What's causing panic on Wall Street? Fear of Chinese financial crisis, debt ceiling status


Stocks moved sharply lower on Monday morning, as investors woke up to a new week with ongoing concerns about some key issues driving the global economy and the financial markets. As of 11:30 a.m. EDT today, the Dow Jones Industrial Average(DJINDICES: ^DJI) was down 504 points to 34,081. The S&P 500(SNPINDEX: ^GSPC) had dropped 69 points to 4,364, and the Nasdaq Composite(NASDAQINDEX: ^IXIC) had declined 307 points to 14,735.

Two of the main issues that investors seem to be in a near-panic about are the China Evergrande Group (OTC: EGRNF)real estate development company in China, and the status of the U.S. debt ceiling. It’s reasonable to wonder whether market participants are overreacting to the situation, or whether their jitteriness is justified. Below, we’ll take a closer look at both issues to see why everyone seems so nervous.

► Stock market: S&P 500 drops on fears of China real estate contagion

Could Evergrande cause a Chinese financial crisis?

The Chinese economy has grown at a faster pace than the rest of the world for years now, and the country’s real estate boom has played a substantial part in driving its economic expansion. Prolific use of debt financing has been a key driver for the Chinese real estate market, helping developers like Evergrande grow at an impressive rate.

Yet Evergrande has faced rising problems for several months. Contractors are filing lawsuits in Chinese courts due to concerns about its debt, and investors have become increasingly worried about its ability to keep making interest payments. With hundreds of thousands of would-be property buyers potentially at risk of losing the deposits that they’ve paid on homes that aren’t yet built, Evergrande could easily produce a ripple effect of negative economic impacts if it proves unable to manage its outstanding liabilities effectively.

A default on Evergrande’s bond obligations would put the Chinese government in a similar position to the U.S. in 2008. It’s far from clear that China would move to bail out Evergrande, although taking steps to try to lessen the collateral damage from a collapse of the real estate developer might be a reasonable middle ground. In a liquidation, Chinese real estate assets would likely see big markdowns, and that has investors in other real estate companies serving China and the surrounding region watching very closely.

At this point, investors seem to be trying to get a handle on just how pervasive exposure to Evergrande is. Most believe that the company’s reach isn’t broad enough to pose a global systemic threat, but that might not rule out significant losses for some surprising names as things play out.

What's causing panic on Wall Street? Fear of Chinese financial crisis, debt ceiling status

Running out of debt

Meanwhile, the U.S. government is facing a debt crisis of its own. The statutory debt limit of $22 trillion was suspended in August 2019 for two years, with a reset to $22 trillion plus cumulative borrowing during the two-year period that ended at the beginning of August 2021.

Shortly after the suspension ended, Treasury Secretary Janet Yellen sent a letter to Congress informing lawmakers of the need to raise the debt ceiling. It also included a list of extraordinary measures Treasury would begin to take, including suspending the reinvestment of various government funds and suspending sales of new specialized Treasury securities.

The Treasury got a break from the fact that estimated tax payments from individuals and corporations were due Sept. 15, bringing in vital cash to finance government operations. Nevertheless, most expect that without action, the government will run out of money sometime in October.

Debt ceiling controversies have happened before, even leading to short-term government shutdowns at times. The problem now, though, is that a technical default on the debt would come at a time when international confidence in the U.S. is far lower than it has been historically. It therefore makes sense for investors to be nervous.

Keep a long-term view

In all likelihood, both Evergrande and the debt ceiling issues will get resolved favorably. Until it happens, though, you can expect volatility to continue – volatility that could actually create buying opportunities for those with the courage to take advantage of them.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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