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Can someone here enlighten me how a default can be "contagious"? I could imagine that Evergrande bonds become worthless so that many investors will realize los

Can someone here enlighten me how a default can be "contagious"? I could imagine that Evergrande bonds become worthless so that many investors will realize losses. But surely no one, or very few, will have invested mostly into Evergrande bonds, right? So presumably, everyone will realize a relatively small loss, no?

s_Hogg 5y ago
It's simple Who's next? Get out of that as fast as possible Enough people think like that, hey presto
lordnacho 5y ago
One firm defaults, all their investors lose a bit of money. Now that they've lost a bit of money, they will have less money to lend to other firms. Now those firms find it harder to service their debts (eg they were planning to roll over their loans with other loans), so some of them default. A firm in the real estate business defaults. That makes people think other firms in that business will also default. So then all real estate businesses find it a a bit harder to borrow. Add leverage. I buy a loan from a number RE businesses, but I don't just use the money in my pocket. I borrow it from the bank at a lower rate than what I receive from Evergrande. They go bust, bank asks me for money, I need to sell my other loans in the RE firms. Those loans will go down in value, reflecting higher rates and making it harder for the firms. This credit cycle is described by Soros in his books. Works both ways actually, when things are good it's the reverse.
- technofiend 5y ago
  That's the gentle dominoes falling version. Then there is the version where lending institutions completely rethink the risk in that sector. In that version they call loans and stop extending credit to same or similar businesses overnight. When Enron collapsed every other energy trading firm lost access to trading capital, taking out the entire sector. Whether or not energy companies should have been speculating in the futures market with borrowed money is a separate conversation.
  - vlovich123 5y ago
    Maybe it’s not a separate conversation? Maybe you shouldn’t be allowed to speculate on the futures in your company’s sector?
- DebtDeflation 5y ago
  > One firm defaults, all their investors lose a bit of money. Now that they've lost a bit of money, they will have less money to lend to other firms. There's a lot more to it than that. You have to take into account 1) We have a fractional reserve banking system. When banks start individually calling in loans, there isn't enough "money" in the system for everyone to repay them. 2) Asset market prices (e.g., equities) reflect the present discounted values of expected future earnings. When everyone suddenly expects those future earnings to be less, the prices of those assets fall precipitously. That's not an issue in and of itself, except that those assets may have been purchased on margin (a loan) which depends on the value of those assets and may suddenly be called in for payment, forcing a liquidation of the underlying assets and further price falls. 3) As businesses scramble to pay loans that have been called and to adjust to a market where credit is difficult to come by (and businesses run on credit not cash) they reduce costs and often do so by laying off workers. This causes a reduction in aggregate demand (worker income) across the economy which further exacerbates the problem. There is inherent instability in the system and all sorts of positive feedback loops that can amplify an initial shock. Suggest reading Irving Fisher and Hyman Minsky to understand more.
  - mohanmcgeek 5y ago
    I agree with (2) but on (1), isn't that about the liquidity _of the bank_. And when banks are illiquid like they were in 2008, the central bank creates liquidity through QE which isn't a bad thing unless you are questioning these banks' ability to repay the money they "borrowed" from the central bank.
edoceo 5y ago
They may sell off other assets to cover the loss, which leads to price decline on other assets. This cascade across the market.
kryptiskt 5y ago
A sale of assets will affect the prices and many of their competitors in real estate development are similarly indebted and on thin ice. Also, their contractors and suppliers will be stiffed and they probably don't have the same diversification opportunities.
- tommiegannert 5y ago
  I think this is a big thing. If everyone defaults at the same time, the property market just vanishes as everyone force-liquidates to manage the defaults. If that affects collateralization levels, it's even a positive feedback loop. The RE companies that have good balance sheets will have great opportunities in the coming years.
ericd 5y ago
If you’re levered 10-1, you only have to lose 10% to get wiped out completely, and the firm that lent you that money will force you to liquidate to try to pay them back - a “margin call”. Even if it’s not a total wipeout, it’s likely you need to liquidate some assets to meet your margin as lenders reevaluate your risk to be higher than they thought. Enough people do that fast enough, and prices of other assets fall, others who are levered need to cover, and on and on until you have a widespread problem. Leverage is great on the way up and horrifyingly terrible on the way down.
patio11 5y ago
It will be a large part [0] of the portfolios of "wealth management products" [1], which will take large hits, which will then see redemptions from retail because these products are sold as being functionally riskless, which will then need to liquidate their other assets, which will per force fall in price, which will... [0] Evergrande is the largest real estate developer and largest user of this type of financing in China, and is reasonably mid tens of percent or higher of some wealth management portfolios. [1] These are investment products which aren't generally sold as such; they're effectively shadow banking. Most users do not understand that they actually are running material capital risk in return for their e.g. 8% annually. There are first-party WMPs and non-first-party WMPs which bundle and resell either bonds or first-party WMPs, etc etc. For more generally, see https://www.reuters.com/world/china/what-are-chinas-wealth-management-products-2021-11-05/ https://www.reuters.com/world/china/what-are-chinas-wealth-m...
Zandikar 5y ago
You're making the flawed assumption that these other investors and players in the market have performed sensibly and are not in a similarly difficult position. This is probably not the case. The question is not only what the financial risk this poses to Evergrande's investors/creditors, but what other companies are suffering similar negative pressures that have pushed Evergrande this far into the red to begin with. If this were an issue isolated purely to Evergrande, then yes, systemically, the loss would be relatively isolated and generally well absorbed. The issue however is more widespread and systemic though, and as a result, Evergrande isn't the only one in this situation. I'm not a financial advisor, I can't detail with any educated accuracy what specifically has transpired, but generally, the CCP has changed it's position and policies on lending to real estate companies and speculation in the real estate market. This is a policy shift in response to negative patterns in the market, namely but not limited to: supposedly large chunks of the real estate properties in china are sitting empty as people are buying them as part of their investment portfolios, artificially inflating pricing and perpetuating development far beyond practical demand, leading to a potential speculative bubble. As a result real estate developers were taking on debt to build new projects to expand their portfolios of real estate that were largely sitting empty and being used to borrow against to build more projects, artificially inflating price in response to their own demand to borrow against it... You can see how that can become an issue when the entire industry starts perpetuating that trend. It's an issue not isolated to Evergrande, they're just the biggest, and thus highest profile. As a result, the "contagion" depends how bad things get with Evergrande, because they're not the only one in this difficult position. The issue is more-or-less systemic, and Evergrande is just the bellweather of sorts by virtue of them being the biggest. Of course there's lots of nuance here, as each individual corporations exact situation differs from each other, as does how the party might choose to deal with them, a number of other factors in play as well. But this should give a glimpse into why this isn't just Evergrande sinking or swimming.
- mellavora 5y ago
  > The question is not only what the financial risk this poses to Evergrande's investors/creditors, but what other companies are suffering similar negative pressures that have pushed Evergrande this far into the red to begin with. Or more accurately, what the rest of the market believes to be true about these companies. or fears is true because they don't have enough evidence to believe, and their prior beliefs just unravelled.
kvathupo 5y ago
In terms of immediate impacts to global financial markets, it depends on the extent to which institutions were exposed to structured credit products that depend on Evergrande's solvency. I'm not terribly familiar with US oversight into structured finance, but I'm all ears.
arenaninja 5y ago
If a company defaults and doesn't pay outstanding obligations to smaller vendors without much cash to keep it afloat, these smaller vendors also have to stop paying their vendors and fire workers to try to stay afloat, recursively I saw this play out at several businesses at the start of the COVID-19 pandemic, until their business was deemed essential and they (along with their customers) were allowed to resume operations
hnaccount_rng 5y ago
The neighbouring comments only give you a part of the answer. Yes there is psychological things, i.e., "if they default, could other default" that makes people more sceptical wrt to the same class of assets (in this case property handlers with exposure in China). But there is _also_ the thing that some institutional investors are only allowed to hold certain parts of their assets in certain risk classes. The subprime crisis got triggered, by one-to-many defaults, which triggered a downgrade in the rating of the securities that the single loans were packaged into, which _forced_ institutional investors (think pension funds) to sell those, which depressed prices, which made the securities even more risky, which let to further downgrades and so on. But there is also the point that the investors of Evergrande may have planned these payments for their obligations. Which, depending on their current stability, may make them unable to honour their obligations, which makes them go into default. Which can then trigger a downgrade of their rating and we are back to the setting above. Unless you know about the exact structure and timing of all payments of all investors and how they cover their payments. There is really no way to be sure that it doesn't lead to a cascade. There is also no reason that it _has_ to lead to a cascade of course.
propter_hoc 5y ago
You've had a few answers so far, but what I've read in the news is different: (1) The rating downgrade that Fitch gave Evergrande to the default on one series of bonds may trigger accelerated repayment covenants in other bonds (source: https://www.aljazeera.com/amp/economy/2021/12/9/bb-chinas-evergrande-officially-defaults-on-dollar-debt https://www.aljazeera.com/amp/economy/2021/12/9/bb-chinas-ev...) (2) The default is reflective of the concern that Evergrande has no money, and although they've been able to stave off defaulting on other series of bonds so far, holders of all series of bonds should expect more defaults later unless Evergrande's debt is restructured. (source: https://www.nytimes.com/2021/12/09/business/china-evergrande-default.html https://www.nytimes.com/2021/12/09/business/china-evergrande...)
hericium 5y ago
> Can someone here enlighten me how a default can be "contagious"? The 2010 movie "Inside Job"[1] about financial crisis in US presents real-life examples, starting with the Icelandic financial crisis. There is also this Warren Buffet interview[2] which presents his unique viewpoint on what happened in the US around the time Lehman Brothers defaulted in 2008. You probably won't gain any knowledge from it other(edit) than how the financial sector assigns blame. edit: word "other" added in previous paragraph [1] https://www.youtube.com/watch?v=T2IaJwkqgPk https://www.youtube.com/watch?v=T2IaJwkqgPk "Inside Job (2010 Full Documentary Movie)" [2] https://www.youtube.com/watch?v=k2VSSNECLTQ https://www.youtube.com/watch?v=k2VSSNECLTQ "Warren Buffett Explains the 2008 Financial Crisis"
- bellyfullofbac 5y ago
  The Icelandic finance minister was flying to the UK (or was it NY) to have some talks about the crisis, he was so worried about the banks collapsing, he brought cash in case his credit card stopped working while he was travelling...
  - lotsofpulp 5y ago
    I take a bunch of cash when traveling regardless of banks being about to collapse. The electricity can go out anytime. And since I am traveling, especially internationally, I might not have access to a network or community I can call on, so it seems prudent to have a rigorous plan B.
sleepysysadmin 5y ago
>Can someone here enlighten me how a default can be "contagious"? 1 persons income is another person's spending. Why would evergrande default anyway? Did they over lever? Definitely, but also their underlying revenues dried up. The war with china is feeling it's effects now. Now that evergrande has defaulted, it means others who needed their money to pay their debts also can't. Afterall, many of them also will be feeling the pain that evergrande is feeling. The war with china didn't target evergrande, they are just the most levered and large enough to realize the pain. The irony of it all, this is capitalist china that's hurting, but China needs capitalist china. If you excluded taiwan, HK, and the other capitalist china zones, china is far worse than greece. They'd have to cut so much that the peasants suddenly are living much worse. Peasant revolt incoming.
refurb 5y ago
Bank which holds Evergrande bonds also issued bonds for another industry. Cash is cash and when they don’t get paid their Evergrande bond repayment they can’t repay their debt obligations.
markus_zhang 5y ago
There are multiple folds. 1) For Evergrande itself, if it defaults on foreign debts, domestic lenders (banks, funds, individual investors) see this as a big crack on its promise to return investment. This might push them to ask for early repayment of previous loans, which only gets things worse for Evergrande. 2) Since Evergrande is one of the biggest realtors, investors naturally will reassess the risk factors for the whole industry. This will probably stop some funding from flowing into it plus higher interest rate. Again, this is bad for all players in the industry. 3) Realtors tend to delay payments to suppliers to enjoy some sort of "free loan". When things go bad, those payments are not going to be the first to be paid, if paid at all. Now the contagion moves to other industries and 1) and 2) are repeated there. 4) Now consider the banks/insurance companies/funds. People invest their money in these financial companies because they believe they can make money. Now that they actually lose money, investors are going to sell shares or/and withdraw money. This is actually the most vicious part of the cycle because financial corporations will have no choice but to fire sale some of their most precious/liquid assets (think US Treasury Bonds, stocks of favored companies such as AAPL/MSFT/GOOG, etc.) to cover the money withdrawn. At step 4, if government doesn't step in, this will quickly (in maybe a few days) turn into a global financial crisis.

s_Hogg 5y ago

It's simple Who's next? Get out of that as fast as possible Enough people think like that, hey presto

lordnacho 5y ago

One firm defaults, all their investors lose a bit of money. Now that they've lost a bit of money, they will have less money to lend to other firms. Now those firms find it harder to service their debts (eg they were planning to roll over their loans with other loans), so some of them default. A firm in the real estate business defaults. That makes people think other firms in that business will also default. So then all real estate businesses find it a a bit harder to borrow. Add leverage. I buy a loan from a number RE businesses, but I don't just use the money in my pocket. I borrow it from the bank at a lower rate than what I receive from Evergrande. They go bust, bank asks me for money, I need to sell my other loans in the RE firms. Those loans will go down in value, reflecting higher rates and making it harder for the firms. This credit cycle is described by Soros in his books. Works both ways actually, when things are good it's the reverse.

technofiend 5y ago
That's the gentle dominoes falling version. Then there is the version where lending institutions completely rethink the risk in that sector. In that version they call loans and stop extending credit to same or similar businesses overnight. When Enron collapsed every other energy trading firm lost access to trading capital, taking out the entire sector. Whether or not energy companies should have been speculating in the futures market with borrowed money is a separate conversation.
- vlovich123 5y ago
  Maybe it’s not a separate conversation? Maybe you shouldn’t be allowed to speculate on the futures in your company’s sector?
DebtDeflation 5y ago
> One firm defaults, all their investors lose a bit of money. Now that they've lost a bit of money, they will have less money to lend to other firms. There's a lot more to it than that. You have to take into account 1) We have a fractional reserve banking system. When banks start individually calling in loans, there isn't enough "money" in the system for everyone to repay them. 2) Asset market prices (e.g., equities) reflect the present discounted values of expected future earnings. When everyone suddenly expects those future earnings to be less, the prices of those assets fall precipitously. That's not an issue in and of itself, except that those assets may have been purchased on margin (a loan) which depends on the value of those assets and may suddenly be called in for payment, forcing a liquidation of the underlying assets and further price falls. 3) As businesses scramble to pay loans that have been called and to adjust to a market where credit is difficult to come by (and businesses run on credit not cash) they reduce costs and often do so by laying off workers. This causes a reduction in aggregate demand (worker income) across the economy which further exacerbates the problem. There is inherent instability in the system and all sorts of positive feedback loops that can amplify an initial shock. Suggest reading Irving Fisher and Hyman Minsky to understand more.
- mohanmcgeek 5y ago
  I agree with (2) but on (1), isn't that about the liquidity _of the bank_. And when banks are illiquid like they were in 2008, the central bank creates liquidity through QE which isn't a bad thing unless you are questioning these banks' ability to repay the money they "borrowed" from the central bank.

edoceo 5y ago

They may sell off other assets to cover the loss, which leads to price decline on other assets. This cascade across the market.

kryptiskt 5y ago

A sale of assets will affect the prices and many of their competitors in real estate development are similarly indebted and on thin ice. Also, their contractors and suppliers will be stiffed and they probably don't have the same diversification opportunities.

tommiegannert 5y ago
I think this is a big thing. If everyone defaults at the same time, the property market just vanishes as everyone force-liquidates to manage the defaults. If that affects collateralization levels, it's even a positive feedback loop. The RE companies that have good balance sheets will have great opportunities in the coming years.

ericd 5y ago

If you’re levered 10-1, you only have to lose 10% to get wiped out completely, and the firm that lent you that money will force you to liquidate to try to pay them back - a “margin call”. Even if it’s not a total wipeout, it’s likely you need to liquidate some assets to meet your margin as lenders reevaluate your risk to be higher than they thought. Enough people do that fast enough, and prices of other assets fall, others who are levered need to cover, and on and on until you have a widespread problem. Leverage is great on the way up and horrifyingly terrible on the way down.

patio11 5y ago

It will be a large part [0] of the portfolios of "wealth management products" [1], which will take large hits, which will then see redemptions from retail because these products are sold as being functionally riskless, which will then need to liquidate their other assets, which will per force fall in price, which will... [0] Evergrande is the largest real estate developer and largest user of this type of financing in China, and is reasonably mid tens of percent or higher of some wealth management portfolios. [1] These are investment products which aren't generally sold as such; they're effectively shadow banking. Most users do not understand that they actually are running material capital risk in return for their e.g. 8% annually. There are first-party WMPs and non-first-party WMPs which bundle and resell either bonds or first-party WMPs, etc etc. For more generally, see https://www.reuters.com/world/china/what-are-chinas-wealth-management-products-2021-11-05/ https://www.reuters.com/world/china/what-are-chinas-wealth-m...

Zandikar 5y ago

You're making the flawed assumption that these other investors and players in the market have performed sensibly and are not in a similarly difficult position. This is probably not the case. The question is not only what the financial risk this poses to Evergrande's investors/creditors, but what other companies are suffering similar negative pressures that have pushed Evergrande this far into the red to begin with. If this were an issue isolated purely to Evergrande, then yes, systemically, the loss would be relatively isolated and generally well absorbed. The issue however is more widespread and systemic though, and as a result, Evergrande isn't the only one in this situation. I'm not a financial advisor, I can't detail with any educated accuracy what specifically has transpired, but generally, the CCP has changed it's position and policies on lending to real estate companies and speculation in the real estate market. This is a policy shift in response to negative patterns in the market, namely but not limited to: supposedly large chunks of the real estate properties in china are sitting empty as people are buying them as part of their investment portfolios, artificially inflating pricing and perpetuating development far beyond practical demand, leading to a potential speculative bubble. As a result real estate developers were taking on debt to build new projects to expand their portfolios of real estate that were largely sitting empty and being used to borrow against to build more projects, artificially inflating price in response to their own demand to borrow against it... You can see how that can become an issue when the entire industry starts perpetuating that trend. It's an issue not isolated to Evergrande, they're just the biggest, and thus highest profile. As a result, the "contagion" depends how bad things get with Evergrande, because they're not the only one in this difficult position. The issue is more-or-less systemic, and Evergrande is just the bellweather of sorts by virtue of them being the biggest. Of course there's lots of nuance here, as each individual corporations exact situation differs from each other, as does how the party might choose to deal with them, a number of other factors in play as well. But this should give a glimpse into why this isn't just Evergrande sinking or swimming.

mellavora 5y ago
> The question is not only what the financial risk this poses to Evergrande's investors/creditors, but what other companies are suffering similar negative pressures that have pushed Evergrande this far into the red to begin with. Or more accurately, what the rest of the market believes to be true about these companies. or fears is true because they don't have enough evidence to believe, and their prior beliefs just unravelled.

kvathupo 5y ago

In terms of immediate impacts to global financial markets, it depends on the extent to which institutions were exposed to structured credit products that depend on Evergrande's solvency. I'm not terribly familiar with US oversight into structured finance, but I'm all ears.

arenaninja 5y ago

If a company defaults and doesn't pay outstanding obligations to smaller vendors without much cash to keep it afloat, these smaller vendors also have to stop paying their vendors and fire workers to try to stay afloat, recursively I saw this play out at several businesses at the start of the COVID-19 pandemic, until their business was deemed essential and they (along with their customers) were allowed to resume operations

hnaccount_rng 5y ago

The neighbouring comments only give you a part of the answer. Yes there is psychological things, i.e., "if they default, could other default" that makes people more sceptical wrt to the same class of assets (in this case property handlers with exposure in China). But there is _also_ the thing that some institutional investors are only allowed to hold certain parts of their assets in certain risk classes. The subprime crisis got triggered, by one-to-many defaults, which triggered a downgrade in the rating of the securities that the single loans were packaged into, which _forced_ institutional investors (think pension funds) to sell those, which depressed prices, which made the securities even more risky, which let to further downgrades and so on. But there is also the point that the investors of Evergrande may have planned these payments for their obligations. Which, depending on their current stability, may make them unable to honour their obligations, which makes them go into default. Which can then trigger a downgrade of their rating and we are back to the setting above. Unless you know about the exact structure and timing of all payments of all investors and how they cover their payments. There is really no way to be sure that it doesn't lead to a cascade. There is also no reason that it _has_ to lead to a cascade of course.

propter_hoc 5y ago

You've had a few answers so far, but what I've read in the news is different: (1) The rating downgrade that Fitch gave Evergrande to the default on one series of bonds may trigger accelerated repayment covenants in other bonds (source: https://www.aljazeera.com/amp/economy/2021/12/9/bb-chinas-evergrande-officially-defaults-on-dollar-debt https://www.aljazeera.com/amp/economy/2021/12/9/bb-chinas-ev...) (2) The default is reflective of the concern that Evergrande has no money, and although they've been able to stave off defaulting on other series of bonds so far, holders of all series of bonds should expect more defaults later unless Evergrande's debt is restructured. (source: https://www.nytimes.com/2021/12/09/business/china-evergrande-default.html https://www.nytimes.com/2021/12/09/business/china-evergrande...)

hericium 5y ago

> Can someone here enlighten me how a default can be "contagious"? The 2010 movie "Inside Job"[1] about financial crisis in US presents real-life examples, starting with the Icelandic financial crisis. There is also this Warren Buffet interview[2] which presents his unique viewpoint on what happened in the US around the time Lehman Brothers defaulted in 2008. You probably won't gain any knowledge from it other(edit) than how the financial sector assigns blame. edit: word "other" added in previous paragraph [1] https://www.youtube.com/watch?v=T2IaJwkqgPk https://www.youtube.com/watch?v=T2IaJwkqgPk "Inside Job (2010 Full Documentary Movie)" [2] https://www.youtube.com/watch?v=k2VSSNECLTQ https://www.youtube.com/watch?v=k2VSSNECLTQ "Warren Buffett Explains the 2008 Financial Crisis"

bellyfullofbac 5y ago
The Icelandic finance minister was flying to the UK (or was it NY) to have some talks about the crisis, he was so worried about the banks collapsing, he brought cash in case his credit card stopped working while he was travelling...
- lotsofpulp 5y ago
  I take a bunch of cash when traveling regardless of banks being about to collapse. The electricity can go out anytime. And since I am traveling, especially internationally, I might not have access to a network or community I can call on, so it seems prudent to have a rigorous plan B.

sleepysysadmin 5y ago

>Can someone here enlighten me how a default can be "contagious"? 1 persons income is another person's spending. Why would evergrande default anyway? Did they over lever? Definitely, but also their underlying revenues dried up. The war with china is feeling it's effects now. Now that evergrande has defaulted, it means others who needed their money to pay their debts also can't. Afterall, many of them also will be feeling the pain that evergrande is feeling. The war with china didn't target evergrande, they are just the most levered and large enough to realize the pain. The irony of it all, this is capitalist china that's hurting, but China needs capitalist china. If you excluded taiwan, HK, and the other capitalist china zones, china is far worse than greece. They'd have to cut so much that the peasants suddenly are living much worse. Peasant revolt incoming.

refurb 5y ago

Bank which holds Evergrande bonds also issued bonds for another industry. Cash is cash and when they don’t get paid their Evergrande bond repayment they can’t repay their debt obligations.

markus_zhang 5y ago

There are multiple folds. 1) For Evergrande itself, if it defaults on foreign debts, domestic lenders (banks, funds, individual investors) see this as a big crack on its promise to return investment. This might push them to ask for early repayment of previous loans, which only gets things worse for Evergrande. 2) Since Evergrande is one of the biggest realtors, investors naturally will reassess the risk factors for the whole industry. This will probably stop some funding from flowing into it plus higher interest rate. Again, this is bad for all players in the industry. 3) Realtors tend to delay payments to suppliers to enjoy some sort of "free loan". When things go bad, those payments are not going to be the first to be paid, if paid at all. Now the contagion moves to other industries and 1) and 2) are repeated there. 4) Now consider the banks/insurance companies/funds. People invest their money in these financial companies because they believe they can make money. Now that they actually lose money, investors are going to sell shares or/and withdraw money. This is actually the most vicious part of the cycle because financial corporations will have no choice but to fire sale some of their most precious/liquid assets (think US Treasury Bonds, stocks of favored companies such as AAPL/MSFT/GOOG, etc.) to cover the money withdrawn. At step 4, if government doesn't step in, this will quickly (in maybe a few days) turn into a global financial crisis.