Beijing’s Evergrande Solution

By | October 7, 2021

Global Source Partners

Beijing believes the risks of a US-style financial crisis caused by a property bubble outweigh the risks of an Evergrande default. But it is also encouraging a “soft” landing for the resolution of Evergrande’s debt problems that would avoid political unrest and a bank crisis. How will Beijing resolve this conflict?

Beijing plans to force the local governments to resolve debt issues locally. This passes the responsibility from the center to the periphery. The Politburo’s attitude is that the provinces have benefited from the success of companies like Evergrande, so it is up to them to solve it. This absolves the center’s financial responsibility.

More importantly, the geographic diversity of debt solutions is likely to avoid a systemic problem in the economy or financial system. One question is crucial: What is the capacity of local governments to absorb Evergrande’s debt?

Catalysts and transmission in the Minsky Moment

A rapid deleveraging of assets requires both a catalyst and a transmission mechanism. China differs substantially from the United States pre-crisis in that it does not have the large pool of securitized assets that led to the U.S. mortgage crisis. The majority of lending to the property market is through the banks. Liquid instruments in the shadow banks – through Trusts, wealth management products, and interbank loans – have been sharply curtailed over the past five years. Even for Evergrande, only about 10 percent of liabilities are WMPs.

The potential catalysts for a property-driven financial crisis include:

  • A collapse in Evergrande’s outstanding WMPs that causes a run on WMPs across China.
  • A rapid reversal in property prices that convinces buyers to sell, a pro-cyclical action that would accelerate the downturn in the property market.
  • A widespread belief that the central government is no longer interested in supporting rising property prices and is willing to accept the collapse of the entire market (even before any specific policy actions have been taken nationally).