By K Raveendran
A virus originating in Wuhan has had the world coming crashing down. Whether the virus escaped from the lab or spread as a contagion from the nearby market is yet to be settled. It is also unclear as to how long is to going to take for the world come out of its sickness. Even as uncertainty continues on this count, a financial virus from China is threatening to spread like a contagion and the world is keeping fingers crossed as to how much damage it can cause. The collapse of Chinese real estate major Evergrande already has shocked the world markets and forcing memories of Lehman that ended up in the 2008 global financial crisis.
For a start, the development has led to tanking of major indexes on global markets and have shaved off billions of dollars from the fortunes of the world’s richest people. The top 10 richest, including Tesla’s Elon Musk, Amazon’s Jeff Bezos, Bill Gates, Mark Zuckerberg, Warren Buffett, and others lost over $26 billion. Musk, the world’s richest billionaire, saw his net worth falling by $7.2 billion to $198 billion, according to the Bloomberg Billionaires Index. The fear of a domino effect, on the lines of the Lehman debacle, has triggered a sell-off in the markets, although initial indications suggest that the market is managing to absorb the shock and keep the impact restricted locally and prevent any deep penetration.
Trouble with Evergrande has not come abruptly. The company, which has been overstretching both its resources as well as capabilities, has sold 1.5 million property units, but is yet to build them, evoking fears of a property bubble. All burst bubbles have a domino effect, affecting every other entity involved with the defaulting company and Evergrande has links to over 300 major companies, including leading banks and financial institutions, causing worry. Stories of ghost towns, unsustainable debts and manipulation of account books have been abounding in recent times, similar to the run-up to the Lehman fiasco. The company has debt in the vicinity of $300 billion.
The 2008 financial crisis had its genesis in a subprime crisis in the United States when banks built up huge toxic exposures to dwelling units with inflated price values and repayment vulnerabilities. Luckily, India remained largely insulated from the crisis because of the weaker linkages with the global financial system at that time, which need not be the case now.
But there is a strong view among a section of the market analysts that Evergrande is not Lehman 2.0 and they base their arguments on two existential facts. One, the company has tangible assets like buildings and lands while Lehman’s $640 billion balance sheet was completely toxic with illiquid subprime mortgages, further polluted by credit default swap excreta. Two, Evergrande’s $300 billion debt is mainly owed to Chinese state banks, which are used to ‘hokey pokey’ accounting standards.
Investment banker Matein Khalid, who says his opportunistic trades made money on Evergrande fallout, points out that Lehman was hostage to short term funding markets that froze when the ostensibly too big to fail (TBTF) investment bank was not saved by the Bush White House. But, according to him, Evergrande’s debt woes have been priced into the global capital markets since at least 2017 and therefore it may be illogical to assume that contagion risk will hit Western banking dominoes as feared.
It seems that the Chinese government has been preparing for such a meltdown, trying to de-leverage the exposure in a gradual manner so as to contain the impact. A stress test of the banks on account of property troubles had forewarned the authorities, who launched containment policies to limit the damage to tolerable levels. This was attempted through curbs in the property developers’ capacity to create additional debts.
Reports from markets around the world suggest that after the initial commotion, markets have taken things in their stride and priced in the troubles properly. In fact, the market’s current obsession is the forthcoming Fed meeting, which is expected to reassure the markets and yet signalling the end of its easing policies put in place to meet the emergencies of Covid pandemic. (IPA Service)