From boom to bust: the real estate collapse that changed China

 

In China, buying a house is not only a symbol of settling down but also a deeply ingrained belief in a 'sure-win' investment. Many people go to great lengths to take out loans for home purchases, convinced that housing prices will only rise. A similar phenomenon is happening in the UK. Indeed, over the past decade, the real estate market has remained fervent, with property prices soaring in cities like London, Manchester, and Birmingham (Cladco, 2025).

However, in 2024, Evergrande, once the largest real estate developer in China, officially filed bankruptcy. The main reason is that the real estate developers in China took on massive debt to expand, while financial institutions blindly issued loans, further inflating the housing bubble. Yet in the end, it was the millions of homebuyers who bore the brunt of the risk. Phrases like “Buy now or it’ll be too late” or “Housing prices only go up” flooded the market. Behind Evergrande’s collapse lie deeper issues of moral hazard, information asymmetry, and the collective investment behavior shaped by consumer psychology.

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The hidden face of Evergrande exposed: a case of moral hazard and the principal-agent problem

As the second largest Chinese property developer in 2022 (Altman, 2022), Evergrande kept taking excessive risks, expecting government support to keep the market stable. For years, the company borrowed huge sums to fund real estate projects, believing they were “too big to fail”. But do you think they would have played such a dangerous game if they knew there would be consequences? Probably not. This is what we call in economics “moral hazard”- when someone takes bigger risks believing that an insurer will cover the damage. Blinded by this false sense of security, the group expanded rapidly (Lepâtre, 2021), even pre-selling unbuilt apartments. Doesn’t sound very sustainable… but why care if you think the safety net is always there?

Evergrande’s executives prioritized short-term profits and pursued aggressive expansion strategies. They took on massive debt without regard for its impact on investors, creditors, or the broader economy. Indeed, Evergrande accumulated 1, 970 billion yuan of debt- about 2% of China’s gross domestic product (Lepâtre, 2021) with little financial transparency. Hence, it was harder for investors to assess the true risks. As a result, those decisions were beneficial to executives and insiders, while shareholders and creditors were bearing the risk.

This is the essence of the principal-agent problem- when an “agent” makes decisions that benefit themselves rather than the “principal”, who they are supposed to represent. Consequently, when China’s government started to limit its support, Evergrande was left drowning in debt. This situation exposes the ugly side of moral hazard: when companies believe they are too big to fail, they take risky decisions and can drag down the entire economy. So, next time you hear about a crisis, ask yourself: was it really bad luck, or was moral hazard at play?

A crisis of bad choices: adverse selection in Evergrande’s rise and fall

In China's hot real estate market, some buyers would rather take on heavy loans to chase high-priced real estate; this seemingly irrational choice is precisely the adverse selection phenomenon caused by information asymmetry. Adverse selection is not a profound theory. It stems from information asymmetry, which makes one party in a transaction unable to accurately assess the real risk of the other party, resulting in higher risk subjects getting trading opportunities more easily, thus distorting market resource allocation.

Evergrande has used some tricks to reclassify debt as equity. As a result, Evergrande's on-balance-sheet liabilities are severely underestimated by investors. Evergrande diverted money that should have been spent on construction projects to some high-risk businesses, adding cashflow to Evergrande's financial report. Low debt and high cashflow show that Evergrande's capital is stable. Homebuyers prioritized developers' projects, trusting their solvency. Foreign investors, on the other hand, rely too much on international rating agencies with lagging information. Fitch did not downgrade Evergrande's credit rating until after the crisis broke out (Tan, 2021). Delayed credit ratings and financial window-dressing misled retail investors, institutions, and foreign banks into consistently perceiving Evergrande's lower-risk profile. Meanwhile, irrational capital influx fueled speculative bets on unapproved properties. It wasn’t until Evergrande’s debt implosion in 2021 that homebuyers awoke to unfinished high-priced homes and vanished speculative bets.

Evergrande’s downfall exposed the truth of adverse selection: information asymmetry distorts investment decisions. Yet, as we face future temptations of high-yield financial products, the challenge remains: How do we access accurate information and make rational choices?

The mind behind the meltdown: How behavioural biases fueled Evergrande’s collapse

Besides developers, investors were key players in the property boom. But why did so many make irrational choices despite the risks? A major factor is overconfidence- many were convinced that housing prices would keep rising and downplayed the risks of market downturns and corporate debt. Some were influenced by anecdotal success stories, falling into the law of small numbers- relying on a few lucky cases, like friends who made money from property, instead of broader trends and data. They overlooked crucial information like macroeconomic conditions and company finances, mistaking rare wins for general truths. These biases drove poor decisions and magnified the impact of the Evergrande crisis on individual investors.

The collapse of Evergrande has exposed a real estate market that appeared prosperous on the surface but was riddled with hidden risks. The fall of this powerful real estate group can be explained by many economic factors which have always been part of our daily lives.

Indeed, from developers’ aggressive expansion and financial institutions’ blind support to homebuyers making decisions under the belief that 'housing prices only rise', the situation reflects moral hazard, adverse selection, and irrational investor psychology. The Evergrande Group serves as the most negative example, warning current housing firms to prevent another collapse (Li, 2024). So, the next time you find yourself in a similar situation, what choice will you make?

Reference List

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-Altman, E.I., Hu, X. and Yu, J. (2022) ‘Has the Evergrande debt crisis rattled Chinese capital markets? A series of event studies and their implications’, Finance Research Letters, 50, p. 103247.

-Cladco (2025) History of UK house prices. Available at: https://www.cladcodecking.co.uk/blog/post/history-of-uk-house-prices (Accessed: 22 March 2025).

-Dao, J. (2021) Evergrande’s debt crisis captures the world’s attention. Available at: https://daoinsights.com/news/evergrandes-debt-crisis-captures-the-worlds-attention/ (Accessed: 22 March 2025).

-Finshots (2021) What is the Evergrande crisis? Available at: https://finshots.in/archive/what-is-the-evergrande-crisis/(Accessed: 22 March 2025).

-Lepâtre, S. (2021) ‘Evergrande, le géant immobilier au bord de la faillite, fait trembler l’économie de la Chine’, Le Monde.

-Li, J. and Qin, Y. (2024) ‘An Analysis of the Causes of Evergrande Debt Crisis’, in SHS Web of Conferences, 188, p. 01030. EDP Sciences.

-Mbanza, A. (no date) When you fear making the “Wrong” decision, Tiny Buddha. Available at: https://cdn.tinybuddha.com/wp-content/uploads/2012/07/Choices.jpg (Accessed: 22 March 2025).

-Tan, W. (2021) Ratings agencies downgrade China Evergrande as concerns over junk bonds rise. CNBC. Available at: https://www.cnbc.com/2021/07/29/fitch-sp-downgrade-china-evergrande-amid-concerns-over-asian-junk-bonds.html(Accessed: 22 March 2025).