Evergrande Defaulted -- Technically

Recently, I was on Twitter/X and noticed that the many bears that seem to plague my feed were upset about the idea that two behemoths in the Chinese property sector, Country Garden and Evergrande, both technically defaulted but nothing has happened. I have said from the very first signs of trouble from Evergrande, that massive defaults in China are NOT the same as in other countries. This has to do with the incentive structure of China’s economic system. 

In general, financial instruments are worth what a buyer and seller agree to. In the liquid US equities markets, it is very rare to see this in action when a company is distressed. This is because equities generally have derivative instruments such as options and swaps that allow for one to express a negative opinion. These instruments have liquidity and can grow to the size that they have only because of the hypothecation system (i.e. lending of shares) that really only became widespread in the last 20-25 years. If there was no stock lending then many derivative products would be more dangerous due to lower liquidity. However, the US markets overall would also have less liquidity.

The bond market, however, does not have an equivalent system. There is no real multiplier on how much you can be short a bond, and unlike stock shares that can be lent more than once, any particular bond can only be shorted once. Moreover, bonds are typically owned by institutions that do not lend their bonds. All this makes them less liquid than stocks. 

This is because the bonds of a given issuer are not always fungible or tradable amongst themselves. For instance, if one person owns a First Lien Bond with default backed by a specific building and another person owns a Second Lien Bond with default backed by a completely different building, then the two bonds are not the same. Both have a problem if the issuer defaults. However, one building might actually be preferable to the other. Moreover, First Lien Bond holders are first in line for default and are paid back first. Second Lien Bond holders are paid back second. 

While many bonds trade fairly liquid, these differing characteristics make standardizing derivative instruments difficult, and thus make the entire bond market far less liquid than equities. Hence, one must understand the nuances upon default in a given country’s market. 

Bonds where the holders are not in the US or Europe as the primary group are traded at the market clearing price. Specifically, as well, you cannot easily short these bonds. It is NOT the equity markets. 

Hence, if:

1) You're in a country where marks are not held to some regulatory body that requires a particular type of mark AND 

2) The bond’s investors don't need the money at the agreed upon time AND 

3) There’s a high incentive to refinance favorably AND

4) A large government is there to try to incentivize you to refinance or adjust terms favorably 

Then you do not get as massive an impact to that country’s economy from a large default that might be seen elsewhere.

In the case of Evergrande and Country Garden, it is still the case that there are hard assets underlying the debt. All you really need is time. 

That is what duration risk actually is. It's not time and default risk. It's time and default risk + any laws, regulations, or customs in that country that relate to what happens after an "accounting" bankruptcy occurs.As relates to the US, the closest you'd be able to visualize how the marks are different is the slow wind-down of certain debt markets when Lehman Brothers failed vs. the rapid immediate movement in stocks. The high-yield bond market didn't have to take the mark as aggressively in the initial aftershock, plus you have the hazard rate to support a non-zero value in many cases (giving time for value to recover).