For the past two decades, Evergrande has taken advantage of cheap credit to massively expand its real estate empire. The company reported $108 billion in annual sales and some $356 billion in assets. Its portfolio is massive: Evergrande owns over 1300 real estate projects across 280 cities in China, has a property services management arm involved in almost 2800 projects across over 310 cities in China, has other ventures across unrelated industries, and directly employs over 200,000 people.

In a page out of the WeWork playbook, Evergrande fancied itself as more than a loss-leading, debt-burdened real estate business. The company turned its health care business unit into an electric vehicle company despite never making a single car. In July, Evergrande was considering an IPO for Evergrande Spring, its bottled water business (you read that right). At the same time, Evergrande was also considering an IPO for its tourism business and an incoherent theme park featuring fairytales from across the world. Guangzhou FC, China's most successful soccer team, is owned by Evergrande (with an Alibaba stake) for some reason.

The situation has grown so desperate for the cash-strapped firm that it demanded employees loan Evergrande money at a high interest rate in order to keep their bonuses, only to stop paying back those loans soon after. The situation has sparked protests led by home buyers waiting on unfinished homes and employees who have lost their life savings.

Research firm Capital Economics estimates that some $200 billion of Evergrande's debt is actually cash put down for 1.4 to 1.6 million unfinished properties, and a huge number of justifiably furious purchasers of these unbuilt homes.

China's debt-laden local governments are also facing grim prospects. Declining income from land sales because of the crisis in the real estate sector and falling tax receipts are expected to cause a 6 trillion yuan shortfall, roughly $900 billion, in local government revenues this year. Local government financing vehicles that have borrowed heavily from banks or issued bonds will have great difficulties servicing their debt.

Weak supervision, poor risk management and corruption that likely drove the small rural banks in Henan into insolvency are systemic among the country's nearly 4,000 small and medium-sized banks with nearly $14 trillion assets.

Large banks in China are in trouble as well. They have lent tens of billions to poor countries as part of China's ambitious Belt and Road Initiative. A significant portion of their credit portfolio is likely to become nonperforming as their borrowers are unable to service the debt due to the global economic downturn.

In retrospect, there's a good case that the reason the bursting of the housing bubble seemed to matter so much was that it was masking an underlying problem of secular stagnation. The same might be said of Japan's real estate-stock bubble of the late 1980s

Steep payments on international sovereign bonds, which comprised nearly 40 percent of the country’s external debt, put Sirisena’s government in dire fiscal straits almost immediately. When Sirisena took office, Sri Lanka owed more to Japan, the World Bank, and the Asian Development Bank than to China. Of the $4.5 billion in debt service Sri Lanka would pay in 2017, only 5 percent was because of Hambantota. The Central Bank governors under both Rajapaksa and Sirisena do not agree on much, but they both told us that Hambantota, and Chinese finance in general, was not the source of the country’s financial distress.

In 2012, Sri Lanka borrowed another $757 million from China Eximbank, this time at a reduced, post-financial-crisis interest rate of 2 percent. Rajapaksa took the liberty of naming the port after himself.

This was in 2007, six years before Xi Jinping introduced the Belt and Road Initiative. Sri Lanka was still in the last, and bloodiest, phase of its long civil war, and the world was on the verge of a financial crisis. The details are important: China Eximbank offered a $307 million, 15-year commercial loan with a four-year grace period, offering Sri Lanka a choice between a 6.3 percent fixed interest rate or one that would rise or fall depending on LIBOR, a floating rate. Colombo chose the former, conscious that global interest rates were trending higher during the negotiations and hoping to lock in what it thought would be favorable terms. Phase I of the port project was completed on schedule within three years.

The prime example of this is the Sri Lankan port of Hambantota. As the story goes, Beijing pushed Sri Lanka into borrowing money from Chinese banks to pay for the project, which had no prospect of commercial success. Onerous terms and feeble revenues eventually pushed Sri Lanka into default, at which point Beijing demanded the port as collateral, forcing the Sri Lankan government to surrender control to a Chinese firm.

There was also never a default. Colombo arranged a bailout from the International Monetary Fund, and decided to raise much-needed dollars by leasing out the underperforming Hambantota Port to an experienced company—just as the Canadians had recommended. There was not an open tender, and the only two bids came from China Merchants and China Harbor; Sri Lanka chose China Merchants, making it the majority shareholder with a 99-year lease, and used the $1.12 billion cash infusion to bolster its foreign reserves, not to pay off China Eximbank.

Our research shows that Chinese banks are willing to restructure the terms of existing loans and have never actually seized an asset from any country, much less the port of Hambantota.

China’s march outward, like its domestic development, is probing and experimental, a learning process marked by frequent adjustment. After the construction of the port in Hambantota, for example, Chinese firms and banks learned that strongmen fall and that they’d better have strategies for dealing with political risk. They’re now developing these strategies, getting better at discerning business opportunities and withdrawing where they know they can’t win.

Over the past 20 years, Chinese firms have learned a lot about how to play in an international construction business that remains dominated by Europe: Whereas China has 27 firms among the top 100 global contractors, up from nine in 2000, Europe has 37, down from 41. The U.S. has seven, compared to 19 two decades ago.

After nearly one million Chinese people were unable to access their bank deposits in central China’s Henan province earlier this year, residents in east China’s Shanghai, south China’s Shenzhen, north China’s Dandong, and central-east China’s Jiujiang reported the difficulties they faced when trying to withdraw cash from their bank accounts. Some banks only serve a limited number of customers per day, some banks limit each client’s withdrawal to no more than 1,000 yuan and others have closed their branches. Even the ATM machines are empty. Bank runs have been happening in the world’s second-largest economy for over a week, which is unusual in China because most of the banks are state-run. “The reason why the bank run issue hasn’t been solved is that China’s economic system is in crisis and the Chinese regime doesn’t have the ability to solve it,” Wang He, U.S.-based China affairs commentator, told The Epoch Times. Zheng Yongnian, one of the economic advisors to Chinese president Xi Jinping, published an essay on June 1, in which he pointed out that China’s economy is facing critical challenges, including over half of the foreign investments, have left China, and China’s private businesses are struggling for survival due to a supply chain crisis and lack of cash. Zheng’s essay was removed from China’s internet soon after it was published.

The protest involved more than 100 delayed projects as of July 13, up from 58 projects just one day earlier. The frustrated buyers accuse the developers of misusing sales proceeds and the banks of failing to safeguard their loans.

But this mortgage strike isn’t entirely unpredictable. Homebuyers have every reason to be angry. Most of the projects were begun by developers who have defaulted. China Evergrande Group led the pack, accounting for an estimated 35% of the total projects that faced mortgage revolts, data compiled by CLSA shows. One such project in eastern Jiangsu province was launched before the Covid-19 pandemic. Construction has been suspended since last August, while property values in its neighborhood has come down by about 10%.

As far back as the spring of 2007, U.S. banks began to underperform financial institutions in Asia. By now, everyone knows most of the subprime mortgage credit risk was inside the USA with domestic banks more exposed than other banks around the world. Notice above, Goldman Sachs (green above) 5 year CDS (the cost of default protection on the bank), began to meaningfully divergence from Standard Chartered. Standard Chartered PLC is an international banking group operating principally in Asia, Africa, and the Middle East. The company has far more credit risk exposure to China – Asia than U.S. banks. It is clear above, more than 12 months prior to Lehman´s failure, banks in the USA were dramatically underperforming from a credit risk perspective. In other words, in 2007 – the cost of purchasing credit default protection on Goldman Sachs was far more expensive than the bank´s Asian peers. Indeed, elephants leave footprints – when large hedge funds see credit risk – they start placing bets months if NOT years before a credit event. The credit market sniffed out Lehman´s demise months BEFORE equity investors got the joke.

Fast forward to 2021, Evergrande headlines are all the media rage, especially with the Lehman, the lucky 13th anniversary this week. But, what are credit markets telling us this time? As you can see above – far right. Credit risk is calm on Asia banks with exposure to China, no difference to speak of. Central bank liquidity is so abundant, there is NO way Lehman would have failed today.

Always with an important lens – our friend, Jens Nordvig reminds us – “foreign involvement is small in China. It is true that the high-yield bond market has a sizable USD component (mostly foreign). But relative to the US, where subprime exposure was sold around the world, it is a much more local (controllable) system.” It has been clear for months, there is Evergrande credit contagion – it’s just inside China at the moment.

Evergrande is the most-indebted property developer in the world. Its on-balance-sheet liabilities amount to nearly 2 percent of China’s annual GDP, and its off-balance-sheet obligations add up to as much as another 1 percent.

For the past several years, Chinese regulators have worked hard—if unsuccessfully—to reduce the economy’s overreliance on debt. As part of this regulatory push, regulators implemented what became known as the three red lines for property developers last year. These consist of hard limits on a company’s debt-to-asset ratio, its debt-to-equity ratio, and its cash-to-short-term-debt ratio.

Evergrande group has more than $300bn of liabilities, about $20bn of which are offshore dollar-denominated bonds. The Chinese government has focused on completing work on its hundreds of projects, where homes have typically been sold to ordinary buyers before completion.