We're about to discuss what is the largest, most far-reaching financial scandal of our era. The sheer scope and reach of the Chinese Real Estate Firm,
Evergrande may be difficult to fully grasp when first you're introduced to it. But, please take the time to investigate this unfolding drama.
Because not only does it affect literally millions of Chinese, but as you'll discover it could very well affect you, and your investments.
There is a particular attitude abroad today. A kind of "laisse faire" attitude that says: “don't worry the powers that be will take care of everything.”
I encourage you, if that's how you feel about our financial markets, please leave those thoughts behind. Because, if I'm right, the
“powers that be” right about now are struggling to come up with some answers.
Our story begins yesterday, when Fitch, one of the three major US Rating Agencies, Fitch declared that Evergrande, the large Chinese Real Estate firm was in Restricted default.
Restricted meaning, I suppose, that Evergrande only defaulted on their dollar-denominated bonds. The bonds they sold to non-Chinese. People like you and me here in America.
Now I know Fitch. I worked with them on occasion when I was in the mutual fund business. Fitch is strictly old school, by the numbers. And it's unusual that Fitch would take this kind of action.
Usually, the conservative Fitch is reluctant to put down the hammer. But this time, that's exactly what they did. They put down what is perhaps the biggest financial hammer of all time.
And they were 100% justified. All they actually did was recognize the facts. And the facts are that Evergrande has defaulted on their bonds. Specifically on their US Dollar Denominated Bonds.
Bonds whose interest payment was due back on November 6th. Were then allowed a 30 day grace period. And finally Fitch, on December 9th called them on. Hey, Evergrande, Fitch was saying, you haven't paid your bond interest payment. You're in default.
Well, not quite.
You see, no one else on Wall Street or in the Financial Press, and certainly not in China, had the intestinal fortitude to make that claim. No one else would call out Evergrande.
And the reason we'll see, as we go through our story, is because literally everyone else is owned by Evergrande. To a degree, I have only just now begun to understand.
It's like the old Wall Street joke. Owe the bank $10,000 and the bank owns you. Owe the bank $10 million dollars and you own the bank.
Well, what would you think if that number were $300 billion. That's how much Evergrande owes. And a lot of it is to US funds and credit companies.
So let's begin with a brief survey of exactly what it is that Evergrande does. Because their role in the Chinese economy is one of the critical things to understand about this story.
Evergrande is no ordinary real estate developer, as we understand that in the US. Evergrande and the other companies in this particular sector are more like the entire Financial Services Industry wrapped up in one.
Real Estate, after all, is the primary wealth management asset for most Chinese. So they often pre-purchase an Evergrande luxury apartment as an investment first. And later as their retirement home. So literally for many Chinese, their entire financial future is with Evergrande.
All together this kind of financial product is owned by about 71 million Chinese and represents over $4 billion dollars in current investment. And that doesn't even count the number of Chinese who actually live in their apartments.
The Chinese Real Estate market is massive almost beyond comprehension. It is, for instance, about 10 times the size of the US Real Estate Market.
In total, the Chinese Real Estate Market Is valued at $55 Trillion dollars and generates 29% of China's Gross Domestic Product. There simply is no other economic sector in the world, which compares. That's why economists call the Chinese Real Estate sector the most important single financial sector in the world currently.
Now, are you starting to see why Fitch's default call, is so momentous? Fitch just said that one of the biggest players in the world's biggest financial sector has a problem.
And you could hear a pin drop on Wall Street.
Up to now, we've just looked at Evergrande from the Chinese perspective. Now we need to see the global impact.
China, you see, is a newcomer to the world of international finance. After all China only really began as a full-fledged player in the world of nations, about 50 years ago.
Hardly enough time to build up the financial resources needed to build the infrastructure, to say nothing of industrial and military resources, that you see today.
China, back in the 1970s, was not a wealthy nation. The average per capita income was tiny.
So how was it that they built the magnificent inland cities we see today? Complete with everything but people.
The answer, which is becoming more and more clear, is that they borrowed the money. And much of those funds came from Western Countries like the USA.
I remind you of the story that broke just this week, of how Tim Cooke, CEO of Apple Computer, entered into a deal with China, which gave them $275 billion dollars.
China's siren song, you see, is their population. And the great potential for American and other countries to step in and sell their products in the world's largest market.
It enticed Tim Cooke, just as it's been enticing American Companies for 3 or 4 decades now.
But direct corporate business ventures are far from the only way that China has been gaining American Capital. The other great road funneling American wealth to China has been Wall Street.
Chinese companies becoming listed on American Stock Exchanges. Although they didn't quite live up to all the requirements. And for our story, American Funds investing billions in Chinese companies, like Evergrande.
Our story began, you'll recall with Fitch challenging the viability of Evergrande's bonds. Actually just observed that Evergrande was not paying its interest on the bonds.
And by now you've no doubt read that Evergrande has $300 billion in various forms of debt, but mainly bonds.
If the truth is known, that actually understates Evergrande bond liability. Because each one of these interest payments that Evergrande misses is actually added to the amount it owes.
Thus the actual Evergrande indebtedness is growing larger by the day. And in fact, will probably increase by the time this story is over.
But who wants to quibble over a few hundred million here and there?
What we do want to talk about, is something that may promise to take the entire Evergrande debacle to the next level.
Here I'm indebted to Dr. Marco Metzler, senior analyst at DCMA a German Investment Research form. Dr. Metzler is doing what I feel is the best research on Evergrande in the world. The only analyst better likely works in the Evergrande Finance Department.
I'll leave links to Dr. Metzler's articles at valueside.com
This next level of potential loss is through Credit Default Swaps. A kind of Financial Round Robin. Where you purchase the Evergrande Bonds. I then offer to insure those bonds from default, for a slight fee. And it really is a slight fee. I make some money, and you feel safer.
Now that Evergrande has defaulted, those Credit Default Swaps will need to be paid. After all, I am going to have to pay you on Evergrande's default. It's in the contract.
When you add up all these Credit Default Swaps, Dr. Metzler estimates that will add another 150 billion roughly to the overall loss.
So now we're estimating the Evergrande Default event alone getting close to half a trillion.
That's going to put a real dent in Christmas Stockings worldwide. As investment bankers and brokers around the world are going to have to pony up that money. Some, almost inevitably won't be able to pay. And that will add to this impact.
So what's the impact here in the US?
Dr. Metzler estimates that pension and investment funds here in this country have already incurred $10 billion in losses, with another $2 billion coming shortly.
The major fund companies which have incurred these losses include UBS, Pimco, Fidelity Investments, and Black Rock.
Reports are that at least a couple of fund managers have been sacked.
And finally, there is the question of contagion. As we've noted Evergrande carefully constructed their debt so that they would gain the US and other offshore investors. They registered specific dollar-denominated bonds. Bonds aimed at non-Chinese.
In fact, it was those bonds that Fitch called out for being in default.
According to the rumors currently on Wall Street, the Street believes that Beijing, read the CCP, will have Evergrande default on all the dollar bonds, in an effort to pay the Chinese locals.
It's a strategy that may make sense to the CCP, as they attempt to placate a very unhappy populace at home.
But the practical effect, I think, will be to cut the Chinese Real Estate Market off, from their only really reliable and stable funding source.
Short-term, bridge-type loans are going to be essential if Evergrande is to make it through this crisis.
Those funds are simply not going to be available. I can't see American funds pouring more good money after bad.
So here's where we stand today. The curtain has been pulled back. The reluctant town crier: Fitch Research, has dared to speak the truth to the whole world.
Evergrande is in default, with total bankruptcy only a moment away. The rest of the global financial world will now have to echo Fitch. In an effort to salvage what little may be left of their own investments.
Like Samson, Evergrande is falling.
The question is: how much of China's and the world's financial house will Evergrande bring down?
References: Dr. Marco Metzler: https://www.dmsa-agentur.de/