Evergrande, Ponzi schemes and our Real Estate Industry. Part 1

By now the world is well acquainted with the debacle of the Chinese real estate sector. Evergrande, the biggest property developer in China with an incomprehensible debt of USD 300 billion is teetering on the verge of bankcruptcy. Having initially missed three payment deadlines on USD bonds it has finally paid $83 million to the Trustee to stave off default. However, its future prospects remain very bleak.

Should Evergrande become bankrupt, it could signal the start of a financial storm which may be bigger than the global financial crisis of 2008 that was triggered in a large part by the collapse of the venerated financial services firm Lehman Brothers. Lehman Brothers was heavily involved with the housing subprime mortgage loans and when the unsustainable real estate bubble in the USA burst, the 161 year old firm went belly up with more than USD 600 billion in assets.

Evergrande is not the only Chinese developer in this precarious position. Other major players in the Chinese real estate industry like Fantasia Holdings, China Properties Group, Modern Land Company to name a few have billions of dollars of debt on which they have failed to make the due interest payments on time. The default by any of these big players could trigger a domino effect leading to the downfall of some of the biggest Chinese companies.

In all likelihood the Chinese government will intervene to save the big property developers like Evergrande from collapsing. Afterall, the real estate industry constitutes 30% of China’s GDP and 70% of the household savings of the Chinese people is invested in property. There may be very profound social and political consequences if a large number of Chinese people wake up one morning to find that their lifelong savings have disappeared. The Communist Party of China is acutely aware of this and will therefore go to any length in order to stop such a fiasco.

So, why has Evergrande suddenly become so infamously known around the world? Obviously, the reason is the possibility of default on its insurmountable debt repayment and the disastrous ramifications if the company were to collapse. Of relevance is the fact that the debt of USD300 billion did not pile up in one week or even one year. This accumulation of debt started modestly after the firm’s incorporation in 1996 and skyrocketed in the last decade. The borrowing binge would have continued unabated had the Chinese government not suddenly enacted new rules and regulations to control corporate debt. And now that the source of funding has stopped, these developers are in a cash crunch. This financial malaise is however not a simple case of a market downturn. It is another novel version of the age old scam known as the Ponzi scheme.

Though the dubious honour goes to Charles Ponzi by whose name this crime is eponymous, the first known practice of the pyramid scheme is credited to Adele Spitzeder who conned people between 1869 to 1872. Charles Ponzi entered the act in 1920 and turned it into a mega business. Since then, there have been hundreds of con artists with subtle variations of the Ponzi scheme who have duped thousands of gullible victims all across the world.

I can understand how Charles Ponzi got away with his scheme in 1920 because of its novelty and his ingenuity for that age. What I do not understand is how the scamsters still evade early detection when we have known about this crime for more than a hundred years. In Bangladesh, how did MLM companies like Destiny (Tk 4000 crore), Unipay2U (Tk 1400 crore), Jubok (Tk 3000 crore) steal such vast amounts of money from ordinary people when the writing was on the wall for years? Whenever there is an offer which is too good to be true, there is invariably some form of subterfuge. Even in my own house hold, despite my pleading and exhortation, some of the staff go to deposit their monthly instalments at one “Samity”or another. The lure of abnormally high returns is irresistible for these poor people. And the fact that they get the promised amount at maturity also enhances their confidence. But that is exactly what Ponzi schemes are all about; the promoters keep paying as per the contract and this way the news of the profitable investment opportunity spreads and more and more people subscribe till a time when due to some intervention, their revenue sources are blocked and the scheme comes tumbling down like a house of cards.

All Ponzi schemes have a common theme; they promise abnormal returns. Was this not also the case of Evaly, Alesha Mart, E-Orange et al? For months they have been offering incredible discounts and spending a fortune on advertising these mouth watering deals. The question that comes to my mind is why did the concerned authorities not notice this abnormal activity when it was being flashed in every possible medium of communication? The objective of the regulatory authority should be to detect these scams at an early stage so that there is minimum collateral damage. What is the point of investigating the case after the company has already collapsed and thousands of ordinary people are left carrying the can?

Evergrande is not a classic Ponzi scheme but it has all the trappings of a malevolent business. It also has a common denominator with the Ponzi scheme which is “greed”. Since the end outcome could be thousands of ordinary people in serious financial distress with their lifelong savings disappearing into thin air, I will classify it as a novel Ponzi scheme. It is reprehensible when businesses cannot control their avarice and gamble with the trust that their customers’ have placed on them. The Chinese government has been caught sleeping. By the time they woke up to the reality, it was too late. Evergrande has piled up a debt of USD300 billion and several other big developers also have debts in billions of dollars which are now looking very risky. If the Chinese government does not intervene, thousands of ordinary Chinese people may be in financial peril and the impact of the real estate sector collapse will not only be felt by China but the entire global economy may go into a tailspin. If they have now put a sudden stop to the borrowing by the big Chinese developers why could a circuit breaker policy not have been put in place earlier which would determine the amount of borrowing a company can do based on the net asset value of its balance sheet?

In every country there are different regulatory bodies who are there to ensure fair trading practices and financial discipline. I think that the regulators must be held accountable for such debacles. After all, they are paid to do a job and if things go wrong under their watch due to their negligence, then they have to be answerable.

Crooks and fraudsters have been around from time immemorial and indeed they will be around till the end of time. They are ingenious and always seem to be one step ahead of the regulators. The world needs better controlling systems so that scams are detected early and nipped in the bud before they cause irreparable  harm. In Part 2 of this article I will elaborate on the Ponzi schemes in Bangladesh and how vulnerable our real estate industry is to this crime.

Comments (3)
  • Thanks for this write up! Ponzy schemes are likely to survive as long as greeds and needs will remain. I wonder how such schemes get legalised even in a country like China or USA where governance and punishments are well practised.

  • Thank you sir for writing about the contemporary topic. People need to be much aware about any financial benefit scheme in any mode/package.

  • Another point to be noted for rising debt of Evergrande & other Chinese developers happended due to based on ‘Crony Capital’ investment dependency by banks. Similar things is happening in our country which makes banking system much vulnerable as most banks concentrated their loans to few larger companies who have high debt. Double blow on banking industry is coming-up specially when loan classification will start in normal way & highly debted companies will collapse simultaneously.

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