Monday, Jan 29, 2024

what the Evergrande liquidation means for risk markets, risk signals reacting, terrorism financing

“The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.” – Isaac Asimov  ||

Hello everyone, I hope you all had a good weekend! I had a lot to say today about some more crypto misconceptions I’m seeing, but with the Evergrande news and the climb in risk indicators, including it all would have made this email impossibly long, so I’ll save it for tomorrow.

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IN THIS NEWSLETTER:

• What the Evergrande liquidation means

• The split lens of risk measures

• Crypto and terrorism – a different approach

WHAT I’M WATCHING:

What the Evergrande liquidation means

For something so drastic, the confirmed liquidation order from a Hong Kong court of Chinese real estate conglomerate Evergrande feels like almost like a sad anti-climax – we’ve been expecting this for so long, its arrival feels more like a sigh of disappointment than bold stroke.

Of course, it’s bad news, but perhaps not as bad as the headlines suggest.

First, the market has been largely discounting this. Evergrande bonds have been trading at less than 2c on the dollar since November of last year.

(chart via Bloomberg)

And mainland real estate stocks have been heading down since well before the pandemic.

(chart via TradingView)

Property investment has been plummeting since the speculation crackdown in 2021 (the year Evergrande defaulted on its debt).

(chart via Bloomberg)

It’s not unreasonable to ask just how much lower sentiment can go – I know, things can always get worse, but the resolution of the Evergrande overhang could end up signaling that property prices could be bottoming.

What’s more, state assistance will most likely continue. Over the past few months, China has lowered interest rates for mortgages, reduced the bureaucratic filters for home-buying, and otherwise actively encouraged lenders to be supportive to developers and home buyers.

This matters for social unrest – real estate woes have triggered protests across the country. That’s not a good look. It also matters for overall economic activity – roughly 80% of the average household’s wealth is tied up in housing. If property values fall, families feel less wealthy and spend less, affecting other sectors.

And the potential for social disaster is significant: according to the Financial Times, roughly 1.5 million investors have paid for homes that have not yet been built.

But the Evergrande liquidation does not mean that they won’t be. A liquidation does not require all activity to cease, it means that new management moves in to sell off everything possible. A restructuring could still happen. Meanwhile, ongoing work will continue to be ongoing if a buyer for the division can be found – and with state encouragement, this is likely.

That doesn’t mean we shouldn’t be worried, though. The bulk of the damage to Evergrande’s investors and clients may have already been done, but the ripple effects are impossible to predict, given the sprawling scope of Evergrande activities.  

There’s the possibility of further hits to the banking sector – late last year, Evergrande concerns triggered at least one bank run that we know of.

And there’s the hit to overall demand as commercial projects shut down, industrial construction goes idle and risk-averse investors withdraw what they can from the market. China’s growth matters for global economic activity, and not just because it has a massive consumer and industrial base eager to consume foreign goods – it also matters because emerging economies around the world depend on Chinese lending.

One big question mark is how China will react to this – Hong Kong’s financial markets operate separately from those on the mainland, and its solvency proceedings have limited recognition. China could appoint separate liquidators which could make the process even more complicated. It could also reject the Hong Kong court’s decision. Since most of Evergrande’s assets are on the mainland, that would make an orderly liquidation almost impossible.

And the bigger picture perception impact is significant. It’s not just that a seemingly safe investment turned out to not be safe, with the hit to investor confidence that brings. It’s also that the Chinese Communist Party, assuming it goes along with the liquidation, is willing to let significant companies, even those that were once deemed “too big to fail”, collapse under their own profit-maximization weight. And that the ultimate “protector”, the state, didn’t protect.

It will take some time to unpick the ideological ramifications of this.  

The split lens of risk measures

What does the Evergrande news mean for global risk markets?