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Date: November 27, 2023     Updated: December 9, 2023

How is China going to fix its Real Estate mess: Socialism with traditional Chinese characteristics

安得廣廈千萬間,大庇天下寒士俱歡顏,風雨不動安如山。    [杜甫 - 茅屋為秋風所破歌]
How could we have millions of buildings to provide shelters for the poor so they can stay calm and relaxed. That should withstand the storms as safely as a mountain.    [Du Fu - Song of Thatched Cottage Broken by the Autumn Wind]

China's strategy - patience and let things work out by itself. Too much tinkering will have unexpected negative effects

The Chinese government is in no rush. It has a strategy to let the situation work itself out slowly.

  1. China will not let those speculative conglomerates die. Bankruptcy is too easy an exit for those who profited from the scheme. It is not China's way of doing business. Bankruptcy, liquidation or bailed out by the government is against the Chinese principle. Allowing the failed real estate developers to collapse would not just leave many Chinese banks with bad debt, it would also leave hundreds of thousands of Chinese home buyers without an apartment that they have paid for. That's why China will keep those business entities alive and not allow them to die. Those who created the mess will have to clean it up themselves, as more than a million people in China are still waiting for their homes to be completed.

  2. China will arrest those responsible and claw back the huge ill-gotten profits. A bankruptcy and liquidation will create social upheaval.

    In September 2021, there were chaotic protests at Evergrande group's Shenzhen headquarters demanding repayment of loans and financial products. That's exactly what China wants to avoid.

    The founder and many high level officers of Evergrande group were put under police surveillance, and eventually the chairman was formally arrested, together with many of the core members of his group.

  3. Claw-back of the huge ill-gotten profits.

    The chairman of China Evergrande Group had previously paid more than CN¥90bn in dividends to some offshore companies in the Cayman Islands controlled by his now 'technically' divorced wife.

    It is entirely possible that she might decide to 'loan' back some of the money to fund the company's operation as part of China's efforts to claw back the funds.

    China will confiscate assets to compensate for the cost of unwinding the mess.

    For example: Evergrande's Ocean Flower Island tourism resort in Danzhou city on Hainan island was worth more than CN¥160bn ($25bn). It has 39 nearly complete residential towers. Those were originally ordered to be demolished because the company had not followed environmental and zoning regulations. A former official of the city was serving a life sentence for bribery. Authorities in Danzhou city later decided to confiscate the 39 residential towers. The city will turn 16 of them into rented housing, 4 into serviced apartments, and 19 into hotel and commercial space. The proceeds may eventually help offset the loss of the banks and other parties.

    The chairman and directors of Country Garden will have to give back to the company in the form of interest-free loans too. They have to sell their private jets and yachts and return the money to the company to finish the apartments. So far, the founding family of Country Garden had come up with $300 million to help fund the company's operation.

    The money thus recovered, and possibly with some government support measures, will help provide for the construction and completion of the apartments sold. It will take time and cause some pain to certain parties involved.

    In the month of November 2023, several major banks had doled out a total of around $4 billion to help the smaller developers to continue building and finishing the apartments sold. That's a small drop in the bucket comparing to Evergrande's $300 billion liabilities.

  4. The apartments sold and paid for will be finished and delivered one way or another.

    With the clawed back wealth and some support from the government, China will make sure the apartments projects will be finished and delivered to the more than a million people in China are waiting for their homes.

    Evergrande group promised to complete and deliver 600,000 units or 50% of pre-sold homes within the year 2022.

    In order to fund its operation and restructuring plan, Evergrande sold two of its private Gulfstream jets for about $50 million and then a Boeing private jet for another $100 million. Evergrande also sold its luxury super-yacht for about $32 million in early 2023. It also sold the land reserved to build its Shenzhen headquarters for CN¥7.5bn ($1billion).

    Those were held in escrow accounts for the construction of the apartments. On top of that, Evergrande still has a total of CN¥170bn of cash yet to be collected from sales.

  5. Apart from clawing back and confiscating assets of the instigators, China will allow assets not under its direct jurisdiction to be disposed according to local procedures and laws.

    Evergrande has more than $300 billion in total liabilities, including an offshore debt of around $32bn. It defaulted on its dollar bond in late 2021. The majority of the money Evergrande owes is to creditors in China, including ordinary homeowners, suppliers and banks.

    Compared to its $31.7 billion in total offshore liabilities, Evergrande has few assets outside of China. The sale of the super-yacht and the private jets means foreign creditors of the company will have fewer handles in any potential liquidation process. Evergrande's offshore bondholders are alarmed by the shrinking of the developer's offshore assets.

    In September 2022, Evergrande's Hong Kong Headquarters and a plot of rural land were seized by creditors. The property was valued at HK$8-HK$9bn ($1-1.15bn) at the time. The building was purchased for HK$12.5bn ($1.61bn) in 2015.

    Two luxury homes of Evergrande's chairman in Hong Kong worth about US$192m have been seized by a creditor.

Socialism with traditional Chinese characteristics

A bailout is totally against the ideology of China's leadership. In fact, some argue that the government deliberately triggered Evergrande's decline because the firm's success relied on an unsustainable bubble.

China's 'three red lines' financial regulatory guidelines, stipulated that 'houses are for living in, not for speculation'. To China's leaders, the painful but necessary measure was the only way to rein in the ballooning debt and to stop relying on artificially high levels of growth driven by the property Ponzi scheme.

Chinese regulator has to tread carefully and gingerly, especially after the effects of the sweeping zero-Covid lock-downs. But it was never going to be a painless process.

After a few years of careful management, when all the apartments are built and delivered, those troubled conglomerates could be dissolved or morphed into something else.

The exchange rate of the CN¥ may go down, which strangely does not seem to affect China's inflation readout. The stock market may go down. Emerging entrepreneurs may have difficulties raising capital. But for really worthy projects, the state has enough capital and resources to provide support. China seems to be able to tolerate these possibilities comfortably.

The only problem that China has to watch out for is illegal capital outflow and the collapse of the shadow banks and its consequences; as the shadow banking giant Zhongzhi Enterprise Group with an estimated CN¥360bn unrecoverable debt is now facing a criminal probe.





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