Ghost of the 1997 Crisis Stalks Hong Kong's Economy

  • Mortgage indebtedness soars as home prices surpass records
  • Experts warn of wide-ranging fallout if property boom reverses

Ghost of the 1997 Crisis Stalks Hong Kong's Economy

In 1997, the Asian financial crisis touched off a six-year property bust in Hong Kong that shaved more than two-thirds off prices and saddled the city with a stagnant economy and deflation.

As Hong Kong gets ready to celebrate the 20th anniversary of its handover to China, which happened just as Asia’s crisis began to unfold, that pain seems all but forgotten. Prices are at all-time highs. Mortgage borrowing is booming. Developers are bidding up the cost of land to records. People young and old are lining up to buy newly built apartments. In short, the kind of fervor that preceded the last bust is back.

Asian Property Services Director Peter Churchouse discusses the risk of a property market crash in Hong Kong.

Source: Bloomberg

That’s got experts fretting about the potential fallout should the city of about 7.4 million people experience another crash. By several measures, Hong Kong looks more vulnerable this time around. On Friday, the de facto central bank announced new measures to contain risks -- its second action in a week.

"When things move to the downside here, they move big time," said Peter Churchouse, author of a financial newsletter bearing his name and a veteran analyst of Hong Kong’s property sector. "A lot of people here view the property market as almost an extension of the stock market and treat it as such."

As central banks flooded the world economy with cheap money over the past decade, property markets in cities from Sydney to Stockholm skyrocketed. Perhaps nowhere was this more pronounced than in Hong Kong, where demand from mainland buyers contributed to the boom.

Hong Kong is particularly exposed because of a huge accumulation of household wealth in property and the fact that banking is one of the main pillars of the local economy, said Xia Le, chief economist at Banco Bilbao Vizcaya Argentaria SA in Hong Kong. A property crash could drag down banks and lead to a “full-fledged financial crisis,” Xia said.

Between 2003 and 2015, inflation-adjusted prices for apartments multiplied almost four times, according to a study by Peter Richmond and Bertrand M. Roehner, published last month in the Evolutionary and Institutional Economics Review. Prices have kept rising, climbing 15 percent since the beginning of 2016.

And because wages have been relatively stagnant, it now takes a household 18 years of median income to buy a home, more than anywhere else in the world, data from Demographia shows. That compares with just over 12 years in Sydney, eight-and-a-half years in London and under six years for the wider New York metropolitan area.

Hong Kong bears have been proven wrong time and again in recent years as the city shook off crises, epidemics, an aging population and China’s slowdown. Thanks to its status as a gateway to the world’s second-biggest economy with Western-style legal protections, it has attracted a steady stream of mainland buyers.

How and when the boom ends is anyone’s guess, but the stakes are increasing for a government that’s repeatedly failed to tame home prices. Obvious risks include a sharp financial or economic crisis in China that ripples through Hong Kong’s increasingly mainland-linked economy.

One measure in particular gives market watchers pause. The value of outstanding mortgages jumped by more than a third in the five years through December and now amounts to 47 percent of gross domestic product, more than 10 percentage points higher than in early 1997.

Aggressive Developers

As developers take on debt to fund expensive land purchases and increasingly compete with banks in providing mortgages, the risks are spreading through the economy, sparking concern at the Hong Kong Monetary Authority. On May 12, the HKMA tightened rules governing bank lending for developments after expressing worry about banks’ exposure to the real estate sector.

That announcement came just as developers waged a bidding war for a commercial plot of land in the Central business district, pushing the price to a record $3 billion. A week later, the HKMA followed up with curbs on second-home mortgages as well as borrowers whose income is derived mainly from overseas.

“For most people, buying a property is not only one of the most important decisions in life, it is also a financial transaction entailing significant leverage through borrowing,” the HKMA’s Chief Executive Norman Chan said at a briefing Friday. “Prospective buyers must be mindful of their ability to cope with the potential risk that may arise from possible changes in the property cycle as well as mortgage interest rates.”

Analysts from Goldman Sachs Group Inc. and Citigroup Inc. were among those seeing the new rules adding pressures on local developers. Goldman Sachs analysts said they expect to see a policy-tightening bias as Hong Kong seeks to prioritize local first-time buyers, while those from Citigroup said they expect the measures to mark the peak of the housing market.

‘Concentration Risk’

Mortgages are increasingly concentrated among buyers aged 25 to 40, according to Raymond Yeung, chief economist of Greater China at Australia & New Zealand Banking Group Ltd. That means young professionals who are building families are extra sensitive to interest rates, threatening to exacerbate the wealth gap in one of the world’s most unequal societies. An increase in mortgage rates could quickly sap consumers’ spending power.

“There’s concentration risk among the first-time home buyers who are in general younger than the rest,” said Ryan Lam, head of research at Shanghai Commercial Bank Ltd. “Once the interest rates move, they will suffer.”

Because Hong Kong’s currency is pegged to the U.S. dollar, the economic fate of those households -- and that of the wider property market -- will be determined 8,000 miles away at the Federal Reserve in Washington. Chair Janet Yellen has already begun tightening and is expected to raise rates again at least once this year, possibly as early as June. Hong Kong’s de facto central bank will have no choice but to follow.

Turning to Parents

Many looking to enter the property ladder are taking additional mortgages from developers, who unlike banks aren’t bound by loan-to-value rules. They’re also turning to their parents for help.

Terry Wong, 32, tapped his mom and dad’s savings to help finance a 20 percent down payment for a HK$5 million ($643,000) apartment in March after he got married. Wong, whose new home in the bustling Kowloon district measures just 390 square feet, financed the rest from a bank and the Hong Kong Mortgage Corp. Ltd.

“Hey, I needed a place to live,” Wong said. “With my parents’ money, I could be more financially flexible in the future.”

At Sun Hung Kai Properties Ltd.’s Eight Regency project in Hong Kong’s New Territories, apartments quickly sold out in the first batch on offer in April. About 40 percent of Midland Realty’s clients who bought flats at the development were under 30, and almost a third of them relied on funds from their parents to make down payments, said Sammy Po, the property agent’s residential chief executive.

Bears Converge

The government’s failure to cool the market means the city’s economic health is getting more intertwined with real estate. Soaring prices means more wealth is tied up in property, and citizens are less inclined to amass other types of savings, said Lam of Shanghai Commercial Bank.

If things turn sour, prices could drop 10 percent to 20 percent “in a short period of time,” according to Lam. He’s not alone: Morgan Stanley predicts home values will enter a multi-year decline, starting with 5 percent this year. JPMorgan Chase & Co.’s Cusson Leung has said prices are economically “unsustainable” and warned that households are exposed should the market turn.

And if things really head south, a crash would hammer government revenues, household wealth and consumer confidence and could trigger deflation as the economy heads into a downward spiral, said BBVA’s Xia.

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The bearish view has precedent. Britain handed Hong Kong back to China in 1997 with an economy growing by 7.5 percent a year, unemployment of 2.4 percent and healthy inflation. By 2002, deflation had gripped the city, unemployment had tripled and growth plunged.

As Michael Every, head of financial markets research for Asia-Pacific at Rabobank International in Hong Kong says, "Hong Kong’s economy is the housing market, sadly."

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