This is the story of a huge
change in the Chinese economy. A story about
hubris, about excess, but above anything else,
it's a story about debts. Eye-watering
amounts of leverage. The rapid expansion of
China's property sector on cheap credit. The meteoric rise
of a company founded by one man who
ultimately thought that he could do
anything as long as he borrowed enough money. This is a story of
the failure of one of China's, and
also the world's, largest real estate developers. A property developer
that came out of absolutely nowhere and within
10 years had $150bn of assets. The most indebted
property company in the world, Evergrande Group. If Evergrande
really goes under it would definitely become China's
biggest ever bankruptcy case. This story goes to the
heart of China's position as the prime locomotive
of global economic growth. For decades the property
sector has essentially anchored China's economy. You can't underestimate how
important the property sector is to China. A third of China's economic
output is in property. For other countries,
say US or UK, the ratio would fall
below 20 per cent. The reason for that
is quite simply one of the most
remarkable things that's ever happened in human history. A great migration of people from
the countryside to the cities of China. Hundreds of millions of sons,
and particularly daughters, of Chinese farmers,
who moved from the farm where they were earning
really the same as they were earning 1,000 years
ago in Chinese history. Absolute subsistence wages. They travelled four or five
hours to the local city, and there they began working
in the big factories, the workshop of the world. In the 1990s, when Evergrande
was launched, about a third of Chinese people
lived in cities. China's urban population
grew from around 415m in 1998, when the housing
reform began, to more than 900m as of the end of last year. Now there are more people
living in cities than there are in the countryside. Before 1998 every
Chinese urban citizen would get a flat for
free from the government. People who lived in
government apartments were allowed to buy
those apartments at really a peppercorn amount. Chinese banks began issuing
mortgage loans and also development loans to
property companies. Every single person that moves
from the countryside in China to a city needs to
live in an apartment. And someone's got to
build those apartments. Construction workers, who mostly
work for property companies, account for more
than 10 per cent of China's total workforce. Land sales, which will
then feed into real estate, account for almost a
third of local government fiscal revenue. It created the perfect
conditions for the world's biggest ever property boom. Evergrande was founded
in 1997 by Hui Ka Yan. It was absolutely
at the right time. Hui Ka Yan was really good
at spotting that opportunity and capitalising on this trend. Developers like Evergrande,
and there are dozens and dozens of them, built China's
cities, in many cases almost from scratch
to accommodate this massive historic
flow of people. Owning your own home after a
period of no property rights, I guess, is a massive
aspiration of the middle class. A middle class that now
numbers well over 400m people. This was the absolute crucible
of China's economic boom over the last two decades. Hui Ka Yan, he just rode it. He just rode it from
the very beginning. He began building all kinds
of projects in Guangzhou. It's why it was able to
just borrow so heavily. So it started from nothing. Within 10 years it had
$150bn on its balance sheets. From 2004 to 2020 Evergrande's
total revenue grew at an annualised
rate of 44 per cent, the fastest growing companies
you would ever see in China. He's really been a poster boy
for how much money you can make out of Chinese real estate. Hui spotted the opportunity
making small shoebox apartments. Instantly became a big success. In 2017 he shot to fame by
heading up the China rich list, clocked $42.5bn. It's quite a departure
from his humble origins. People who've met him
say he's an extremely charismatic person, an
extraordinary salesman. He likes to hire people from top
tier universities in the west to be his personal
secretary, to make him look like a westernised boss. He also was very
good at cultivating political connections. You need those
connections in order to get access to more credit. He cultivated very
good connections with Joseph Lau, a
notorious Hong Kong tycoon, whose company had lots of
investment in Evergrande. He was also part
of the delegation for when Xi Jinping visited
Great Britain in 2015. You don't just
randomly get invited to join those sort
of delegations. So it definitely made
the effort to make those political connections. The chairman of Evergrande's
had a massive taste for luxury. He has lived this lifestyle
associated with newly minted Chinese billionaires. He's got a luxury
house on the Peak. He had a superyacht. He was quite a
generous gift giver. He loved to mix with some of the
most important people in China, in Hong Kong, even from the UK. In 2015 when his soccer
team, Guangzhou Evergrande, had won the Asia
Premiership, he had Prince Andrew, Jack Ma over at
his hotel, popping champagne. One of the ways in which he
sort of ingratiating himself with some of these tycoons was
that he had these card nights. The folly of his
ambition is no better seen than in this huge sprawling
plot in Hong Kong called Project Castle,
where he intended to build this Palace of
Versailles-style mansion in one of the most overdeveloped
places in the world. Ten years on it's a
muddy plot of land. Evergrande went from nothing
to being this huge developer with over 1,000 projects
in over 200 cities across mainland China. Over two trillion renminbi of
assets on its balance sheet. It's a business model that lends
itself to very rapid expansion. Real estate developers
in China are buying land from local governments. Local governments are a key
economic actor in China. They are the people who
decide whether or not to build an industrial park
over here, a factory over there, real estate
development somewhere. So these developers
buy their land, build apartments on the land,
and they sell the apartments to customers before
they've built them. The homebuyers need to
make in advanced payment. Evergrande has
allocated the funds to other areas,
which, in turn, has cost the projects to be
stalled, which would then anger these homebuyers. This arms race between
multiple developers encourages them to move
as quickly as possible. Once you inject that into it,
the whole thing speeds up. The Chinese government has tried
to control and constrain it, limiting the use of
onshore debt to buy land. It's one reason that offshore
debt, international bond markets, became so attractive. But Evergrande took advantage
of seemingly limitless demand from global investors for
Chinese real estate debt. It just seemed so
clear that it was going to become too big to finance. The last two decades
in China have really seen an unprecedented period
of economic growth, driven by the property boom. But now a lot of people
are thinking that China is running out of road. The growth rate of
urban population has been above 3 per
cent or 4 per cent. The rate last year has dropped. So that era of
very strong demand in the cities for migrant
workers is largely over. The ratio of empty apartments
in China could range between 10 per cent and as high as 40
per cent, or even 50 per cent in some small cities. There are enough
empty homes in China right now to house
about 90m people, greater than the population
of Germany or the UK. Newer developments were
built quite quickly without a lot of consideration
for the logistics. I've travelled to
many parts of China, where you go to a suburb and
suddenly you see this forest of apartment blocks. Carry on for five, 10 minutes
in your taxi, and you're still going through
apartment block after apartment block
with nobody in them. I visited one of the most
famous ghost cities, Ordos, in the middle of the desert,
very far away from anything. It was quite strange,
because it's not like there's necessarily jobs there. Housing affordability
in China is among the worst in the world. It would take more than 50
years of median household income in Beijing to buy
an average apartment. The ratio is around
15 years in London and 10 years in New York. Policymakers, led
by President Xi, wouldn't allow that to happen. They realised that you can't
keep on building property which is often unsold by using
debt that property companies ultimately will not
be able to repay. Developers always
had a way to take on more debt, which prompted
the three red lines policy. In about August 2020
everyone was talking about the three red lines. Three debt ratios
Chinese developers must follow to gain
access to bank lending. First one is a liability to
asset ratio of less than 70 per cent, which is
essentially a way of avoiding too many liabilities. Evergrande has over
$300bn of liabilities. The second one is a net
gearing ratio of less than 100 per cent. That's essentially a
way of measuring debt compared to equity. And the third ratio is a
cash to short-term debt ratio of more than one,
which just means you've got more cash than
you've got short-term debt. A vast majority of
Chinese major developers were not able to meet
that requirement. They lost access to credit. It has changed the mindset
of lenders in China not to lend too much to
Evergrande and other property developers. At the same time the
government advised banks to quietly slow down the
issuance of mortgage loans. Evergrande can't
sell apartments. It also can't borrow from banks. How could it pay off the loans? And that's where the problem is. These three red lines
have created pretty much a sudden stop in terms of using
debt to fund debt payments. A huge part of the
appeal of investing in any Chinese
company is the belief that the government is going to
bail out any prominent player if things go wrong. This is still a
country controlled by the Communist party. China saw, with shock, the
western economies almost collapse during and after
the 2008 financial crisis created by a
massive debt bubble. It just couldn't afford to
shoulder that type of risk itself. The government is taking a
particularly negative view on excessive leverage. Evergrande is the poster
child for excessive leverage. The Chinese property market
is a bit like a game of Jenga. The wealth management investors,
offshore bondholders, banks. You've got the local governments
that sells land to Evergrande who need it for financing. You've got the
central government that's trying to control
leverage in the economy, trying to control the economy. You've got ordinary citizens
who are buying homes from Evergrande and
other developers. You've got construction
workers who rely on Evergrande for their income. A whole supply chain
of companies, not only within China, but
outside of China, that are providing the goods and
services to build apartments. Some of these blocks have
been pulled out entirely, making the tower sort of
teeter and list to one side. One of the first
blocks, which has not been pulled out entirely,
has been consumer demand. The really big one that
was pulled out entirely, and made the tower list,
was the three red lines, the ability of
property developers to borrow in many
different forms. It's not so much just that
Evergrande is a tower that's ready to crumble. In many ways it
already has crumbled. But the Chinese property machine
hasn't completely crumbled. This is really, in many
ways, only just beginning. We've got bank lending,
a Jenga block that's still in the tower, and
commercial paper issuance still in the tower. These are areas where
property developers would be fundamentally vulnerable. If those Jenga blocks
were to be pulled out it really would bring the
whole tower crashing down, and it would bring the
Chinese property market to its knees, many more
bankruptcies among property developers all over the country. What we might be
seeing here are just the kind of teething
pains of what happens when the most powerful
economic forces in the world begin to unravel. If that's true then this is
all the tip of the iceberg, and we're not looking at
one Jenga tower collapsing. We're looking at a
whole forest of towers. In the summer it
really looked like it was going to default. Hundreds
of ongoing residential projects, in hundreds of
cities across China, suddenly ground to a halt. In September 2021 there was
a hugely crucial moment. Evergrande missed payments on
wealth management products. The wealth management
market in China is where ordinary people
can put their savings, and the money is usually
going into real estate, often to companies
like Evergrande. And these people,
who had invested, hadn't got their money back. They descended on the
headquarters of Evergrande in Shenzhen. We don't know where
to get our money. And now we go to Shenzhen
government, and nobody help us. This was the point
at which it went from it might be a crisis to,
well, it probably is a crisis. About a week later they just
didn't pay an interest payment on one of their dollar bonds. It's the first time
that a Chinese property developer of this
size has defaulted on its offshore debts. And the entire bond market for
the Chinese property sector collapses. These are some of the world's
biggest investment banks, investment funds. When it comes to investing
in Evergrande bonds everybody expects to
take a massive haircut. Other property
companies in China are going to really struggle
to raise any financing at all on offshore markets. People no longer trust
Chinese companies that say we're issuing bonds offshore,
we expect to honour them. That's all completely changed. The offshore bondholders
ploughed $20bn into this company on the
basis that everyone believed that China just would never
let its property sector fall, would never let its
construction sector fall. Some people might
panic over what it meant for the entire
global financial system. There's a lot of talk about how
Evergrande may be restructured, potentially allowed
to go bankrupt. The scale of Evergrande's
borrowing is so vast. $300bn is 2 per cent of GDP. So the idea that there could be
any failure of a restructuring, and the whole thing could go
into a complete liquidation, one, would go on
for likely a decade, and, two, would have
unimaginable consequences on China's property
sector and its economy. Evergrande will probably
fail in some form. It would be the
biggest bankruptcy ever in China's history. Investors around the world
have been incredibly spooked by Evergrande. It led to this sort
of domino effect. In the wake of Evergrande we've
had so many different defaults and companies getting into
serious financial strife, companies which have
international investors who issued international bonds. There are comparisons that are
being made between the Lehman Brothers collapse, which
triggered the financial crisis in the US of 2008. The big question
everyone's been waiting for is when's the
next financial crisis. The most indebted property
developer in China defaults on its debt, it
sounds like there we are. We've got our crisis. We just don't know how
big the ripples will be, which is why there's
so much uncertainty and worry in global markets. The question now remains whether
the collapse of Evergrande will spread over to China's
financial industry in general. There are obvious similarities. The Evergrande story is a story
about massive unmanageable debts. I don't think we're going
to see a financial market meltdown in China
of the type that we saw in the aftermath
of the Lehman crisis. The Chinese government
will do everything to contain the fallout. That is a really key difference
between that and 2008. The situation with the Chinese
crisis is very, very different. Everyone knew this
stuff was risky. These are high yield bonds. So many people had called
this as a disaster waiting to happen that it seems crazy
that the offshore bondholders did put so much cash
into the company. Massive investors from BlackRock
to Goldman Sachs to HSBC, their funds invested
in these bonds. They ploughed
billions of dollars into an already
overheated market because they believed
that China would never let its construction or
its property sector fall. Turned out to be nonsense. Whether or not they're able to
effectively restructure does reflect whether or
not, in the future, investors will have
that confidence. One of the big
unanswered questions in the collapse of Evergrande
is, where were its auditors? Where were PwC? They had a Big Four audit
firm auditing them for years, signing off their accounts,
signing off the figures that management had
presented to them. And then, suddenly, halfway
through 2021, Evergrande tells its investors
that it might not be able to meet its
financial obligations. The audit regulator in
Hong Kong has already launched an investigation
into PwC's work. Evergrande has
become this symbol of this critical juncture
in China's economic story. It changes the outlook for
China as the world's locomotive of economic growth. Building bridges, building
houses, building entire cities has been such a profound
driver of growth, not just for China, but for
the entire global economy. It is a very big
moment for a rethinking by Chinese policymakers of
the reliance on property to fuel economic growth. According to the IMF, China's
contribution to global GDP growth, between
2013 and 2018, was more than double the
contribution made by the United States in the same period. A small fluctuation, a few
percentage points, in China can have an impact
all over the world. And it is a few
percentage points that Evergrande is now chilling
the Chinese economy by. It's difficult to overstate the
spell that Evergrande helped cast over property in China. It's been a byword
for a property sector that couldn't fail, prices
that were always going to rise. Thousands of ordinary
Chinese citizens have made investments in the
company and bought its homes, but it remains to be
seen how many of them will get the homes
that they have been promised and,
in many cases, paid upfront for, in full. It doesn't look good to
have people running around in extreme wealth
at the same time when you're trying to
reassure the middle class that you're looking
after their interests. It is a monumental
fall from grace. I think it's lost trust. I think it's lost
its credibility. We see it time and again
across China at the moment, billionaires stripped
of the luxury lifestyles that they lead. The Evergrande fallout
is a pivotal moment for China's economic model. It might be seen as
the inflection point where China's growth model
shifted from one thing to something
completely different. Greener growth investment
in green industries, an economy that's
more stable, that's less susceptible
to external shocks. Evergrande matters
because China matters. And Evergrande has
become this symbol of this critical juncture
in China's economic story. We've had two decades of
go-go growth, created largely by the booming property sector,
and now this really marks the end of that boom. You can't just grow the economy
by borrowing, borrowing, and borrowing.
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How do I short it… oh yeah DRS my GME shares.
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