A large, financially interconnected company is on the verge of being burdened with massive debt. The government is considering a bailout. There isn’t an easy answer. Doing nothing runs the risk of serious financial upheaval. But taking it out would indicate that greed, irresponsibility and moral hazard are of no consequence.
This is a tough call. And if this all sounds too familiar, you’re right. In 2008 the US government was faced with the dilemma of what to do about Lehman Brothers, the country’s fourth largest investment bank, which found itself unable to pay back more than US$600 billion in debt.
Now the Chinese government is facing a comparable situation with Chinese asset and financial giant Evergrande.
Lehman Brothers, founded in 1847, survived the American Civil War, the Great Depression, and two World Wars. Then in the 1980s in a fiery bubble of risky bets on the US mortgage market, it plunged into deep trouble.
US Treasury Secretary Hank Paulson – a former senior Wall Street executive – was, by all accounts, outraged that Lehman had held the position so casually. Why not send out the message that the US government is not going to give relief to the bad-behaving big banks?
The answer, it turned out, was to let Lehman fail through America and the global economy.
When Lehman filed for Chapter 11 bankruptcy protection, it was facing the largest bankruptcy in history. Those who owed it money were immediately put under pressure. This put pressure on those who owed their money. The money market almost completely froze.
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Even Goldman Sachs — Wall Street’s most respected firm and originally on the good side of mortgage-market trades — was hammered. Veteran investor Warren Buffett pumped US$5 billion into the company to avoid running a modern-day bank.
China’s Lehmann moment?
Unlike Lehman Brothers, Evergrande is not an investment bank. Basically it is a real estate developer, responsible for building apartments across China. But it has become much more than that – a highly leveraged and integrated company that does everything from banking to asset development to selling electric cars.
Like many things in China, the exact state of affairs is a bit unclear, but one reading is that Evergrande is basically a hedge fund with a property and vehicle business.
The closest cause for concern is Evergrande’s non-payment of US$83 million in interest on 23 September. The clock is running out, it has 30 days to “fix the breach” and figure out a way to pay. Otherwise things, as the good kids say, “will start to get real”.
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For now Evergrande has agreed to sell its stake in a local bank (Shengjing Bank) to the state-owned Shenyang Shengjing Finance Investment Group for about 10 billion yuan (about US$1.5 billion).
But Evergrande has US$300 billion in debt, so there’s really no running away from the issue for Chinese officials. If Evergrande has any more tumultuous deals on the books, that would be US$1.5 billion buying just in time.
If things in the state of Evergrande are as rotten as many observers think, the Chinese government will have to pull it out, or let it fail.
In a sense, the CCP must have seemed “now we are all Hank Paulson”.
China spare equipment
That said, there is an intriguing – if somewhat troubling – option available to Chinese officials.
They could bail out the company but punish its top executives with severe personal sanctions. Simply put, they don’t need to be concerned with the specifics of due process like the US government.
The Chinese government, if it so desires, can stop the echoes throughout the economy that would flow from the collapse of Evergrande, but prevent future moral hazards. This can send a very clear message of consequence to officials engaging in reckless and potentially corrupt practices. Maybe life imprisonment. maybe worse.
This is an interesting, if rather serious, example of the Tinbergen rule – named after Jan Tinbergen, the winner of the first Nobel Prize for Economics. This rule states that each policy challenge requires an independent policy instrument. The US government had one. There are two under Chinese rule.
It all raises big issues
There are bigger issues beyond this. How well are Chinese enterprises really performing? So far it looked like the answer was remarkably good. But is all this a mirage, which has persisted because of the lack of transparency in all Chinese institutions?
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It seems that there can be two types of Chinese corporations: those that make “things” that have been and still are successful, and those that “bank” things, which in the Western world resembled their capitalist counterparts when Moral hazard and corruption are allowed to run rampant.
The shocks of the coming years will reveal much about the economic base of China’s global power.