Too Big To Disappear


Audio Length: 00:47:36

This week, Felix Salmon, Emily Peck and Stacy-Marie Ishmael talk about the precarious position of the huge Chinese real-estate company Evergrande, the debt ceiling and revolving door of tax policies, and the foreign policy dustup over submarines.

In the Plus segment: Corruption in the Treasury Department.


S2: Hello.

S1: Welcome to the too big to disappear episode of Slate Money. Your guide to the business and finance news of the week. I’m Felix Salmon of Axios. I’ve got the whole crew here. I’ve got Stacy-Marie Ishmael of Bloomberg at Bloomberg. In Bloomberg.

S2: All things Bloomberg

S1: here on Slate Money, we have Emily Peck and fundraise. Hello. Hello. We are going to talk about Evergrande. We are going to talk about geopolitics. We are going to talk about submarines. We are going to talk about the corruption of the Treasury Department in Slate Plus. What else are we talking about? We have a jam packed

S3: the debt ceiling Felix.

S1: We are going to talk about the debt ceiling. Of course, we have to talk about the debt ceiling. We’re going to talk about basically everything except for platinum coins. Everything you need to know about anything is coming up on this show. It’s a relatively short but very dense and super meaty and lots of fun show. It’s all coming up on sleep money.

S3: I spent all week trying to figure out Evergrande, and I feel like I understand it a little bit. I’m curious what you think.

S1: Nice. All right. I want you to explain it to me. Emily. What do you think? All right.

S3: I’m cracking my knuckles here. I have listened to OddlotsAxios and read some articles. So here we go. Evergrande is a giant Chinese real estate developer. They build stuff and own stuff. Real estate wise. They also own other weird things like electric vehicles and soccer, a soccer team in China. They’re huge. They borrow lots and lots of money, and it winds up in all kinds of places all over the global economy. And they don’t have enough money anymore to pay their debts. Three hundred billion dollars in debt. And so this week, that all kind of came to a head and people started freaking out and saying, Evergrande is that some people saying, actually, I saw some people apparently were saying, it’s the next Lehman Brothers. But in reality, I saw more takes that were like explaining why Evergrande is actually not the next Lehman Brothers. So I came away thinking, this is a huge crisis on Wednesday. But by the time we’re recording this on Friday, my new thought is this is probably fine.

S1: So to bring us up to about as much speed as I can do, given the recording in this home Friday. This is a fast moving story. But on Thursday there was a big coupon payment due Evergrande had to pay 83 and a half million dollars to its American, well to its international bondholders on a U.S. dollar bond and has a lot of dollar borrowings. And it didn’t. So it is clearly having difficulty paying its debts because it didn’t make that payment. Technically, that doesn’t actually put it in default because it has the 30 day grace period, like bonds always come with 30 day grace periods. But it’s in default, and they have been trying to do like resolutions and work outs with their domestic creditors, who include a bunch of, you know, mom and pop individual retail Chinese investors. And this is why it’s a really big deal in China is there are literally millions of Chinese households who are exposed to this company, either because they lent it money or because they bought a house from it, which they haven’t moved into yet. Like, they like all homebuilders, they sell their apartments before that built and get this. There are 1.6 million Chinese households who have paid for houses in China, which haven’t been finished yet, and that house by Evergrande. So that’s just an insane number of people.

S3: And one interesting thing I learned from OddlotsAxios podcast on Bloomberg is that in China, there are all kinds of limits on what kind of investments individuals can make. So real estate is like this very huge big deal investment that people make homes. There are not just things you live in, but things like you expect to make money off of. And Chinese are very price sensitive if they feel like the value of their apartment or their house is going to go down, or even if they live in an apartment building where they bought at a price, and now they see other homes selling for lower. There’s a freak out.

S1: There’s it’s it’s been this absolutely insane wealth generation machine in China. Basically, I think in late 1998 or thereabouts, China started basically giving away or selling at very low prices. All of the housing in China to the people who lived in that housing. And ever since then, the price of housing in China, the value of apartments has just been steadily going up not just in Beijing and Shanghai, but in second, third, fourth fifth tier cities. Everywhere you look, these apartments are selling for absolutely eye watering amounts of money. You know, 50 times the median salary, that kind of thing, and that has now become the overwhelming majority of most household wealth in China is like the value of the apartment that they live in. And so people are acutely conscious of the value of that apartment and they really see it, you know, as much as like their retirement, their financial security, as much as they do like the place where they need to cover their housing short and just live, right?

S3: So how is this not like the housing bust back in in our country back in 2006? Those elements where people are looking at their homes like investments, piggy banks feel so familiar to me.

S1: It is familiar, I think the one difference is that you you don’t have the crazy subprime mortgage situation in China that you did in the United States. No one’s really worried. I mean, the apartments are very expensive, but like what I haven’t seen as a lot of stuff saying, like Chinese buyers leveraging themselves up to the eyeballs to be able to buy these apartments and then they’re defaulting. And then the people you know who wrote those mortgages, the banks of those mortgages are going to go bust. That’s the one I haven’t seen. The leverage seems to be much more at places like Evergrande, which I mean, it’s insane. They were borrowing money at like 15 percent to build these houses, which, you know, and the only way that would make sense was like if house prices went up by more than 15 percent and it was this crazy ultra levered bet which had to go wrong at some point. It’s had a single S. credit rating for the past three years, like low junk. Everyone knew that it was super risky, and that’s one of the reasons why there haven’t been massive repercussions in terms of contagion and stuff. It’s just because everyone knew is not a risky investment. And you get crises when seemingly safe bonds default. Not when, like ultra risky bonds default.

S3: So why are people saying or even bringing up Lehman Brothers? Like what’s going on there?

S2: Commercial paper, baby.

S1: Well, it’s you know, I mean, I think the main reason is just the sheer size of the debt, right? So Evergrande have $400 $450 billion of debt, something like that. They’ve managed to bring that down to about 305 billion right now. But $305 billion of debt is just completely bizarre because the amount of debt, if you remember, you know, the Argentina default was Stacey, and I remember vividly that was just like earth shattering and that was 93 billion. If you remember the Greece default, which more or less destroyed the planet, you know, that was 200 billion. So Evergrande, in terms of its total liabilities, is bigger than Argentina and Greece combined. Like Lehman Brothers was 600 billion. But with Lehman Brothers, ultimately everyone got paid back. Right? There was a default. But then the recovery post default was actually over 100 cents on the dollar because there was all of this statutory interest of seven percent and all the rest of it. People who bought the defaulted Lehman debt did extremely well for themselves. No one is expecting much recovery from the Evergrande default. If you bought an Evergrande bond at one hundred and you know it defaults and you just keep on holding it until everything is resolved. Who knows how much you might get back? Maybe like 20 cents.

S3: And the Chinese government, though, is not going to just let this company go completely bankrupt, though, right? It’s going to step in. This is clearly it’s too big to fail. I saw something like represents two percent of Chinese GDP or something like that.

S1: It has millions of workers, either directly employed or indirectly employed by it. You know, as I say, I was one and a half million homes to Chinese individuals, so that core part of its business. You know, maybe the football team can disappear, but the core part of its business, the you know, the stuff which isn’t the electric cars has to wind up continuing being operated by someone. And since the chairman of the company is so politically well-connected, it’s probably going to continue to be him. So, yeah, we’re going to see an insanely complex sort of financial restructuring and work out, but I don’t think we’re just going to see the company disappear, like it’s just too big to disappear.

S2: This is the new too big to fail.

S1: Yeah. Like we need to kind of define what does fail mean? Right? When you have an entity of this size, probably it just means, oh, you know, all of the debt needs to get wiped out somehow. And then the company manages to continue going on without the burden of $300 billion of debt. Something like that. That’s really bad. If you are like an employee who was basically arm twisted by your employer into lending the money or any of the smaller individual Chinese creditors. And so I think that’s where the Chinese government comes in, and it’s going to start having to sort of play favorites and say, OK, these local regional banks are going to do OK. These individual lenders are going to do OK. Those, you know, international hedge funds, they can take losses.

S3: Yeah. Do you think the reason people were saying like this could be it, this is Lehman is because there is this like generalized feeling of anxiety right now that things have to explode? Or am I over reading into it? But it just feels like the economy’s doing relatively well. Equities are doing relatively well, something’s got to give. And there’s just the feeling of what’s it going to be kind of.

S1: I think the standard that there’s been a long running China bear case rate going on for years and years where people have said there’s too much debt there, too much non-performing loans, there’s too many badly run companies. The minute these loans are called, they’ll never get paid back. There’s going to be this like chaotic deleveraging in China, and that’s going to be terrible for the Chinese economy, and it’s going to ripple throughout the economy and people have been making that case. Like China, bears have been making that case for years. And I think a lot of them look to Evergrande and said, this is the first domino.

S3: Stacey, what do you think?

S2: I do think the idea of too big to disappear is really interesting because it’s sort of a modern gloss on two Felix is what systemic risk looks like. And Emily, I don’t think one. I think we are in a state of everybody being generalized anxiety over any number of things. So, yeah, I don’t want to. I don’t want to speculate about the underlying psychology of the markets, but I do think there are various questions that folks have about what will the next thing be. And there is absolutely a sense where people are kind of pointing at whatever that thing might be and being like, Ooh, China says it’s banning cryptocurrency transactions. That might be the thing like Evergrande. That might be the thing Biden infrastructure bill. That might be the thing. So far, none of these have been the thing. But I do. I am detecting a kind of a zeal to find it.

S3: Yeah, we’ve got to find the thing. What’s the thing?

S1: This is a Segway Emily is the thing, and a US sovereign default brought on by congressional inability to raise the debt ceiling. How is that going to cause the world to come to an end?

S3: Felix I know because I read his email every week, as everyone should, Felix says. No big deal. Don’t even it’s don’t. Even everyone is freaking out about the debt ceiling and that the U.S. is going to default on its obligations, including Janet Yellen, including all the Democrats, blah blah blah. But Felix Salmon in his newsletter is like, What if it’s fine if we default? What if it’s actually not that? To be clear, no

S2: defaults just fail to raise the debt ceiling.

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