How China Will Bail Out Evergrande and Avoid a “Lehman Moment”

Stocks opened higher this morning before tumbling around noon. Concerns over the global financial structure lingered after Evergrande, China’s second-largest real estate developer and top issuer of commercial paper, missed two debt payments today.

Analysts reacted to the news differently. Some said it was the early stages of China’s very own “Lehman moment,” referencing the epic Lehman Brothers collapse of 2008 that helped spark the global financial crisis. Others disagreed. Lehman filed for Chapter 11 bankruptcy after accumulating over $613 billion in debt opposite its $639 billion in assets.

Evergrande owes a much smaller $305 billion vs. $315 billion in assets. Still, many experts think an Evergrande bankruptcy could have dire consequences. And not just in the Asian markets.

“Evergrande seems like China’s Lehman moment,” tweeted Uday Kotak, CEO and founder of Indian mega-lender Kotak Mahindra Bank.

“Reminds us of IL&FS. Indian Government acted swiftly. Provided calm to financial markets. The Government appointed board estimates 61% recovery at IL&FS. Evergrande bonds in China trading ~ 25 cents to a $.”

Kotak was chosen by the Indian government to oversee the Infrastructure Leasing & Financial Services (IL&FS) restructuring three years ago after the company missed several debt payments. He was able to “defuse” the IL&FS situation with the government’s help.

Most strategists argued over the last 24 hours that China would have to do the same to limit the economic fallout.

What they don’t agree upon, however, is whether Evergrande’s impending bankruptcy is as dangerous as Lehman’s was back in 2008.

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“China’s situation is very different,” wrote Barclays analysts this morning.

“Not only are the property sectors’ linkages to the financial system not on the same scale as a large investment bank, but the debt capital markets are not the only, or even the primary, means of funding.”

The note continued, explaining that Beijing is likely to leverage bank lending in Evergrande’s rescue attempt:

“The country is, to a large extent, a command-and-control economy. In an extreme scenario, even if capital markets are shut to all Chinese property firms (which is not occurring and is only a tail risk at this point), regulators could direct banks to lend to such firms, keeping them afloat and providing time for an extended ‘work-out’ if needed.”

“The only way to get a widespread lenders’ strike in a strategically important part of the economy would be if there were a policy mistake, where the authorities allow the chips to fall where they may (perhaps to impose market discipline), regardless of the systemic implications. And we think that’s very unlikely; the lesson from Lehman was that moral hazard needs to take a back seat to systemic risk.”

In the US, real estate made up 27.9% of household wealth according to data collected in 2014. In China, real estate accounts for 74.7% of household wealth by comparison. Evergrande owns a large chunk of China’s real estate market. As Evergrande goes, so goes China’s financial system.

That’s why a “no bailout” scenario is seemingly out of the question. And because all of China’s banks are state-owned, Beijing will be able to offset a deflationary shock – something that occurred immediately after Lehman went bust. This strategy would ultimately cost China trillions in new stimulus, but these days, who really cares?

Fed Chairman Jerome Powell is expected to announce a taper delay tomorrow after months of hinting that the Fed would indeed start tapering at long last. That, combined with a full Chinese bailout, might just be enough to kick stocks back into their long-term uptrend.

Inflation will continue to climb higher without any tapering, of course. That should flatten the market’s real gains until the Fed decides to finally reduce its monthly bond purchases.

There’s no telling when that’s actually going to happen, though, so buying the dips in the meantime is probably still the best move.

And it’s all because the Fed is too scared to finally pull the plug on the biggest “everything bubble” in history.

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