As Evergrande in China implodes, what have we learned f …

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As events around China’s leading real estate developer Evergrande unfold, I find myself reflecting on Lehman’s collapse. And while the financial geniuses of the world assure us that the situation in Evergrande is not the same as that in Lehman, I can’t help but think that it may be useful to remember the reasons why Lehman had trouble in the first place.

Sasha Plantation

Sasha Planting is a seasoned financial journalist and business writer associated with the Daily Maverick Business.

First published in the Daily Maverick 168 weekly newspaper.

“Debt, we have learned, is the match that lights the fire in every crisis. Every crisis has its own set of bad guys – choose your favorite: bankers, regulators, central bankers, politicians, overzealous consumers, credit rating agencies – but all require a similar ingredient to create a real crisis: too much leverage.

Most of us will be able to resonate with the words of Andrew Ross Sorkin, American journalist and author of Too Big to Fail, the detailed account of the events that led to the collapse of financial services firm Lehman Brothers nearly 13 years. years ago. Thunderstorm clouds had piled up on Wall Street all year round, but it was this event that sparked the era’s global financial crisis, the consequences of which are still being felt globally. Until that fateful Monday in September, everyone believed that if the pressure really did arise, governments would offer a bailout to troubled banks. After all, the Bank of England bailed out distressed mortgage lender Northern Rock in 2007, in early 2008 the US Federal Reserve orchestrated JP Morgan Chase’s takeover of the Wall Street Bear Stearns investment bank which was was heading for bankruptcy, and in September the US government nationalized the heavily indebted mortgage companies Freddie Mac and Fannie Mae.

But Lehmans was too far a bridge, and the Fed refused to be the lender of last resort, fearing it would use taxpayer money to bail out an investment bank. Instead, US Treasury Secretary Hank Paulson tried to persuade Bank of America or Barclays to save the bank. But with $ 613 billion in debt, time is running out to liquidate Lehman’s assets and no U.S. government guarantees to come, it quickly became apparent to the men and women in black that saving the bank was impossible. The result was the largest corporate bankruptcy filing in US history. After September 15, all banks – from HBOS (mother of the Bank of Scotland) in the UK to Goldman Sachs in the US – were perceived to be at risk. The financial markets have entered a free fall. On September 16, the $ 62.6 billion Reserve Primary Fund “broke the bullet,” meaning the fund managers were unable to keep its share price at face value. A day later, on September 17, the collapse spread. Investors withdrew a record $ 196 billion from their money market accounts. If the race had continued, businesses would not have been able to raise money to fund their day-to-day operations and within weeks the economy would have collapsed. Credit markets were ultimately rescued by Congress, which reluctantly approved a bailout for banks, hedge funds and pension funds that held the toxic mortgage-backed securities that threatened to sink them. By bailing them out, Paulson hoped to stabilize the global banking system and end the financial crisis.

As events around China’s leading real estate developer Evergrande unfold, I find myself reflecting on Lehman’s collapse. And while the financial geniuses of the world assure us that the situation in Evergrande is not the same as that in Lehman, I can’t help but think that it may be useful to remember the reasons why Lehman had trouble in the first place.

But first, why is Evergrande relevant to us? The company is grappling with $ 300 billion in debt and warned last week that it could not cope with impending interest payments. A collapse could harm the Chinese economy as a whole and, by extension, the global economy. But what’s interesting is that this flaw was precipitated by Chinese regulators, who toughened the legislation a year ago. Previously, the Chinese authorities dealt with such defects, without causing any ripple in the market. But Chinese President Xi Jinping is seeking to reduce the debt of the Chinese economy, and the authorities have therefore introduced limits on the amount of debt that major Chinese real estate developers could incur. But it may be too little, too late. For years, authorities have looked the other way as developers ramped up their cheap debt to fuel the growth of the Chinese real estate market. The IMF noted in 2018 that China’s strong GDP growth after the global financial crisis was supported by the credit boom and warned of the risks. “International experience suggests that credit growth in China is on a dangerous path, with increasing risks of disruptive adjustment and / or a marked slowdown in growth,” he said. But China has created a monster: It must inject ever-increasing amounts of credit into the system to maintain its GDP targets. As anyone who borrows from one credit card to pay off another knows all too well, the road is finally gone. How China will tame the monster will no doubt serve as a case study in business schools for years to come. In the meantime, maybe it’s time to reflect on the reasons for Lehman’s failure, which are set out in an article written by Rosalind Wiggins, Thomas Piontek and Andrew Metrick of the Yale School of Management – risk, culture, excess. confidence and inaction of regulators.

Risk because Lehman has failed to match its liabilities with its assets – using short-term debt to fund long-term assets. This meant that when the overnight wholesale funding markets started to dry up – from which Lehman borrowed billions of dollars every day to operate – it couldn’t liquidate its assets quickly enough to stay afloat.

Culture because the company rewarded managers for taking excessive risk and ignored the advice of its chief risk officer. Overconfidence because the company has invested heavily in the real estate market and the complicated products that go with it, but chose to ignore the signs, as early as 2006, which indicated that the poor performance of loans from subprime borrowers is likely to be a source of concern.

Finally, regulators took no action in 2007 when it became apparent that Lehman was taking too much risk and did not publicly disclose to rating agencies that the bank had exceeded risk limits. Perhaps it was a unique confluence of circumstances. But history has a way of repeating itself, so let’s hope China has learned some lessons from the past. Because whether it’s China or the US that sneezes, when they do, we all get colds. DM168

This story first appeared in our weekly Daily Maverick 168 which is available for R25 from Pick n Pay, Exclusive Books and airport bookstores. For your nearest dealer, please click here.

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