In 2008, U.S. economic policymakers faced their largest policy challenge in years in the form of serious financial problems at Lehman Brothers, a midsized New York investment bank. They failed that challenge by allowing Lehman to file for bankruptcy in September 2008.
The rest, as it is said, is history. The Lehman bankruptcy triggered severe financial market contagion both at home and abroad, which in turn brought on the 2008-09 Great Recession.
Today, Chinese economic policymakers face their own major policy challenge in the form of serious financial trouble at Evergrande, the world’s most indebted property developer. They do so as the country is experiencing a housing and credit market bubble of epic proportions and as the government is cracking down hard on the country’s technology sector. Meanwhile, the rest of the world economy is drowning in debt, and the global economic recovery seems to be losing pace.
For the sake of both the Chinese and the global economy, let’s hope the Chinese economic authorities do not repeat the U.S. Lehman mistake. Instead, one must hope they find a way towards an expeditious and orderly restructuring of Evergrande’s debts and that they provide adequate support to the rest of the Chinese financial system in order to prevent Evergrande’s problems from having damaging financial spillover effects.
The importance to the Chinese economy of an orderly restructuring of Evergrande’s debts cannot be overstated. With property accounting for as much as 28 percent of the Chinese economy, the last thing the country can afford is the loss of confidence in this sector.
Yet that is what would occur if Evergrande were allowed to default on its $300 billion in debt obligations. This would seem to be especially the case if Evergrande left high and dry the 1.5 million Chinese households that have made advanced down payments on housing units that are still to be delivered.
A disorderly Evergrande default would also have major spillover effects on the rest of the Chinese financial system, especially in light of the extraordinarily large credit boom that the country has experienced over the past decade.
According to the Bank for International Settlements, Chinese debt has increased from 150 percent of GDP in 2008 to around 250 percent of GDP at present, which makes it one of the world’s largest ever credit booms. This underlines the case for forceful government intervention to contain the Evergrande debt crisis from contaminating a vulnerable Chinese financial system.
From a global perspective, a Chinese credit event, particularly of the size of Evergrande, would come at a very delicate moment for the world economy. It is not only that the COVID-19 delta variant is slowing the global economic recovery and that the world’s major central banks appear to be at the start of tapering their aggressive bond-buying programs. More importantly, the world economy in general and the emerging markets in particular have never before been as indebted as they are today.
The last thing a highly indebted world economy needs is a credit event in China, the world’s second-largest economy. Such an event would be bound to cause global investors to become risk averse. That, in turn, would induce them to repatriate their money from abroad, thereby setting up the real prospect of another emerging market debt crisis.
Fortunately, unlike most other governments, the Chinese government is not constrained from taking quick and bold action to intervene in the country’s financial system. Not only does it have control over the country’s central bank. It also has control over its major banks.
For the sake of both the Chinese and the world economy, let’s hope the Chinese government does not repeat then-Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke’s 2008 policy mistake of allowing a disorderly Lehman bankruptcy. Rather, one must pray that it does everything in its power to forestall any semblance of a domestic financial crisis.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.