Evergrande group blog

Evergrande unlikely to cause the next Global Financial Crisis

Investors who have loaned money to Evergrande will also likely lose most or all of their money. New Zealand investors are unlikely to have much exposure to Evergrande.

Paul Brownsey Paul Brownsey 3 minute read

For those of us that remember the wild and destructive days of the Global Financial Crisis, events this last week have an eerie resonance.

Back in 2008, the global financial system was teetering on a precipice as Lehman Brothers went into default, unable to pay loans that were falling due.

The knock-on effect of this was a refusal by other banks to lend money under any circumstances as they feared a domino effect. If Lehman fell, who next?

Today, substitute Evergrande for Lehman and we have what at first glance looks like a similar situation. Evergrande is a giant in the Chinese housing and construction industries, but it is not a poster child for a well-managed company.

Highly indebted Evergrande owes the equivalent of more than US$300 billion to Chinese and international lenders. And it can’t make interest payments that are currently falling due. Caught between assets it can’t turn into cash (land, apartments) and high debt, Evergrande’s cash position is grim.

This last week we saw markets sell off on fears that the failure of Evergrande could lead to a domino effect of corporate bankruptcies, lost investor confidence and a market crash.

According to some commentators, we aren’t out of the woods yet and the risk of systemic collapse and aftershocks that affect global markets are still likely.

I don’t agree at all. Whenever I see “shock! horror!” headlines I am immediately suspicious. It is human nature to extrapolate to the worst possible case.

Outrageous headlines sell stories, and if a commentator does happen to be right with a low probability, high impact call then they can trade off that reputation for years. Never mind if it was only one out of 20 predictions that was right.

So why can we be a bit more relaxed about this?

Total loans to Evergrande make up about 1 per cent of Chinese bank loans. In the greater scheme of things, even if all of this defaulted, it would not be fatal. Banks would take a heavy hit to profitability, but it is difficult to see widespread failures.

China may look like a market-based economy but scratch below the surface, and the answer is only “kind of”.

Chinese regulatory authorities wield significant powers and are not scared to use them, especially if the wider interests of the state are at risk. In recent months we have seen very strong actions taken against tech companies, educational companies and others that have acted in ways the Chinese Community Party frowns upon.

So, expect at some point a very strong response from the central Government that protects the interests of the regular person in China at the expense of the wealthy business class.

The most likely outcome is an orderly wind down of Evergrande where the current shareholders lose everything.

Investors who have loaned money to Evergrande will also likely lose most or all of their money. New Zealand investors are unlikely to have much exposure to Evergrande.

Having said that, at least one passively managed KiwiSaver fund has a small amount in Evergrande, but this isn’t likely to have a significant impact.

So Evergrande probably won’t be the catalyst for a market correction. Sooner or later something else will be, we will let you know when we identify it.

-Paul Brownsey is the Chief Investment Officer at ethical fund manager and KiwiSaver provider Pathfinder Asset Management, which is part of Alvarium Wealth. Pathfinder Asset Management has no investments in Evergrande.

(This article was originally published by Stuff September 27, 2021) (Picture Source: Getty Images)

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