Everything You Need To Know About the Chinese Evergrande Crisis (So Far) - How Money Works

Evergrande is China’s largest  property development company   and was (up until recently) one of the  most valuable companies in the world. However most analysts are now  predicting that this company   is on the verge of insolvency and won’t  be able to meet its mountainous debt   obligations without direct government  intervention within the next few weeks. For those of you who are not already aware   this has the potential to be far more than  a run of the mill corporate bankruptcy.   The company employs over 200,000 people directly  while also providing work for as many as 4 million   subcontractors who work to erect thousands  of buildings for the company every year. Beyond just job losses, the company is also  holding deposits for 1.5 million properties   that may not be delivered to regular Chinese   citizens who were just looking for  a home or an investment property. Now loosing a home is terrible in ANY  country, but perhaps nowhere more so   than in China. The value of these properties  compared to the incomes of people buying them   is astronomical, and it often takes multiple  family generations to save up for a deposit. Because of this, real estate has become basically  the only thing that most people invest in,   and over a million people losing that investment  will have massive knock on economic impacts beyond   just putting people out on the streets  (as is that wasn’t bad enough already) Despite these social issues and the apparent  threat to the national and global economy   the Chinese government has said that they  are not prepared to bail out the company. Why? Well politics… but there  are a few things that you need   to understand about this crisis as  we watch it play out in real time. The first is how this collapse actually   started in what looked like an  otherwise very healthy company. The second is how bad could this get  if the government DOESN’T step in. And the third is, Will this all be contained?   Or could this leak out and cause an economic  collapse in countries outside of China? Well it’s time to learn how money works so  you can have a better understanding about   what all of these alarming headlines really  mean. This is video was brought to you by   the channels patrons and channel members. If  you want early access to video’s and an extra   free video every month please consider helping  the channel out on either of these platforms. Alright, so many people are  calling this China’s Lehman moment,   in reference to the American investment  bank Lehman Brothers which was allowed to   go bankrupt in 2008 effectively kicking  off the 2008 Global Financial Crisis. There are a lot of similarities here. Both of these companies are very large, they both  have a lot of debt on their books, that debt is   being offset with assets that may not be nearly  as valuable as people might think, and finally   they both look to have been left for dead by their  governments which have decided to let them fail. Now of course Evergrande is not a bank,  it’s a property development company,   but in China that’s almost worse. Property is basically the only thing  that average citizens invest in   so it’s as if you took the us financial  market and housing market and rolled   them all up into one for people to  speculate on… sort of like in 2008. Now the regulators knew this, and  they saw the problem of an asset   price bubble having the potential  to cause major economic factors. It’s because of this, that the  story of Evergrande’s problems   actually start more than a  year ago in august of 2020. Property is never “owned” in China, it is leased  from the government for a set amount of time   most commonly 70 years. These land leases are then  purchased by property developers like Evergrande.   The property developers will then design apartment  buildings and pre-sell the units they designed to   regular investors who will put down a deposit and  wait for the buildings to actually be finished. The developer can then take this money and use  it as a down payment to borrow even more money   to either buy up more land leases, or to use on  the actual construction of buildings on that land. This system works very well for rapid expansion  and it is in theory a win-win for everybody. Evergrande and other developers were able to buy  up more 70 year leases and build more houses,   regular investors were able to get access  to properties that were far cheaper than   existing apartments for sale in china, and the  banks and non-bank lenders were able to give   money to an institution that was offering  good returns on a secured line of credit. Most of these lenders figured that in  the extremely unlikely scenario that   a company like Evergrande defaulted  on it’s debt’s they could just yoink   the properties they had on their books  and easily cover all of these loans. Now… Evergrande had seen that properties in China  were appreciating at a rate of about 10 – 15%   per year so they wanted to  push this limit to the extreme. They wanted to borrow more money, buy up  more land rights, presell more apartments   all in an attempt to grow as fast as possible. This DID work well, the company was highly  profitable, it always had more assets than   liabilities and continually gave consistent  returns to both equity and debt investors. But all good things must come to an end and that  brings us back to August of 2020 when the Chinese   government introduced new laws in to control the  amount of debts that developers could take on, and   also how the money that companies like Evergrande  were getting of pre-sales could be used. This was a big problem because it  radically altered the high growth business   model that the company had become reliant on. The company basically needed a constant stream  of new money coming in from property buyers to   keep the whole operation running,  but it did have a backup plan. If this money ever slowed down  the developer could just lower   the prices on their pre-sales  to attract more buyers and prop   up the system again. Sure they wouldn’t make  as much profit, but it’s better than nothing. In a worst case scenario the company just kept  certain properties on their own books as real   estate assets. This meant that they could borrow  even more against the value of these finished   properties and never need to realise a loss by  selling a property for more than it cost to build. This was not a bad strategy considering  property price growth in China meant   that the company only ever needed to  hold onto these properties for a few   months at most before market forces  made them profitable to sell again. However these new regulations meant  that the company was forced to hold   onto more and more existing properties  while also needing to sell off their   new developments at increasingly steep  discounts to keep the money flowing in. This caused two problems, for starters it   undermined all of the holdings that  they had to offset their liabilities. I said at the beginning of this video that the  company had more assets than it did liabilities,   and that is technically true, but only if you  accept that HUNDREDS OF BILLIONS OF DOLLARS   worth of residential real estate holdings  are worth as much as the company says it is. Even if we ignore the propensity of Chinese  companies to… “massage”… their figures a bit, this   is an alarming number because these assets are  NOT liquid… which leads us to the next problem. The new regulations have made it harder for  the company to borrow money to complete the   projects it was working on. This has meant that  they company has had to sell more presales to   fund existing projects which are in turn  going to be even harder to get funding for. The questions raised about the true value  of the companies real estate holdings has   meant that the company has had to seek finance  from not one or two banks like most companies,   but from over 128 different banks and  hundreds of other non-bank lenders. This started to raise alarm bells  with individual property investors   who were waiting on their homes to be finished. Potential investors were starting  to see these massive real estate   development projects (that used to  sell out within a matter of hours)   were now being discounted over and  over again to try and attract buyers. Even if their overall attitude towards  the real estate market was bullish,   it only made sense to sit back a bit and see if  they could snag themselves a bigger discount. This closed the faucet on the cash injector that  kept everything going causing bigger discounts and   bigger question marks over how much the companies  inventory of property was actually worth. Now the company is in a situation where it  lacks the funds it needs to pay for day to day   operations beyond the next few weeks. Of course it  could sell off these existing real estate assets   as a last ditch attempt to free up some cash flow  but it would now be at a massive discount given   the bad press and the fact that they wouldn’t  really have time to negotiate too hard on price. Now that leads us onto how bad this could get. … If the government did not intervene at  all the company would go into liquidation,   the 1.5 million people that have paid  their deposits for homes that have not   yet been built would lose that money  and the properties on the companies   books would be sold off as quickly as possible  flooding the market with properties for sale. Even in a company as hungry for real estate as  China this would inevitably drive down prices. It would simultaneously put more eyes on the other   property development companies who would  inevitably be in a similar situation. If property prices fall then their  inventories are going to be worth less too,   meaning they will have less assets to secure  loans against, which means more difficulty   completing projects, which means more trouble  paying off loans which means more liquidations. If you replace the words “Chinese  Apartments” with “Mortgage Backed   Securities” it is easy to see why  people are calling this a Lehman Moment. Which leaves just one final question…  Will this impact markets in the west? The GFC quickly spread from the US to Europe  and then on around the world. China is the   second largest economy in the  world so it’s not unreasonable   to be a little concerned with the  same thing happening here right? Well yeah, we should all be  cautious of what this could mean,   but I wouldn’t be overly worried just  yet. China’s markets by design are very   closed off to the outside world which means  that they are much less interconnected with   American markets than say American  markets are with European markets. What’s more is that it’s hard to believe  that the Chinese government would let it   get quiet that bad. The strength and  unfaltering growth of the Economy has   been the linchpin of the current government.  If they were to loose that they would not only   have to deal with an economic catastrophe,  but also widespread civil unrest as well. As I said, this is a developing situation so  your guess about what comes next is just as   good as mine, but at least you know the nuts  and bolts of the problem that they are facing. Now if you want to learn about something a little  bit more light-hearted go and watch my video   on why jellyfish have secretly been used as a  global reserve currency for the past few decades. A regular video will still be coming at some  point this week, so this one is just an extra   to keep you all up to speed on this situation.  These video’s are made possible by my amazing   channel members and patreon supporters. If you  enjoy these video’s please consider supporting   the channel directly so that everybody  can keep on learning How Money Works.

Channel: How Money Works

Views: 1,980,461

Keywords: evergrande, evergrande collapse, bankruptcy, evergrande default, evergrande vs evergreen, evergrande stock, evergrande news, china economic collapse, china real estate, china stock market, china debt crisis, chinese economy, evergrande fc, what happened to evergrande, why is evergrande collapsing, evergrande explained, chinese economy explained, china news investing, investments, finance, economics, business, infotainment, edutainment, how money works, china evergrande

Id: vq4n3DXD7z0

Length: 10min 0sec (600 seconds)

Published: Sun Sep 19 2021

Reddit Comments

[u/[deleted]]

So eventually people stopped buying, causing others to question the real value of the property. Causing speculation on the opposite end, where it would instead drop lower, and nobody wanted to be the one left holding the bag.

I mean that reversal of speculation could easily cause us harm as well, as foreigners make up such a large percent of our buyers. These debt bubbles created on faulty valuation of asset prices are pretty serious. Allowing companies to leverage more debt on something as ephemeral as housing prices is a stupid idea.

[u/[deleted]]

If anything canadian market became more attractive for chinese money

[u/[deleted]]

I keep saying it’s international and idiots on this sub keep telling me to leave Toronto (I don’t live in Toronto)

[u/False_Examination_59]

Collapsing? Evergrande already screwed people over so it has already has begun collapsing.

[u/ABoredChairr]

What happened on Evergrande is the intended consequence of China government's policy change. Some people in this sub is no smarter than Trump supporters who can only follow a simple binary classification