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Evergrande liquidation rulling

Now, that's big news, the Hong Kong courts ordered the winding up of Evergrande.  It makes the actions of Peter's Chinese client who sold all 18 of their properties look incredibly wise.  I write this as we are flying back to the UK.  Peter's client was funny because he was saying that the possible rent for his properties was less than 1% of the value of the real estate.  Which explains why no one rents out apartments.  There's no money there!

It is important to remember that the support for housing was driven by two goals, creating jobs and a domestic outlet for China's private savings.  It gets worse, #2, #3, #4 largest development companies are state-owned enterprises.  Their liabilities are guaranteed by the state.  

The Hong Kong court decision could play out in three different ways:

(1) The Chinese government allows the application of Hong Kong law and Evergrande is liquidated following standard market bankruptcy rules: Likelihood 0.0001%

(2) The Chinese government declares the Hong Kong court ruling as non-binding on China (remember one county two systems), and formally rejects the Hong Kong court's demand.  Likelihood 10%

(3) The Chinese government ignores the Hong Kong courts and thereby stymies the liquidation:  Likelihood 89.9999%

The first two are unlikely because Evergrande's problems are not specific to the company, they are endemic to the sector.  What matters is there is a massive oversupply of housing in China.  It has been evident for years.  

Finally, the third is the most obvious because it fits with the Chinese government's behaviour of the past few years: Shovel forward and make it a problem for another day.  Option #3 is the best for China's bureaucracy, they don't even have to collude, because the impact on China's economy of Evergrande's bankruptcy is so obvious.  They don't have to consult anyone, they just need to say no, or simply ignore the problem, and through bureaucratic morass stimy the liquidators' efforts.

To give a sense of size comparison, the US housing and loan crisis was caused by a 3% to 5% excess supply in the US housing sector.  In China, the excess supply is estimated at between 100% and 300% of the total supply.  It gets worse, demographics in China are not conducive to household formation, and state and local depend for their survival on the sale of land as their sole source of revenue.  The number is so massive, that the Chinese government itself has estimated that there is sufficient excess housing to lodge between 1.5 and 3 billion Chinese.

So demand for housing in China is probably much lower than estimates and already massively overleveraged state and local governments not only will not be able to service their debts but will be unable to meet their salary obligations.

The consequence of Evergrande's bankruptcy is far-reaching because for multinational companies (and their insurers) it will clarify their rights to enforce Hong Kong contracts in mainland China.  As they say, "Could the last one out turn off the lights!"





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