Executive Summary

The Evergrande company, a massive Chinese property developer once listed as the world's most valuable real estate company, defaulted and has now been ordered to liquidate, posing both short- and long-term impacts on the Chinese economy. The real estate sector, which has been one of the most important drivers of Chinese growth for years, has started to collapse, with the Evergrande serving as only the first domino. Both the economy and the citizens of China will now suffer due to the damaged real estate industry.

Overview

A. Pointed Summary

• Evergrande Default
• Chinese Economic Disaster
• Short and Long-Term Economic
• Implications of Evergrande Collapse

History

Founded by Hui Ka Yan in 1996, Evergrande was created during a period of mass urbanization in China. Yan used a simple approach: borrow money in order to buy land, sell homes on the site before they are built, and then use the cash to pay lenders and finance the next real estate project. For two decades, starting in the mid-1990s, this approach was extremely profitable as Chinese home prices rose. Hui, a former rural steel industry employee became China’s richest man as Evergrande became a real estate empire.   

However, as Evergrande grew increasingly ridden with debt over time, the company resorted to strange methods of generating funds. According to a former employee, by 2016, at least one Evergrande subsidiary was encouraging staff to buy financial products from the group’s wealth-management unit, which helped fund property development. In early 2020, Hui publicly pledged to “significantly lower” his company’s debt. However,  Beijing began to implement regulations aimed at restricting the financing of highly leveraged developers. By 2021, Chinese property sales were starting to decline, and the government crackdown led to a series of defaults by developers, with many going bankrupt.    

One place the company sought funds from was so-called trust firms, also known as “shadow banks,” since they operate outside many of the rules that govern commercial banks. Trust firms were keen to capitalize on the needs of an industry desperate for credit, and they could charge far higher interest rates than the closely regulated banks. As the general credit crunch intensified in 2020 and 2021, Evergrande had difficulty selling its local yuan bonds, and widespread concerns about their creditworthiness began to come about. Evergrande also diverted loans that had been secured by its publicly listed property-services unit to pay Evergrande’s operational and financial needs.    

Evergrande reported a combined loss of $81 billion for 2021 and 2022. In March 2022, trading of Evergrande’s Hong Kong shares was suspended. Hui has reduced his stake in the company, and his personal fortune is now worth less than a tenth of what it was in 2019. The company faces considerable legal issues, as well: according to Evergrande, there are more than 2,200 lawsuits totaling roughly 535 billion yuan ($73.40 billion) in potential liability.         

Evergrande’s default represents a turning point in the Chinese real estate industry and fueled a liquidity crisis in the sector. Since then, over 50 developers have defaulted on debts, and thousands of people have lost real estate jobs. Sales of newly built homes in China fell 6% last year, returning to a level not seen since 2016, according to Chinese officials. Prices are falling, even in the country’s wealthiest cities, with local Chinese governments losing a major source of revenue as land sales decline. 

Policy Problem

A. Stakeholders

‍Citizens as stakeholders are hit the worst since they paid in advance for the apartment projects whose completion has been affected by the crisis. Due to the property crisis precipitating, several projects are not being finished, and people are struggling not only to have their houses ready on time but also to receive a refund of the deposit rightfully owed to them. Additionally, this would place other creditors in a tough spot as their recovery options would be negligible. Investors trading in Evergrande have seen extreme fluctuations, which started with values plummeting to trading being entirely halted. This further hampers investor sentiment due to Evergrande facing the likelihood of selling its offshore assets and listed subsidiaries to pay off its creditors. Evergrande’s asset portfolio comprises three categories: shares and assets in an Evergrande property management company; investments in electric & hybrid cars, and healthcare; and investments in holding companies with several subsidiaries.    

Foreign creditors, shareholders, and entities who are shareholders are pursuing recourse against the company following governmental interventions that disrupted its business model, implemented to mitigate the housing bubble. The liquidation order, coupled with the absence of a viable or timely restructuring proposal, has further exacerbated Evergrande’s insolvency and surging debt, a major deterrent to China’s already slowing economy. Ultimately, it was realized that it was in all stakeholders’ best interest to wound up the company and extract the remainder value from the accessible assets. The liquidation order details a protracted process to wind up its $240 billion in assets. The rationale is that professional liquidators have the ability to overtake the company and management, secure its remaining assets, and review and devise a restructuring plan. In the pecking order following its liquidation, a hierarchy of claims dictates the sequence and priority of disbursements. This entails retrieving assets from subsidiary entities, each potentially encumbered with its own creditors, among whom are homeowners who have invested in units across various property developments.  

‍B. Risks of Indifference

‍China’s real estate sector has historically been instrumental in driving its growth, constituting 20% of the Chinese economy. Previously, a flourishing real estate sector served as a fundamental driver of China’s economic growth, with home construction and its ancillary industries contributing up to a quarter of the nation’s annual economic output. However, this once-potent economic force has transitioned into a significant impediment to growth. In 2023, China’s economic growth was 5.2%, marking one of its most sluggish growth rates in decades. Developers like Evergrande leveraged readily available credit at low costs to fund successive phases of construction. This involved building high-rise apartment complexes on plots of land procured from China’s local governments, which were contingent on land sales to service debts and sustain fiscal outlays. In 2021, the Evergrande group defaulted on its bond repayment, which sent shockwaves across the Chinese real-estate sector and subsequently snowballed into a $300 billion debt for the company. This led to a domino effect as over 50 developers faced a similar outcome due to failure to meet debt repayments. Official data indicates a 9.6% decline in real-estate investment over the previous year, a collapse that has propelled overall private-sector investment into negative territory.  

‍C. Nonpartisan Reasoning

‍Beyond its immediate impact on economic growth, analysts widely attribute the real estate sector’s challenges to a dampening effect on consumer expenditure. Decreasing property prices and booking volumes erode household wealth, prompting consumers to adopt a more conservative approach by increasing savings rather than engaging in discretionary spending. The wealth of citizens is predominantly invested in real estate due to the limited investment avenues available to Chinese individuals. Mismanagement of a property crisis by the government could potentially escalate into widespread civil unrest. An additional concern arises from the severe strain imposed on local government finances, resulting in diminished revenue streams and an inability to fund the infrastructure projects that constitute a cornerstone of Beijing’s strategy to achieve its growth targets. Multiple metrics, including new housing initiations, completions, and residential property transactions, collectively underscore the sector’s significant precariousness. Despite official assertions of minimal declines in home prices across prominent urban centers since the peak in 2021, numerous economists posit that actual depreciation in property values is likely more pronounced. Ultimately, the court judgment does not commensurately affect the parent company in mainland China, but instead, Tier-3 cities with unfinished housing projects will bear a disproportionate brunt of these repercussions as offshore entities try to extract value, potentially resulting in a pressure problem. 

Policy Options

In a situation similar to the 2008 financial crisis and the collapse of Lehman Brothers, China’s economy and real estate sector have faced a halting downturn since the bankruptcy of real-estate giant Evergrande. When Lehman Brothers went under, the Fed did not bail them out, however, they bailed out lenders Bear Stearns and AIG in similar situations, setting a precedent of intervention in the financial system. Just as Bear Stearns’s collapse wreaked havoc through Wall Street and unveiled underlying issues in the housing market, Evergrande’s poor financial habits are coming back to bite: before it's bankruptcy, Evergrande’s total liabilities were 10 times more than its revenue, about 1.8% of China’s GDP. $25.4 billion of its debt was owed to foreign creditors, which is partially why it filed for Chapter 15 Bankruptcy in the United States. 

Filing for bankruptcy in early 2023 was only one route that Evergrande could have taken. Though bankruptcy- specifically Chapter 15- offers foreign companies the chance to reconcile with American creditors in court, it is also more restrictive than a restructuring policy. Ultimately, Evergrande tried restructuring anyways, but failed, which is why Hong Kong mandated its liquidation earlier this year. 

It is unclear how China is going to recover from this blow. About 70% of Chinese families invest in apartments as their main source of income, and about ⅓ of China’s GDP is related to real estate, so this sector is clearly vital to their economy. Many of Evergrande’s customers were prospective homeowners, meaning that if confidence in the housing market seems to be deflating, China must stimulate growth in other areas. One solution is that the government can emphasize expansion in the manufacturing sector. Manufacturing has traditionally been China’s strong point, and is a large element of their relationship with the United States. With the clear issues in real estate and recent disinflation, perhaps China can exploit these lower prices and produce more goods, for less. This circumstance would negatively affect American manufacturing companies, who would have to lower prices even more to compete with China, but would most likely stimulate the economy and boost morale during this period of uncertainty and awakening.

Conclusion

Overall, the collapse of Evergrande serves as a significant warning signal for broader concerns regarding the Chinese economy. This incident has been a huge blow to China's confidence internationally and domestically, especially since Chinese citizens are seeing their one major asset, housing, depreciate. Chinese banks and lenders may be compelled to reduce lending, leading to a credit crunch. Consequently, businesses may struggle to operate and expand due to insufficient funding, potentially resulting in failures. U.S. consumers won't see an immediate impact yet. However, consumer prices fell lower in China at the fastest rate in the past three years. Given China's substantial role in the global economy, any domestic deflation they experience could lead to the potential necessity of exporting deflation. This implies that U.S.-based markets might need to reduce their prices to remain competitive with the lower prices of Chinese products. Businesses could close, people could lose their jobs, and consumers would be worse off, especially with the hugely intertwined Chinese and U.S. economies. Only time will tell how the Chinese government will deal with this real estate crisis and its potential economic implications. 

Acknowledgment

The Institute for Youth in Policy wishes to acknowledge, Michelle Liou, Joy Park, Nolan Ezzet and other contributors for developing and maintaining the Policy Department within the Institute.

References

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