S. Korea’s Poisoned Chalice of Household Debt Restricts ParkSangwon Yoon
After a series of failed business ventures, Kwon Eui Moon decided to get rich in a more traditional way in South Korea by taking out a mortgage in 2002 and waiting for house prices to soar. They haven’t.
After 10 years, Kwon still owes 112 million won ($103,107) on his 109-square-meter (1,173-square-foot) apartment in a southern Seoul suburb. His 5 million won in monthly living costs and debt payments is four times what he makes in a good month importing toys from China. The value of his home since he bought it hasn’t even kept pace with inflation.
The total household debt of Kwon and other Koreans rose to a record 959.4 trillion won last quarter, undermining Park Geun Hye’s election promise to expand the middle class after she takes over the presidency next week. The debt reached 164 percent of disposable income in 2011, compared with 138 percent in the U.S. at the start of the housing crisis, according to Royal Bank of Scotland Group Plc.
“Park’s top priority in the domestic economy is a soft landing for the household debt issue, which has such big ramifications for the real-estate market and on individuals’ financial soundness,” said Kim Dong Yul, senior research fellow at Hyundai Research Institute. “It’s like managing South Korea’s high-blood pressure, which is high enough for a potential heart attack.”
Park has promised to usher in a “People’s Happiness Era,” bolstering the middle class to 70 percent of the 50 million population, from 67.7 percent now.
She will “immediately” introduce an 18-trillion-won “happiness fund” to help avoid defaults by those with low incomes, economic adviser Yoo Sung Kull told reporters today in Seoul. The new government will finance it through spending cuts, Yoo said, without addressing concerns that such cuts won’t be enough for both the fund and other proposed welfare programs.
Park suggested state institutions could buy stakes in mortgaged apartments that have fallen in value, such as Kwon’s. The stakes would then be used as collateral for asset-backed securities, using rent from homeowners to pay interest to investors.
Mortgages from banks, insurers and smaller savings banks accounted for about 42 percent of all household borrowing and credit purchases, according to the Bank of Korea. Household debt is the biggest risk to South Korea’s financial system, according to the central bank’s January survey of 90 experts and fund managers.
Bank of Korea Governor Kim Choong Soo said in a Feb. 19 interview that while household debt could be “a cause of another crisis,” the likelihood is low.
“I voted for Park because her household debt relief pledges sounded most sincere,” Kwon said. “It’s been two months since she was elected and I haven’t heard a peep out of her on how she is going to realize any of them. Meantime, my interest payments are ballooning.”
Kwon’s three-bedroom apartment in the Hosu Maeul Jayeon Desiang complex is now worth about 260 million won, compared with the 224 million won he paid a decade ago. The nation’s property prices have slid from a peak in 2006 after then-President Roh Moo Hyun’s government raised capital gains tax to curb speculation.
South Korean regulators have been working on a “soft landing” policy since June 2011, including limits on bank lending and tax breaks for homeowners switching to fixed-rate loans. About 85.8 percent of mortgages are currently adjustable.
Bank mortgages increased 3.5 percent last year to 316.9 trillion won, the slowest pace in five years. The average bank rate for new home loans stood at 4.16 percent in December, down from 4.19 percent in November, according to the Bank of Korea.
“The quality of household debt is worsening,” said Lee Eun Mi, senior research fellow at Samsung Economic Research Institute in Seoul. Park needs “measures to stymie the rising danger of a massive default crisis.”
Bank lending to households declined by 3.5 trillion won last month to 463.1 trillion won, the biggest drop since the central bank began compiling the data in 2003. The decline was largely due to a 2.3 trillion won drop in mortgage lending after a tax break for home-transactions expired at the end of last year. The National Assembly of lawmakers has yet to vote on a six-month extension of the measure.
“Government measures and low rates should help boost demand in the next 12 months, but house prices will remain flat or grow slightly at best,” Moody’s Analytics economist Matthew Circosta, said in an e-mailed report today. “Since residential real estate accounts for about 70 percent of Korean household assets, the housing market shapes the consumer demand outlook.”
While consumer spending is expected to pick up this year as uncertainty about the global economy and the domestic political environment recedes, it could also easily extend its slowdown into a third year if the housing market wobbles, the Sydney-based Circosta wrote.
Some borrowers have staved off default by taking out further loans to pay mortgage interest. Kwon received help from outgoing President Lee Myung Bak’s government, borrowing about 10 million won through the Financial Services Commission’s Sunshine Loan program, which offers an interest rate of about 12 percent to 13 percent, in comparison with the 40 percent or more charged by private lenders.
“I need the government to help me pay off my existing debt on my own, not offer more loans,” said Kwon, who owes 6 million won for the Sunshine Loan he got to finance his mortgage interest payments. “I don’t expect my debt to be written off, but I would like a grace period to buy me time.”
The government will have to bear most of the cost of the overdue loan and mortgage payments, which will worsen the budget deficit and government debt, said Park Sang Hyun, chief economist at Hi Investment and Securities Co. in Seoul.
“The ideal solution would be improving debtors’ ability to pay off their own loans by creating more and better jobs, instead of just giving away money to welfare,” Park said. “The greatest threat to that happening is a further deterioration in the climate for South Korean exports.”
South Korea’s gross domestic product increased 1.5 percent in the third quarter from a year earlier. A 23 percent gain in the won against the yen over the past six months has threatened to restrain exports by aiding companies in Japan.
Irresponsible household borrowing began after the 1997-1998 Asian financial crisis, said Kim Mi Sun, a debt counselor at a non-profit organization called Edu Money in Seoul. In the wake of corporate defaults during the crisis, the government curbed companies’ ability to sell credit, prompting banks to expand lending to consumers, including a rapid increase in home loans.
“It became so much easier to get loans after the crisis and everyone started taking out debts and mortgages they couldn’t afford,” said Kim. “The crux of the issue is that people simply don’t know how to manage their finances.”
The credit boom early in the last decade caused house prices to soar and left many Koreans with large loan obligations. Credit growth has slowed as households pay these down, which is positive in the long run but weighs on consumption currently.