The Evergrande Situation: What You Need to Know#

First off, Evergrande is a giant property development company over in China. Not long ago, it was one of the biggest companies around the globe. But now, most folks who look at these things (analysts, they’re called) are saying it’s about to run out of money and likely can’t pay back its huge debts unless the government steps in soon – like, in the next few weeks.

This isn’t just any old company going bust. It’s a big deal, and here’s why:

• Direct Employees: The company directly employs over 200,000 people.
• Subcontractors: It provides work for a massive number of subcontractors, as many as 4 million. These are the people who build thousands of buildings for Evergrande every year.
• Home Buyers: This is a really tough one. 1.5 million properties that haven’t been finished yet had deposits paid by regular Chinese people. These folks were just looking for a place to live or maybe an investment property.
• Impact of Losing a Home: Losing your home deposit is awful anywhere. But in China, it’s particularly painful.
  • Properties cost a lot compared to what people earn – it’s an astronomical difference.
  • Saving up for a deposit often takes contributions from multiple family generations.
  • Because of this, real estate has become pretty much the only place most people invest their hard-earned money.
  • Over a million people potentially losing this investment won’t just put them on the streets (which is bad enough), but it will have massive negative effects on the wider economy.

Government’s Stance and Key Questions#

Despite these big social problems and the clear threat to China’s economy (and maybe even the global one), the Chinese government has publicly stated they are not planning to bail out the company.

Why? Well, politics plays a part, but there are a few key things we need to understand about this unfolding crisis:

1. How did a company that looked pretty healthy actually start to collapse?
2. Just how bad could things get if the government doesn’t step in to help?
3. Will this problem stay contained inside China? Or could it spill over and cause economic troubles in other countries outside of China?

Understanding how money works helps make sense of all those alarming headlines you might be seeing.

(A quick note from the video creator: This video was made possible by people who support the channel on platforms like Patreon. If you want early access to videos and an extra free one every month, maybe consider helping out.)

Comparing Evergrande to Lehman Brothers#

Lots of people are calling this China’s Lehman moment. This refers back to Lehman Brothers, a big American investment bank that was allowed to fail in 2008. That failure is often seen as the spark that really set off the 2008 Global Financial Crisis.

There are definitely similarities:

• Both companies are very big.
• Both have a lot of debt listed in their accounts.
• The value of the assets they hold to balance out that debt might not be as high as people think.
• In both cases, it looks like their governments have decided to let them fail.

Now, sure, Evergrande isn’t a bank; it’s a property developer. But in China, that’s almost worse. Property is basically the only thing regular people invest in. It’s like if you took the US stock market and the housing market and mashed them together for people to speculate on – kind of like what happened in 2008 with housing.

How the Crisis Began: The August 2020 Regulations#

The regulators in China knew there was a potential problem with property prices getting too high (an asset price bubble) and that it could cause big economic issues. Because they saw this, the story of Evergrande’s current problems actually starts over a year ago, in August 2020.

To get how it started, you need to know a bit about the Chinese property system:

• You don’t really “own” property in China; you lease it from the government for a set period, usually 70 years.
• Property developers like Evergrande buy these land leases.
• They design buildings (like apartment blocks) and then pre-sell the units to regular investors before the buildings are even finished.
• Investors put down a deposit and wait for construction to be completed.
• The developer takes this deposit money and uses it as a down payment to borrow even more money. This borrowed money is used to buy more land leases or build on the land they already have.

This system worked really well for growing quickly. In theory, it was a win-win:

• Evergrande and others could buy more land and build more houses.
• Regular investors could buy properties that were cheaper than existing ones.
• Banks and other lenders felt good giving money because they thought if the developer defaulted, they could just yoink (that’s a technical term!) the properties held as security and easily get their money back.

Evergrande saw that property prices in China were going up fast, about 10-15% per year. They pushed this strategy hard, borrowing more, buying more land, and pre-selling more apartments to grow as fast as possible.

It worked! The company was profitable, always had more assets than debts, and gave good returns to those who invested in it.

The Turning Point: New Government Rules#

But, as they say, all good things come to an end. That brings us back to August 2020.

The Chinese government introduced new rules to:

• Control the amount of debt developers could take on.
• Control how developers could use the money they got from pre-selling properties.

This was a HUGE problem because it messed up the high-growth business model Evergrande relied on.

Evergrande basically needed a constant flow of new money from people buying properties to keep everything going. They had a backup plan:

• If money slowed down, they could lower pre-sale prices to attract buyers. Less profit, but better than nothing.
• In the worst case, they could hold onto finished properties as assets. This meant they could borrow more against the value of these finished buildings and didn’t have to sell them at a loss (by selling for less than it cost to build). This worked because property prices were growing so fast they only had to hold them for a few months before they could sell them for a profit.

However, the new regulations changed this. Evergrande was forced to:

• Hold onto more existing properties.
• Sell off new developments at increasingly steep discounts just to keep cash coming in.

This created two main problems:

1. Undermined Asset Value: It made the value of their property holdings (which offset their debts) look shaky. They technically had more assets than debts, but only if you believe that hundreds of billions of dollars worth of residential real estate is truly worth what they say it is. Even if we ignore the tendency of some Chinese companies to… well, massage their numbers a bit… this amount is alarming because these assets are NOT easy to sell quickly for cash (not liquid).
2. Difficulty Borrowing: The new rules made it harder to borrow money to finish projects they had already started. This created a vicious cycle: they had to sell more pre-sales just to fund existing projects, which in turn needed even more funding that was now harder to get.

The Current Squeeze and Investor Doubt#

The questions about the real value of Evergrande’s property assets meant that instead of borrowing from just a couple of banks like most companies, they had to seek money from over 128 different banks and hundreds of other lenders (not just banks).

This started to make individual property investors nervous. They saw these massive development projects, which used to sell out in hours, now being discounted repeatedly to attract buyers. Even if people were generally positive about the property market, it just made sense to wait and see if they could get an even bigger discount.

This waiting game closed the tap on the cash flow Evergrande desperately needed. This led to bigger discounts, which raised bigger questions about how much the properties they already held were actually worth.

Now, the company is in a spot where it doesn’t have enough money for day-to-day running costs beyond the next few weeks. Their last resort would be to sell off those existing properties, but because of all the bad news and needing cash fast, they’d have to sell them at a massive discount. They wouldn’t have time to really haggle on the price.

How Bad Could This Get?#

Okay, so what happens if the government doesn’t step in?

• The company would likely go into liquidation.
• The 1.5 million people who paid deposits for homes that aren’t finished would lose that money.
• The properties Evergrande currently holds would be sold off quickly, flooding the market with houses for sale.
• Even in China, where people want property, this rush of supply would likely drive down prices.

This is where it gets scary. If property prices fall, it puts a spotlight on other property developers, who are likely in a similar situation.

• If property prices fall, their property holdings are worth less too.
• This means they have less value to use as security for loans.
• This makes it harder for them to finish their projects.
• Which makes it harder to pay back their loans.
• Which could lead to more developers going into liquidation.

See the pattern? If you swap out “Chinese Apartments” for “Mortgage Backed Securities” (which were packages of home loans), you can easily understand why people are worried this looks like the Lehman Moment all over again.

Will This Affect Markets in the West?#

The Global Financial Crisis (GFC) in 2008 spread pretty fast from the US to Europe and then around the world. China is the second-biggest economy globally, so it’s fair to be a little concerned, right?

Well, yes, we should all be aware and cautious about what this could mean. But maybe don’t panic just yet.

• China’s markets are designed to be quite closed off from the outside world. This means they aren’t as tightly connected with American markets as, say, American and European markets are.
• Plus, it’s hard to believe the Chinese government would really let things get that bad. The strength and constant growth of the economy have been a main pillar for the current government’s power. If they lost that, they’d be dealing with not just a massive economic disaster but potentially widespread public unrest too.

Wrapping Up#

As I mentioned, this is a situation that’s still developing, changing day by day. So your guess about what happens next is probably as good as mine! But hopefully, now you understand the basic parts and problems behind what’s happening.

(Another quick note: If you’re looking for something a bit less heavy, you might like my video about how jellyfish have secretly been used as a global reserve currency! A regular video will still come out later this week, this one was just an extra update. These videos are possible because of generous channel members and supporters. If you enjoy them, please consider supporting the channel so everyone can keep learning how money works.)