Is China's housing bubble - the main "wealth effect" for hundreds of millions of middle class Chinese - finally about to burst?
On Friday, trading in onshore bonds of China Evergrande, China's second largest and the world’s most indebted property developer, was halted after reports it was seeking government help to stave off a cash crunch caused the price of its shares and debt to tumble, and sparking a crisis of confidence among creditors who’ve lent the world’s most indebted developer more than $120 billion.
As Bloomberg reports, long-simmering doubts about the property giant’s financial health exploded to the fore on Thursday, following reports it had sent a letter to Chinese officials warning of a potential cash crunch that could pose systemic risks. The news sparked a furious liquidation in the company's bonds that continued into Friday, sending the price of Evergrande’s yuan note due 2023 down as much as 28% to a record low. Losses in the company’s dollar bonds spread to high-yield debt across Asia.
The selloff was so intense that according to the Financial Time, it forced the Shanghai stock exchange to suspend trading in Evergrande bonds for half an hour on Friday morning, due to "abnormal fluctuations", which is a polite euphemism for "selling."
The crash in Evergrande shares and bonds was sparked after a letter, purportedly from the company, circulated on Chinese social media on Thursday requesting support for a previously planned reorganization from the provincial government in Guangdong, where Evergrande is based. In the purported letter dated August 24, the FT reports that Evergrande asked the Guangdong government to approve a plan to float its subsidiary Hengda Real Estate on Shenzhen’s stock exchange through a merger with an already listed company (another eerie similarity to the Nicola SPAC-reverse merger). Evergrande reportedly added that a failure to complete the reorganization would pose "systemic risks."
In response, and in continuing its most sincerely imitation of Trevor Milton, the company said in a filing to Hong Kong’s stock exchange late on Thursday that the documents "fabricated and pure defamation" and that it had reported the matter to China’s security authorities.
"There are rumors circulating on the Internet about the reorganisation of Hengda Real Estate. The relevant documents and pictures are fabricated and are pure defamation, causing serious damage to the Company’s reputation. The Company strongly condemns such acts and has reported the case to the public security authorities.”
Just to be safe, reports that Evergrande also asked its employees to post on social media platform WeChat a statement saying the letter was fake, according to the FT.
The full-blown attempt at deflecting investor skepticism proved woefully insufficient, however, and resulted in a wholesale puke in the company's publicly traded securities, with Evergrande shares falling 9.5% to the lowest level since May at the close of trading in Hong Kong.
Alas, where there's smoke there is usually fire - especially in an economy that has been ravaged by the coronavirus pandemic - and on Thursday rating agency S&P poured fuel on the fire when it cut its outlook on Evergrande’s B+ credit rating outlook from stable to negative.
"Evergrande's short-term debt has continued to surge, partly due to its active acquisition of property projects," it said. "We had previously expected the company to address its short-term debt, especially given the tough economic climate."
Making matters worse, there is a near-term trigger that could catalyze a full-blown debt and liquidity crisis and which is further spooking investors. As part of an agreement Evergrande struck with some of its largest investors, the company raised about 130 billion yuan ($19bn) by selling shares in Hengda and needs to repay investors if fails to win approval for a backdoor listing on the Shenzhen stock exchange by Jan. 31.
This is a problem because that amount represents 92% of Evergrande cash and cash equivalents of 142.5 billion yuan in. And since the fate of the company itself is suddenly determine by its stock price - a reverse merger appears very much unlikely if Evergrande can't stabilize its stock price - the possibility of a toxic feedback loop emerges, where the lower the stock price drops, the more aggressive the selling, the more likely a terminal liquidity event occurs and forces the company to demand a shareholder-liquidating bailout. S&P agrees, saying that Evergrande will have to repay a portion of its investments in Hengda, even as it sought to contain the panic by adding that the risk of a liquidity crunch was "still low for now." We'll check back in a week.
Though it’s unclear why Evergrande has yet to win approval for its listing plan, Bloomberg speculates it may relate to China’s efforts to tame sky-high home prices and restrain fundraising by developers. Regulators have been using a wide range of policy levers since 2016 to deter speculative home-buyers, curb expensive land prices and restrict lending to residential builders.
Evergrande has said it won’t raise new funds through the listing in Shenzhen, but the transaction could allow the company to achieve a higher valuation and thus easier access to future financing. Its stake sale to strategic investors in 2017 implied a valuation of about 425 billion yuan for the unit, which holds most of Evergrande’s real estate assets. That’s almost three times higher than the market value suggested by the developer’s existing shares in Hong Kong. Chinese property developers trade at about 12 times projected earnings on average in Shanghai and Shenzhen, compared with about 5 times in Hong Kong.
In yet another red flag, Bloomberg reports citing five sources that at least five Chinese banks and two trust firms held emergency meetings on Thursday night to discuss their Evergrande exposure and access to collateral. Among them was China Minsheng Banking Corp., whose exposure to Evergrande exceeds 29 billion yuan. And since this is China, where once a default cascade begins it may never end, reader will recall that Minsheng Bank, also known as "China's JPMorgan" was itself in crisis last spring when it missed a bond payment in January 2019 and sought money from its employees to avoid collapse.
But while Minsheng may be stable for now, Evergrande is anything but especially after at least two of the banks that were present in the emergency meetings decided to bar the company from drawing unused credit lines, effectively capping the company's liquidity just as it will desperately need access to every incremental yuan. The developer had credit lines of 503 billion yuan as of June 30, of which 302 billion yuan were unused, according to Bloomberg.
“Regardless of the authenticity of the letter, we think the situation may have prolonged negative impact,” Manjesh Verma and Stella Li, credit analysts at Citigroup, wrote in a report. "It increases concerns among various investors and lenders and hence increases difficulty in funding access and refinancing."
Meanwhile, the FT notes that analysts have long been concerned that any issues at Evergrande could ripple through China’s financial system: "Evergrande is a significant source of systemic risk,” said Nigel Stevenson, an analyst at GMT Research. "There are huge debts in the listed parent company that will ultimately need to be refinanced."
Just how huge are the debts? One look at the chart below should answer all questions on why the second most important Chinese property developer is also a systematically important company for a country where the bulk of household wealth is not in the stock market but in real estate.
As Bloomberg adds, Evergrande has long been viewed as a poster child for highly leveraged companies in China, where corporate debt swelled to a record 205% of gross domestic product in 2019 and has likely climbed further this year as firms increased borrowing to tide themselves over during the pandemic. Evergrande has tapped banks, shadow lenders and the bond market in recent years to expand beyond the property industry into businesses ranging from electric cars to hospitals and theme parks –- areas that often align with Chinese President Xi Jinping’s policy priorities.
The core problem that Evergrande has faced as it unleashed this historic debt issuance spree, is that it did not expect the coronavirus to cripple the Chinese economy. Following the coronavirus pandemic, investors have sharpened their focus on China’s heavily indebted property developers, which have huge volumes of outstanding debt held by foreign entities (amusingly enough, FTSE Russell just announced Chinese government bonds will be included into its flagship World Government Bond Index from October 2021, as China can never find enough greater fools to whom it can sell even more Evergrande debt).
Amid the economic slowdown, Evergrande this month was forced to slash the price of its properties in China by 30%. The company has said the discounts were a "normal sales strategy" for September and October. Just one problem: those two months are a peak time for home sales in China, which means that Evergrande is lying. Again.
* * *
One big variable surrounding the future of Evergrande is whether Beijing will merely swoop in and bail it out if it is unable to repay creditors. While the Chinese government has a long history of bailing out systemically important companies to maintain financial stability, policy makers have in recent years sought to instil more market discipline and reduce moral hazard. Case in point, as part of China's spotty efforts to rein in risk, authorities have recently nationalized indebted conglomerates such as HNA Group, Anbang and Tomorrow Group. They’ve also introduced new rules for financial holding companies, including Evergrande, that impose minimum capital requirements and other restrictions meant to reduce the threat of systemic blowups.
In any case, every ponzi scheme eventually comes to an end, and unless Evergrande can find a way to continues it unprecedented debt expansion, it is facing a brutal debt maturity schedule...
... which sees billions in existing yuan and dollar bonds set for repayment. If the company remains locked out of capital markets, if it can't restore access to its line of credit, and unless it can complete its reverse merger, it just may be over for Evergrande, and also for China's gargantuan housing bubble.
Las Vegas Strip faces growing bed bug problem
With huge events including Formula 1, CES, and the Super Bowl looming, the Las Vegas Strip faces an issue that could be a major cause for concern.
Las Vegas beat the covid pandemic.
It wasn't that long ago when the Las Vegas Strip went dark and people questioned whether Caesars Entertainment, MGM Resorts International, Wynn Resorts, and other Strip players would emerge from the crisis intact.
In the darkest days, the entire Las Vegas Strip was closed down and when it reopened, it was not business as usual. Caesars Entertainment (CZR) - Get Free Report and MGM reopened slowly with all sorts of government-mandated restrictions in place.
The first months of the Strip's comeback featured temperature checks, a lot of plexiglass, gaming tables with limited numbers of players, masks, and social distancing. It was an odd mix of celebration and restraint as people were happy to be in Las Vegas, but the Strip was oddly empty, some casinos remained closed, and gaming floors were sparsely filled.
When vaccines became available, the Las Vegas Strip benefitted quickly. Business and international travelers were slow to return, but leisure travelers began bringing crowds back to pre-pandemic levels.
The comeback, however, was very fragile. CES 2022 was supposed to be Las Vegas's return to normal, the first major convention since covid. In reality, surging cases of the covid omicron variant caused most major companies to pull out.
Even with vaccines and covid tests required, an event that was supposed to be close to normal, ended up with 25% of 2020's pre-covid attendance. That CES showed just how quickly public sentiment — not actual danger — can ruin an event in Las Vegas.
Now, with November's Formula 1 Race, CES in January, and the Super Bowl in February all slated for Las Vegas, a rising health crisis threatens all of those events.
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The Las Vegas Strip has a bed bug problem
While bed bugs may not be as dangerous as covid, Respiratory Syncytial Virus (RSV), Legionnaires’ disease, and some of the other infectious diseases that the Las Vegas Strip has faced over the past few years, they're still problematic. Bed bugs spread easily and a small infestation can become a large one quickly.
The sores caused by bed bugs are also a social media nightmare for the Las Vegas Strip. If even a few Las Vegas Strip visitors wake up covered in bed bug bites, that could become a viral nightmare for the entire city.
In late-August, reports came out the bed bugs had been at seven Las Vegas hotel, mostly on the Strip over the past two years. The impacted properties includes Caesars Planet Hollywood and Caesars Palace as well as MGM Resort International's (MGM) - Get Free Report MGM Grand, and others including Circus Circus, The Palazzo, Tropicana, and Sahara.
"Now, that number is nine with the addition of The Venetian and Park MGM. According to the health department report, a Venetian guest reported seeing the bloodsuckers on July 29 and was moved to another room. An inspection three days later confirmed their presence," Casino.org reported.
The Park MGM bed bug incident took place on Aug. 14.
Bed bugs remain a Las Vegas Strip problem
Only Tropicana, which is soon going to be demolished, and Sahara, responded to Casino.org about their bed bug issues. Caesars and MGM have not commented publicly or responded to requests from KLAS or Casino.org.
That makes sense because the resorts do not want news to spread about potential bed bug problems when the actual incidents have so far been minimal. The problem is that unreported bed bug issues can rapidly snowball.
The Environmental Protection Agency (EPA) shares some guidelines on bed bug bites on its website that hint at the depth of the problem facing Las Vegas Strip resorts.
"Regularly wash and heat-dry your bed sheets, blankets, bedspreads and any clothing that touches the floor. This reduces the number of bed bugs. Bed bugs and their eggs can hide in laundry containers/hampers. Remember to clean them when you do the laundry," the agency shared.
Normally, that would not be an issue in Las Vegas as rooms are cleaned daily. Since the covid pandemic, however, some people have opted out of daily cleaning and some resorts have encouraged that.
Not having daily room cleaning in just a few rooms could lead to quick spread.
"Bed bugs spread so easily and so quickly, that the University of Kentucky's entomology department notes that "it often seems that bed bugs arise from nowhere."
"Once bed bugs are introduced, they can crawl from room to room, or floor to floor via cracks and openings in walls, floors and ceilings," warned the University's researchers.
spread social distancing pandemic
Americans are having a tough time repaying pandemic-era loans received with inflated credit scores
Borrowers are realizing the responsibility of new debts too late.
With the economy of the United States at a standstill during the Covid-19 pandemic, the efforts to stimulate the economy brought many opportunities to people who may have not had them otherwise.
However, the extension of these opportunities to those who took advantage of the times has had its consequences.
A report by the Financial Times states that borrowers in the United States that took advantage of lending opportunities during the Covid-19 pandemic are falling behind on actually paying back their debt.
At a time when stimulus checks were handed out and loan repayments were frozen to help those affected by the economic shock of Covid-19, many consumers in the States saw that lenders became more willing to provide consumer credit.
According to a report by credit reporting agency TransUnion, the median consumer credit score jumped 20% to a peak of 676 in the first quarter of 2021, allowing many to finally have “good” credit scores. However, their data also showed that those who took out loans and credit from 2021 to early 2023 are having an hard time managing these debts.
“Consumer finance companies used this opportunity to juice up their growth at a time when funding was ample and consumers’ finances had gotten an artificial boost,” Chief economist of Moody’s Analytics Mark Zandi told FT. “Certainly a lot of lower-income households that got caught up in all of this will feel financial pain.”
Moody’s data shows that new credit cards accounts that were opened in the first quarter of 2023 have a 4% delinquency rate, while the same rate in September 2022 was 4.5%. According to the analysts, these levels were the highest for the same point of the year since 2008.
Additionally, a study by credit scoring company VantageScore found that credit cards issued in March 2022 had higher delinquency rates than cards issued at the same time during the prior four years.
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Credit cards were not the only debts that American consumers took on. As per S&P Global Ratings data, riskier car loans taken on during the height of the pandemic have more repayment problems than in previous years. In 2022, subprime borrowers were becoming delinquent on new cars loans at twice the rate of pre-pandemic levels.
S&P auto loan tracker Amy Martin told FT that lenders during the pandemic were “rather aggressive” in terms of signing new loans.
Bill Moreland of research group BankRegData has warned about these rising delinquencies in the past and had recently estimated that by late 2022, there were hundreds of billions of dollars in what he calls “excess lending based upon artificially inflated credit scores”.
The Government's Role
Because so many are failing to pay their bills, many are wary that the government assistance may have been a financial double-edged sword; as they were meant to alleviate financial stress during lockdown, while it led some of them to financial difficulty.
The $2.2 trillion Cares Act federal aid package passed in the early stages of the pandemic not only put cash in the American consumer’s pocket, but also protected borrowers from foreclosure, default and in some instances, lenders were barred from reporting late payments to credit bureaus.
Yeshiva University law professor Pam Foohey specializes in consumer bankruptcy and believes that the Cares Act was good policy, however she shifts the blame away from the consumers and borrowers.
“I fault lenders and the market structure for not having a longer-term perspective. That’s not something that the Cares Act should have solved and it still exists and still needs to be addressed.”
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Inflation: raising interest rates was never the right medicine – here’s why central bankers did it anyway
We need to start cutting rates, but there’s something that has to happen first.
Inflation remains too high in the UK. The annual rate of consumer price inflation to September was 6.7%, the same as a month earlier. This is well below the 11.1% peak reached in October 2022, but the failure of inflation to keep falling indicates it is proving far more stubborn than anticipated.
This may prompt the Bank of England’s Monetary Policy Committee (MPC) to raise the benchmark interest rate yet again when it meets in November, but in my view this would not be entirely justified.
In reality, the rate hikes that began two years ago have not been very helpful in tackling inflation, at least not directly. So what’s the problem and is there a better alternative?
Right policy, wrong inflation
Raising interest rates is the MPC’s main tool for trying to get inflation back to its target rate of 2%. The idea is that this makes it more expensive to borrow money, which should reduce consumer demand for goods and services.
The trouble is that the type of inflation recently witnessed in the UK seems less a problem of excessive demand than because costs have been rising for manufacturers and service providers. It’s known as “cost-push inflation” as opposed to “demand-pull inflation”.
Inflation rates (UK, US, eurozone)
Production costs have risen for several reasons. During the COVID-19 pandemic, central banks “created money” through quantitative easing to enable their governments to run large spending deficits to pay for furloughs and other interventions to help citizens through the crisis.
When countries started reopening, it meant people had money in their pockets to buy more goods and services. Yet with China still in lockdown, global supply chains could not keep pace with the resurgent demand so prices went up – most notably oil.
Oil price (Brent crude, US$)
Then came the Ukraine war, which further drove up prices of fundamental commodities, such as energy. This made inflation much worse than it would otherwise have been. You can see this reflected in consumer price inflation (CPI): it was just 0.6% in the year to June 2020, then rose to 2.5% in the year to June 2021, reflecting the supply constraints at the end of lockdown. By June 2022, four months after Russia’s invasion of Ukraine, CPI was 9.4%.
The policy problem
This begs the question, why has the Bank of England (BoE) been raising rates if it’s unlikely to be effective? One answer is that other central banks have been raising rates. If the BoE doesn’t mirror rate rises in the US and eurozone, investors in the UK may move their money to these other areas because they’ll get better returns on bonds. This would see the pound depreciating against the US dollar and euro, in turn increasing import prices and aggravating inflation.
Part of the problem has been that the US has arguably faced more of the sort of demand-led inflation against which interest rates are effective. For one thing, the US has been less at the mercy of rising energy prices because it is energy self-sufficient. It also didn’t lock down as uniformly as other major economies during the pandemic, so had a little more space to grow.
At the same time, the US has been more effective at bringing down inflation than the UK, which again suggests it was fighting demand-driven price rises. In other words, the UK and other countries may to some extent have been forced to follow suit with raising interest rates to protect their currencies, not to fight inflation.
How harmful have the rate rises been in the UK? They have not brought about a recession yet, but growth remains very weak. Lots of people are struggling with the cost of living, as well as rent or mortgage costs. Several million people are due to be hit by much higher mortgage rates as their fixed-rate deals end between now and the end of 2024.
UK GDP growth (%)
If hiking interest rates is not really helping to curb inflation, it makes sense to start moving in the opposite direction before the economic situation gets any worse. To avoid any damage to the pound, the answer is for the leading central banks to coordinate their policies so that they cut rates in lockstep.
Unless and until this happens, there would seem to be no quick fix available. One piece of good news is that the energy price cap for typical domestic consumption was reduced from October 1 from £1,976 to £1,834 a year. That 7% reduction should lead to consumer price inflation coming down significantly towards the end of 2023.
More generally, the Bank of England may simply have to hope that world events move inflation in the desired direction. A key question is going to be whether the wars in Ukraine and Israel/Gaza result in further cost pressures.
Unfortunately there is a precedent for a Middle East conflict leading to a global economic crisis: following the joint assault on Israel by Syria and Egypt in 1973, Israel’s retaliation prompted petroleum cartel OPEC to impose an oil embargo. This led to an almost fourfold increase in the price of crude oil.
Since oil was fundamental to the costs of production, inflation in the UK rose to over 16% in 1974. There followed high unemployment, resulting in an unwelcome combination that economists referred to as stagflation.
These days, global production is in fact less reliant on oil as renewables have become a growing part of the energy mix. Nonetheless, an oil price hike would still drive inflation higher and weaken economic growth. So if the Middle East crisis does spiral, we may be stuck with stubborn, untreatable inflation for even longer.
Robert Gausden does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.recession unemployment economic growth reopening bonds monetary policy mortgage rates currencies pound us dollar euro governor lockdown pandemic covid-19 recession gdp interest rates commodities oil uk russia ukraine china
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