The problem is leverage and currency risk.
Evergrande has ~30bn in assets and 300bn in liabilities ($80 million of which is due this week, but they have already stated that they cannot pay this interest). Much like 2008, the real estate market in China is highly levered and in an extreme bubble. This is because the Chinese government imposed strict limits on who can invest in certain types of assets (mostly equities) but lifted almost all restrictions on real estate/housing market. Ergo, many of the middle class started investing in “investment properties” and as demand grew, so did the prices. The problem was, Evergrande used the increases in the price of land and began taking out equity on that increase in order to fund more and more real estate deals. They currently account for ~2% of China’s GDP and is the second largest real estate developer (and 30% of chinese gdp comes from real estate)… yeah a pretty big deal.
Now, how does this shitstorm in China affect the US Markets?
Theoretically it shouldn’t be but a ripple right? Well, when Evergrande was raising capital, they did so by selling commercial paper and investment grade bonds. The buyers of these bonds and CP were large large banking + investment institutions: Vanguard, Blackrock, HSBC, Goldman, etc. These institutions then took these bonds, rolled them into mortgage backed securities and sold them to anyone who would buy them. Much like 2008… everyone believed that if something happened to Evergrande, that the Chinese government would step in. After all, how would it be conceivable that the CCP would let their second largest real-estate developer fail?
This is where things started going wrong. Everything was fine until the insiders started getting word of Evergrande’s overinflated balance sheet. But once investors started selling out, Evergrande’s bonds started taking a nosedive. The intl banking institutions didn’t want to be left holding the bag, so my guess is they started deleveraging these toxic assets to any firm willing to buy. How do I know this? Evergrande’s investment grade bonds are now downgraded to junk bonds, and they are trading at 20cents on the dollar. This became such a big issue in fact that these very firms and their executives were in China this weekend to discuss “risk management”
https://finance.yahoo.com/news/china-wall-street-meeting-focused-092729599.html
Now, the ripple effects would most likely be as follows: banks + institutions will seek to continue to sell toxic investment and decrease their exposure to the real estate sector. The firms that were dumb enough to buy these toxic assets from firms unloading are now left holding the bag. The once “investment grade” bonds are now junk, and no one will accept them as collateral. So they get margin called. Firms will all rush to find cash, but the smaller firms will inevitably have to liquidate their long positions in order to remain solvent. This will likely happen in growth stocks and tech stocks with high PE ratios that have continued their bullrun since the middle of last year. As these equities start losing their value, other firms with exposure to these US equities will be forces to manage their risk to the downside and sell their positions, thus further driving the price down. This cycle will probably continue until firms have de-leveraged, defaulted, or until the fed decides to buy the toxic assets from these institutions (much like 2008).
So in short, the effects of Evergrande defaulting will likely have huge implications to the US + international markets.
Not financial advice.
