Why China’s real estate crackdown is alarming investors

China Beige Book CEO Leland Miller joins Yahoo Finance Live to discuss why China property fears are concerning investors.

Video Transcript

AKIKO FUJITA: Let's dive a little deeper into the debt crisis facing Chinese property giant, Evergrande. The firm, which reportedly has liabilities totaling $300 billion, facing some key bank repayment deadlines this week with $100 million in interest due on Thursday. Let's bring in Leland Miller, he is the CEO of China Beige Book. And Leland, for those like you who've been watching China for many, many years, there have been warning signs about the debt pile growing more and more over the years. How much of what we're seeing right now with Evergrande is specific to the firm? How much of it you think is a sign of things to come in this space?

LELAND MILLER: Well the problems have been there for so long that most people watching the Chinese economy have just started ignoring them because they said, look, yeah, it's a Ponzi scheme, but apparently it can go forever. Now, obviously, most people didn't think that, but they weren't particularly worried about Evergrande until the recent ripples.

This is a company that is far, far, far, far, far more in debt that can ever pay back. So it's a question right now of how does the government maintain? How do they settle these liabilities that are out there without causing systemic stresses? And the major issue here is can the government contain the problems within the property sector or do they come part of the financial system and cause stresses there?

So we don't think that there's going to be financial system stresses. This is not a contagion risk because of the fact that the Chinese government is a non-commercial financial system and are able to step in and stop these dominoes from connecting. But there's still going to be a lot of scary headlines. And there's still a lot of damage being done in the property sector.

BRIAN CHUNG: Hey, Leland, Brian Cheung here. Now, those are all arguments in favor of the government stepping in here, but we haven't seen them do that yet. And one reason might be maybe it's the Chinese government wanting to make an example out of Evergrande as a cautionary tale to all the other large conglomerates in China as part of, maybe, the broad theme that they've had over the past few years of trying to deleverage a lot of these sectors. How do you think that plays into the political approach and the timing by which the Chinese government has been approaching this whole situation?

LELAND MILLER: I think it's exactly right. I think that it's not a coincidence that Evergrande is failing right now. The Chinese government clearly gave-- it may not have created this mess, but it's certainly allowing it to unravel at this time because there is a very specific political program focused on de-risking parts of the economy. And the property sector is right at the top of that list.

So yes, I think that the government intends on the fall of Evergrande to teach everybody in the system a lesson. You can't do this anymore. They will step in at a certain point in order to make sure that there's no contagion, but there's going to be a lot of pain. Almost everybody involved with this is going to get a chunk taken out of them, if not worse.

AKIKO FUJITA: What does that government help look like? When you talk about the government stepping in at some point. I mean, to add to what Brian just mentioned, Xi Jinping for many, many years has been warning about the risks in the growing debt in the property space. And he's tried to deleverage, de-risk, but that has come, in some ways, at the expense of the growth in the Chinese economy. That's been the other concern to that effort.

And so, if it is about, number one, trying to make an example out of Evergrande, but making sure that the fallout isn't significant enough to ripple across the economy, how does he manage that?

LELAND MILLER: Well, if you want to teach a lesson, you have to cause pain. But at the end of the day, you don't want the contagion to hit all sides of the Chinese economy. And one of the things that Beijing can do, again, because it runs a non-commercial financial system, is to be able to step in and order lenders to lend and order suppliers to supply and order bondholders to negotiate.

And so at the end of the day, there will be the ability of the government to step in and create an outcome that avoids worst case scenarios for it. But I don't think it wants to step in just yet. They want to make sure there's plenty of pain. Evergrande and everyone involved in Evergrande, whether it's people who invested in the model or bought WMPs based on high, unrealistic returns from the company's investments, all of these need to learn their lesson. And then at a certain point, the government will step in. But it's going to be ugly. There's no question about that.

BRIAN CHUNG: Leland, is there a lesson for regulators in China specifically? Because what's interesting about Evergrande is that there is the financial systemic risk, but it's not primarily a bank type of company. That's one big difference between people trying to draw a comparison here with Lehman Brothers.

Now, because of that, maybe the regulatory structure wasn't necessarily in place for one primary bank regulator to oversee exactly what Evergrande was doing because at one point, they had a mineral water business, they owned a soccer team at one point. So it wasn't necessarily clear who was supposed to be keeping watch on this company. Do you think there's any sort of waves that could be made in the regulatory structure in China to make sure that this type of thing doesn't happen again in the future?

LELAND MILLER: Well, the Lehman moment analogy was always flawed for China because one of the problems with Lehman is that companies after this happened, after you've got all this bad news, they looked at each other and said I don't want to lend to you. I don't know whether I could trust you. I don't know credit risk. So liquidity froze up.

You're not going to have that in China for the reasons I mentioned before. The government can order parties to lend. You have a very different situation when the government owns or controls all the counterparties in the system. And that's the case for China. So that's not the problem here. It's not that regulators don't have the tools, regulators are proxy for the party. The party has the tools to do anything it wants.

The question is are the people on top willing to make the trade off in terms of headline growth in return for fixing the system. And I think the answer now is yes. People are starting to realize this, that markets haven't really gotten to this conclusion yet.

I think right now there, is a paradigm shift going on right now where China is willing to accept lower growth in order to de-risk the system. It's been a reform effort that's been pushed off for years, but it looks like it's begun.

AKIKO FUJITA: Yeah, quality of growth is something that we've heard from the leadership there in years past. And now, we're seeing the impact from that. Leland Miller, China Beige Book, CEO. Always good to talk to you. Appreciate it.

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