To bail out or not to bail out: China’s Evergrande dilemma

An unfinished Evergrande housing complex in Luoyang, China.
An unfinished Evergrande housing complex in Luoyang, China.
Image: Reuters/Carlos Garcia Rawlins
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The Evergrande Group, one of China’s biggest real-estate developers, owes more than $300 billion to a number of lenders. Its interest liabilities are rising by an average of $28 million daily. On Thursday, Sep. 23, alone, the company needs to pay around $120 million as interest payments to bondholders.

If Evergrande begins to default, it will present the Chinese government with a dilemma. Should the company be bailed out, or should it be allowed to fail?

The prospect of a bailout presents China the same kind of moral hazard that the US, for instance, faced during the banking crisis of 2008. If the government props Evergrande up, it might unwillingly signal a kind of acceptance, or even encouragement, of risky behavior. Other companies can interpret the bailout as reassurance that, if they ever wish to fly too close to the sun, the government will always be there to save them.

But this isn’t a signal China wants to send. Quite the opposite: China has been trying to cut down on the ballooning debt in its real estate sector, setting strict new rules on how developers find financing. In fact, China is worried about debt and defaults across the economy; two years ago, it set up dozens of US-style bankruptcy courts across the country to shepherd companies towards the kind of corporate restructuring that American firms find under Chapter 11. If companies fail, China wants them to fail well.

What if China lets Evergrande collapse?

The cost of not keeping Evergrande afloat might be a high one too. The markets are worried about the contagion effect that an Evergrande collapse will have on the economy; comparisons to the 2008 insolvency of Lehman Brothers, and the financial meltdown that ensued, have already been aired. There’s no good time for an economic crisis, but a particularly bad time for one is when the world is already in the grip of a pandemic.

If Evergrande does go into a bankruptcy court and has its debt restructured, its investors will all take significant haircuts on what they’re owed. But according to the so-called “seniority waterfall”—the pecking order in which creditors get paid—the Chinese government itself makes money first, since state-owned banks are among Evergrande’s biggest creditors.

Private investors, ranking lower down the waterfall, will take a bigger hit. So will the 1.7 million people who have deposited down-payments for Evergrande homes that may never be built. So will Evergrande’s employees, who were forced to loan the company money.

That presents a different kind of risk to the government: the specter of public protests. Chinese authorities are acutely sensitive to social unrest, forever worried that it could escalate into a bigger, anti-government movement. In the final analysis, China’s decision on what to do with Evergrande might hinge as much on anxieties about a social contagion as about an economic one.