar
Southeast Asia’s Lar

With more stellar listings of IPOs and many various new cryptos popping out of the blue with their interesting mechanism, and catchy names and their gains showing double, triple, and maybe quadruple the price, it's only understandable why….

Evergrande, a Chinese real estate developer, is having problems, which has led to comparisons to Lehman Brothers' collapse in 2008.

Analysts don't believe that China's more tightly regulated financial system is about to experience a repeat of the outbreak that followed Lehman's collapse. But there is a significant connection between the two incidents: When a long-lasting mortgage bubble burst, Lehman failed. Evergrande is having the same trouble because China is attempting to move away from an economic growth model that greatly relies on debt, making the system more empty.

Read the latest news about China’s investment and major players movements and its crypto related adversaries.

China is not unique in its love of debt, but unlike the United States, it does not borrow to lower taxes or pay for social transfers. Instead, it makes investments in construction, infrastructure, and real estate. As long as the investment actually increases national productivity, the model makes sense.

The debt followed by the property boom—and, as a result, its economic growth—has long been a source of concern for long-term investors. They aren’t alone: Chinese policymakers have been trying to tackle the debt in its economy—a reason they were much more restrained in providing Covid-related stimulus in 2020 and the reason for the property crackdown that sparked the current slump.

What is Evergrande and how did it happen?

Exactly a week ago, Chinese real estate tycoon Evergrande, whose liabilities surpass $300 billion (£228 billion), missed interest payments to foreign investors.

The problem at the corporation with the highest level of debt in the world grew worse.

Due to this, Evergrande was deemed in default by Fitch, an organization that rates the financial risk of firms. The problem has alarmed investors who worry about a ripple effect throughout China's banking and real estate sectors.

Evergrande was expected to pay back interest on loans from abroad totaling approximately $1.2 billion. But the money had still not been transferred as of Wednesday.

Evergrande's restructuring discussions with investors may be hampered as a result of Fitch, one of the largest credit rating agencies in the world, declaring the company in default on Thursday.

Major investors pay significant attention to Fitch's risk rating.

What did the organization do and how did it affect the people of China?

When it was revealed that the world's most indebted corporation had missed a major repayment date, the issue there grew worse.

Evergrande, a powerhouse in the Chinese real estate market with debts over $300 billion (£228 billion), has not been able to satisfy its foreign investors' interest obligations. Evergrande was subsequently declared in default by Fitch, a company that rates the financial risk of businesses.

What Evergrande does?

Evergrande, previously the Hengda Group, was established in Guangzhou, southern China, by businessman Hui Ka Yan in 1996. Currently, Evergrande Real Estate owns more than 1,300 projects spread over more than 280 Chinese cities. Real estate development is now only a small part of the larger Evergrande Group. Its industries include producing food and beverages, building electric automobiles, and wealth management. It even owns Guangzhou FC, one of the top football teams in the nation. Despite seeing his wealth decline in recent months, Mr. Hui, who was once Asia's richest man, has a personal fortune of more than $10 billion (£7.3 billion), according to Forbes.

Why would it be important if Evergrande failed?

Evergrande's issues are critical for a number of reasons. First of all, many people purchased real estate from Evergrande even before construction started. If it fails, they can lose the money they have paid in deposits.

There are furthermore the businesses that transact with Evergrande. Construction and design companies, as well as suppliers of materials, are at risk of suffering significant losses that could drive them into bankruptcy.

Thirdly, if Evergrande defaults, banks and other lenders would be forced to reduce their lending. This might have an effect on China's financial system.

This could result in a credit crunch, in which businesses find it difficult to obtain loans at reasonable rates. The second-largest economy in the world would suffer greatly from a credit crunch because businesses that cannot borrow find it impossible to expand and, in some cases, are unable to continue operations. Foreign investors can become uneasy as a result and think twice about investing in China.

Is Evergrande 'too big to fail'?

The very significant possible consequences of such a heavily-indebted corporation collapsing have led some observers to think that Beijing may step in.

According to Mattie Bekink of The Economist Intelligence Unit, "we think the government will probably find a solution to ensure Evergrande's core company continues" rather than taking the chance of upsetting supply chains and upsetting homeowners.

Others, however, are unsure.

The influential editor-in-chief of the state-owned Global Times newspaper, Hu Xijin, stated in a post on China's chat app and social media platform WeChat that Evergrande should not rely on a government bailout and instead save itself. 

Mortgage suspensions are a different feature than during past bumps in the housing market, and, worry it could constrain developers of even viable projects that end up getting stalled because of the lack of financing. That could create further ripples in a market where housing prices are already slumping and economic uncertainty is high after Covid-related lockdowns led to anemic second-quarter economic growth.

There is no denying the economic risk, given that the property market is a major engine of growth. Defaults could rise as tighter liquidity stresses developers and some banks, which could also suffer, though many are state-owned and the government can easily infuse liquidity, limiting the risk of a systemic financial crisis.

While the bank itself made this mess to compensate for the losses incurred or maybe for a greater benefit for its customers, from their point of view, this certainly isn’t a capital investment that you can simply put up there for trade.

What was the Lehman crisis how is it analogically related to this?

After Lehman Brothers a multimillion company crashed in September 2008, Barclays PLC bought the company's U.S. brokerage division.

 Lehman Brothers and its affiliates' property was taken over by a team of hundreds of bankruptcy experts working under the guidance of turnaround company Alvarez & Marsal. This property included a multi-billion-dollar portfolio of corporate loans and securities as well as its residential mortgage loans and securities.

The dispute entered a new step in 2011 when a bankruptcy judge authorised the firm's compensation approach. More than $126 billion has been dispersed since then to the holding company's debtors by specialists.

Lehman Brothers Holdings Inc.'s bankruptcy was the most expensive in ever because it cost nearly $6 billion to shut down the failing investment bank and refund investor funds. It is accounted for the most fatal crash in the history of investment holdings companies.

Researchers noted that Lehman's bankruptcy fees and costs "far exceed those of any prior chapter 11 bankruptcy," noting that Enron Corp.'s fees, the largest non-financial bankruptcy ever, didn't even surpass the $1 billion threshold.

The cost of unwinding Lehman's brokerage, which regulates the liquidation of brokers, was estimated by the researchers to be $1.4 billion. The U.S. firm paid all of its customers in full, giving them $92.3 billion practically immediately after Lehman failed.

Conclusion-

Fearing a ripple effect across China's banking and real estate industries, the crisis has alarmed investors. Monday was the deadline for Evergrande to pay back the interest on nearly $1.2 billion in foreign loans. The money had not yet been transferred as of Wednesday, though.

The difference between the collapse of Lehman Brothers and the Evergrande issue is that when the US government needed to act, it had to adopt laws in order to have the right to intervene, whereas the Chinese government does not have this problem.

Beijing knows which developers are likely to default since it controls the country's property sector through state-owned banks, which Washington could not say during the subprime mortgage crisis.

Simultaneously, China is far more selective in its actions than the United States was during the global financial crisis. Unlike Washington, which bailed out some of the world's largest banks, China's Communist Party is taking a more cautious approach.

Evergrande's restructuring discussions with investors may be hampered by Fitch's declaration as a defaulter. Fitch is one of the largest credit rating agencies in the world.

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