Korean mortgages reveal tactical shift

First published in The Korea Herald.

A lot has been written in recent months about Korea’s soaring household debt and its implications for the economy. Many experts seem to agree that the country is staring at a catastrophe waiting to happen, and call for the debt to be reined in if the country has to strengthen its economic fundamentals.

Bank of Korea Governor Lee Ju-yeol is also of the view that efforts need to be made to control the growth of household debt, as it may dampen consumer spending ― even though the central bank’s decision to cut interest rates in August and October has indirectly promoted its growth.

In the face of all this, Finance Minister Choi Kyung-hwan has stated that an increase in household debt would have a “limited” impact on the economy and the focus should be on reinvigorating the sluggish economy.

As of end-September, the latest Bank of Korea data showed that outstanding credit to households by financial institutions, including commercial lenders, insurers and financial agencies, stood at 1,060.3 trillion won ($960 billion), with total loans registering 1,002.9 trillion won, of which mortgage loans alone accounted for a whopping 445.2 trillion won. If you add up mortgage loans by Korea Housing Finance Corporation and the National Housing Fund, it amounts to 480.9 trillion won.

Not surprisingly, experts have come out against the government decision to relax the real estate policies, which has led to a rise in household loans, saying that it is like adding fuel to fire.

In end-July, the government lowered hurdles for property purchases, as part of a stimulus package aimed at spurring economic growth, which fell in the second quarter to the slowest pace since early last year, loosening caps that were imposed in the mid-2000s when the property market was booming.

It reset the loan-to-value ratio, a gauge of loan size to the underlying collateral, to a uniform 70 percent, from between 50 and 85 percent depending on region; and at the same time, the debt-to-income ratio, which measures a borrower’s ability to repay, became 60 percent across the country, as against 50-65 percent previously.

To top off these measures, it also announced real estate deregulation measures, which included easing reconstruction of old apartments and lessening the supply of new homes.

Critics say the government’s policies will actually increase household debt in the long term and stifle domestic demand, as they encourage households to stack up higher debts. When delinquency rates rise and housing prices fall, it will trigger distressed sales for repayments, which will apply additional downward pressure on asset prices, creating a vicious cycle leading to debt deflation.

As of now, it is too soon to predict the impact of these measures, but the household loans are certainly not expected to decline anytime in the near future.

Many economists are concerned that the massive household debt problems will negatively and significantly affect economic growth, with many doubting the effectiveness of countermeasures, as excessive borrowing could discourage spending.

It could of course be a nonissue if Korea acts quickly to boost economic growth and makes household income rise faster than debt, which is what the government is trying to do.

Amid all this noise the financial regulator, the Financial Services Commission, has underplayed the doubts, saying that the quality of debt is improving. It cited the shift in the type of institutions from which people are borrowing. Those who previously would have had no other choice than to borrow from nonbanking financial companies at higher interest rates have mostly changed course to apply for loans at banks due to the relaxed regulations. That lowers the financial burden of interest payments, reducing the overall risk of defaults.

Is this really the case?

Let us take a look at the household credit data that was released by the BOK on Nov. 25. If we look at the two-month period before the housing mortgage rules were eased and two months after, there seems to some movement in that direction.

In June-July bank lending to households was 6.5 trillion won while nonbank lending was 5.1 trillion won. In the August-September period, banking lending was higher at 9.3 trillion won, while nonbank lending was lower at 2.6 trillion won. In other words, bank lending grew by 43 percent and nonbank lending fell by 49 percent. There is merit to what the FSC has been saying, something that has been lost in the din raised by critics.

Moreover, even the case of debt deflation that the experts are concerned about is not happening. Recent data shows that housing prices have been increasing since the new rules came into force.

The Land Ministry has noted that the number of home transactions reached an eight-year high of 108,721 in October, spiking 20.4 percent from a year earlier. Also reflecting an apparent recovery in the real estate market, the number of groundbreakings for housing construction jumped 53.9 percent on-year to 60,085 last month.

As they say, there are two sides to every coin. There is no doubt that the government should keep a watch on the growth in household debt and step in immediately when there are signs of a problem. But clearly as of now, one should not jump to conclusions just on the basis of the absolute figures for household loans.

I think it is premature to suggest that Korea is staring at a crisis. The household debt issue should be considered in the context of the households’ ability to repay.

With the tactical shift in housing loans from the insecure nonbanking sector to the more secure banking sector, there seems to be less risk of widespread default.

The biggest risk is a sharp fall in residential property prices. Korean households have more than 80 percent of their assets in real estate. It is expected that the recovery of the real estate market will boost domestic demand and household income, which may eventually solve many fundamental problems.

In any case, the country has the means and experience to deal with a banking crisis. The saving grace: history has endowed Korea with a legacy of distortions in its credit system, which has taken time and a few crises to resolve. Today, its financial system is more mature and less prone to such crises than before.

Also, basic tools to manage household debt are already in place ― for example, the “Measures to Enable Soft-Landing of Household Debt” (June 2011) and “Measures to Promote Structural Soundness of Household Debt” (February 2014).

This is not to suggest that there will not be a problem. But we should be confident that the government will adequately manage the risk factors, if any, of household debt.