China may still be successful in averting disaster with the collapse of real estate giant Evergrande – but its leaders will feel Beijing’s wrath.
A large, financially interconnected company is on the verge of collapse, weighed down by massive debt.
The government is considering a bailout. There is no easy answer. Doing nothing risks causing serious financial upheaval. But bailing it out will signal that greed, irresponsibility and moral hazard have no consequences.
It’s a tough call. And if this all sounds strangely familiar to you, then you are right. In 2008, the US government was faced with the dilemma of what to do about Lehman Brothers, the country’s fourth-largest investment bank, which found itself unable to pay debts totaling over $ 600 billion.
Now the Chinese government is facing a comparable situation with Chinese real estate and finance giant Evergrande.
Lehman Brothers, established in 1847, survived the American Civil War, the Great Depression, and both World Wars. Then, in the feverish risk-betting bubble in the US mortgage market of the 1980s, he found himself in serious trouble.
US Treasury Secretary Hank Paulson – a former senior Wall Street executive – was, by all accounts, offended that Lehman had become so recklessly in this position. Why not send the message that the US government is not going to bail out the big banks that have behaved badly?
The answer, it turned out, is that letting Lehman fail ricocheted through the United States and the global economy.
When Lehman filed for Chapter 11 protection, he faced the biggest bankruptcy in history. Those to whom she owed money were immediately put under pressure. It put those to whom they owed money under pressure. Money markets have almost completely frozen over.
Even Goldman Sachs – Wall Street’s most venerable company and essentially on the good side of mortgage market transactions – has been hammered. It took legendary investor Warren Buffett to pump $ 5 billion into the business to avert a modern day bank run.
China’s Lehman moment?
Unlike Lehman Brothers, Evergrande is not an investment bank. Apparently, he’s a real estate developer, responsible for building apartments across China. But it has grown into more than that – an integrated, high-leverage company that does everything from banking and real estate development to selling electric cars.
Like a lot of things in China, the real picture is a bit hazy, but one reading is that Evergrande is essentially a hedge fund with a real estate and auto business attached.
The immediate cause for concern is that Evergrande did not pay interest of $ 83 million on September 23. Time is running out, that is, he has 30 days to “remedy the breach” and find a way to pay. Otherwise, things, as cool kids say, will “start to get real.”
For now, the disaster has been averted by Evergrande who agreed to sell his stake in a local bank (Shengjing Bank) for nearly 10 billion yuan (about $ 1.5 billion) to the state-owned Shenyang Shengjing. Finance Investment Group.
But Evergrande has $ 300 billion in debt, so Chinese officials really can’t run away from the problem. If there are more questionable transactions on Evergrande’s books, then that $ 1.5 billion will just save time.
If things are as bad in Evergrande State as many observers seem to think, then the Chinese government is going to have to bail it out, or let it fail.
In a sense, perhaps the CCP feels that “we are all Hank Paulsons now.”
China’s additional tools
That said, there is an intriguing – albeit somewhat troubling – option available to Chinese authorities.
They could bail out the company but punish its senior officers with severe personal sanctions. Frankly speaking, they don’t have to worry about the intricacies of due process the way the US government does.
The Chinese government can, if it wishes, prevent the economy-wide repercussions that would result from an Evergrande collapse, but deter moral hazard in the future. This can send a very clear message of consequence to executives who engage in reckless and potentially corrupt behavior. Maybe life imprisonment. Maybe worse.
This is an interesting, if rather bleak, example of Tinbergen’s rule – named after Jan Tinbergen, the winner of the first Nobel Prize in economics. This rule says that for every political challenge, there needs to be an independent political instrument. The US government had one. The Chinese regime has two.
All of this raises bigger issues
Beyond that lie much bigger issues. How well have Chinese companies actually performed? So far, it seemed like the answer was remarkably good. But is it all a mirage, supported by the lack of transparency that envelops all Chinese institutions?
It seems that there could be two types of Chinese companies: those that “make” things, which have been successful and still are, and those which “bank” things, which look strangely like their capitalist counterparts in the United States. Western world. when moral hazard and corruption are allowed to prevail.
The upheaval in the years to come will reveal much about the economic basis of China’s global power.
Richard Holden is Professor of Economics at UNSW
This article originally appeared on The Conversation and has been reprinted with permission