The least surprising bond default in the world happened this week.
Evergrande – the big Chinese property developer – has been declared in default.
Evergrande owes a lot of money. And it's only the tip of the iceberg that is the Chinese property sector.
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So is this just the first domino to topple? Is it something you need to worry about?
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The Chinese property sector is in a lot of trouble
Credit ratings agency Fitch has declared that overseas bonds issued by Chinese property developer Evergrande are in default.
Fitch, to its credit, is early on the scene compared to its peers. But as with most of the things that credit ratings agencies pronounce, it's merely a statement of the bloody obvious.
On Monday, Evergrande was meant to shell out $82.5m in interest payments on some of the IOUs that overseas investors own. It didn't, and so far it hasn't. When someone who owes you money misses a deadline to pay it back, that's a default.
Evergrande had missed payment deadlines before but it had been avoiding actual technical default by making the payments within 30-day grace periods. That's not happened this time.
So what's the effect been on the market? The Evergrande share price fell by nearly 4% – but in the context of Evergrande that's a pretty mild move. Wider Chinese indices basically shrugged.
Why? How can this be when just a few months ago we had people talking about how this would be China's “Lehman Brothers” moment?
This wasn't a Lehman Brothers moment and it was never likely to be.
Lehman became a “moment” mostly because of one thing: the element of surprise. Everyone knew there were problems in the credit markets, but not the extent of the problems. And everyone assumed (or rather, hoped) that Lehman would have a managed sale, rather than be allowed to collapse abruptly.
Evergrande has been on the market radar for a very long time indeed. The share price most recently peaked in July last year and has been on the slide ever since. So this has been expected for a long time.
And there's a good reason for that: the Chinese government has deliberately cracked down on the property sector; they thought house prices were too expensive and a source of social unrest, so they've been trying to pop the bubble, and that's been clear for a while.
In some ways, it's a bit like Turkey's woes (although those are being inflicted in a less deliberate manner). The immediate situation is bad, but it's been bad for so long that most of the people who were most exposed have reduced their exposure to manageable levels.
No one is trying to pretend that it's not a problem (which was very much the case with the credit crunch). So no one – or certainly no one systemically important – is going to get caught off guard.
Of course, saying that a financial event is not a Lehman Brothers moment is not the same as saying that said financial event is entirely harmless, in much the same way as saying you'd rather be punched in the face by an ordinary adult male rather than Mike Tyson is not saying that you would relish either option.
So none of that is to say that this doesn't matter. But as I said a few months ago, this is more of a chronic than an acute problem.
No bailouts – but there will certainly be managed wind-downs
So what happens now? More of the same, probably. As you'd expect, given that this is a sector-wide crackdown, Evergrande is not the only troubled property developer; Fitch also downgraded Kaisa, another in the sector.
The Chinese government itself is making it clear that a full-on bailout is not an option. Yi Gang, the head of the Chinese central bank (the People's Bank of China – PBOC) said at a seminar in Hong Kong that Evergrande's default is “a market event", notes the FT.
However, there are market events and then there are market events. Evergrande might not be being bailed out, but the company now has a new risk management committee on which four of the seven seats “are held by representatives of state-owned enterprises". In other words, civil servants.
So you've got the government already stepping in to oversee and manage the dismantling of the company and to untangle its web of debts and obligations and connections.
At the same time, the central bank is also making more money available to wider markets to soothe the impact of any jitters. Meanwhile, the crackdown on the property sector has become less severe: last week, the government said it would take steps to “boost public housing and support the housing market".
It's a juggling act for sure, but China has been a juggling act for a very long time; a constant swing between permissive and restrictive policies, because on the one hand you can't allow too much wealth inequality, but on the other hand you need constant economic growth and you also can't risk blowing up the entire financial system.
This is one reason why, generally speaking I'm not a big fan of investing in China. You are very much subordinate to the goals of the government and, while you might do fine for a while if you buy at the right time, eventually your property rights and their five-year plan have a good chance of coming into conflict, and there's only one winner there.
However, in terms of how this affects wider markets, I just struggle to make a big scary story out of it. China will want to contain the fallout. There's a lot of it, but if it dismantles it slowly and keeps markets lubricated with cheap money at the same time, then that'll be manageable.
There are plenty of things for investors to worry about that could trip up markets at any moment – rampant speculation and overvaluation, the threat of rising interest rates, inflation. But fingers crossed, China's property market is not one that I'd put high on that list.
