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Difficult Puzzle to Solve Measures against Declining Housing Prices
Measures to make the mortgage loan structure more stable
Difficult Puzzle to Solve Measures against Declining Housing Prices
  • By matthew
  • September 11, 2012, 11:16
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Domestic housing prices have been on a downward spiral since 2006. Though the incumbent government has brought out new real estate policies on 18 separate occasions, all have fizzled out in the end due to shocks from the global financial crisis and demographic change caused by the retirement of baby boomers. This increase in the number of old-age households, along with one and two-person families, now account for almost 50% of all households. Under the circumstances, the demand for large apartment houses is falling, with the housing market changing fundamentally, and thus requiring the government to reassess its property market policy.

In Spain, home prices shot up 44% between 2004 and 2008 before plummeting nearly 30% since then. The number of savings banks, which were intent on providing more mortgage loans than competitors, has dropped from 40 to 10 in the past two years as a result and the repercussions have spread to the banking sector, triggering a national fiscal crisis. Japan’s long-lasting crisis since the 1990s is attributed to a collapse in its real estate market.

If house prices in Korea continue to fall, home loans amounting to 400 trillion won will turn into bad debts, blocking the flow of funds in the financial sector and affecting even the real economy through a chain reaction. The government must put a brake on such downward movement before things get worse.

Then, what must be done to prevent the subprime mortgage crisis of the United States from occurring in Korea, where the risk of non-performing loans is increasing for declining housing prices? Needless to say, a critical situation will be inevitable if prices fall rapidly. This is why experts are pointing out that market demand must meet the supply of houses on sale to ensure that the bubble does not burst in one swoop. Some are claiming that the interest rate structure be changed from variable and short-term to fixed and long-term.

A sufficient transaction volume does matter to block loans from going into default. These days, however, people rarely step out to purchase a house no matter how cheap it is. In other words, investor confidence is at a low. “Both the outstanding balance and default rate have skyrocketed amid the current economic downturn, and consumer confidence is getting extremely pessimistic, as evidenced by the increasing frequency of failed biddings,” said researcher Huh Yoon-kyung from the Construction Economy Research Institute of Korea. She added, “It seems that there are few options to turn the tables but aggressive government measures to boost trade in the real estate market.” JustR CEO Kim Woo-hee echoed, “A variety of ways for demand creation will have to be considered in order to induce more transactions.”

Acquisition tax reduction for home buyers, which expired at the end of last year, is one such measure. Until 2011, households purchasing their first house worth 0.9 billion won or less and those that bought their first or extra worth over 0.9 billion paid 1% and 2% of the acquisition cost in taxes, respectively. However, these figures rose to 2% and 4%, respectively, this year. “Acquisition tax cut was the most effective tool for the substantial expansion of transactions last year,” said Real Estate 114 director Kim Kyu-jung.

In the meantime, there are some voices calling for an overhaul of the Bogeumjari Housing Program, in which the government supplies 1.5 million houses until 2018 at a cost of 120 trillion won. The Bogeumjari houses, excluding rent, are for very limited beneficiaries and become personally owned in the end, thus losing their function as public goods. “The government will be able to improve housing welfare and boost transactions if it channels just one-tenth of the budget for the Bogeumjari Project to the purchase of unsold apartments or cheap detached houses in downtown areas and lease them to low-income families,” said a construction industry insider.

Zero-interest loans for first-time home buyers was discussed as another method for the same purpose by some members of the ruling New Frontier Party in November last year. It is said that no less than 100,000 households will be able to have their own homes within one year once the plan is put in place. “The National Housing Fund is providing 10 trillion won or so annually for the Bogeumjari Program only,” remarked an expert, adding, “The interest loss will be more than offset if just 10% to 20% of the amount is diverted to the loans for first-time purchasers”.

Authorities Expanding Pre-workout while Promoting Long-term and Fixed-rate Loans

The financial authorities, on their part, have set out to deal with the market slump. They are mulling over expanding banks’ preemptive debt restructuring scheme, a so-called pre-workout program, in order to relieve the pain of mortgage loan holders. The program’s purpose is to cut the interest or extend the repayment period to lessen the burden of those likely to be in arrears.

In the longer term, authorities are leading banks to change their lending structure, characterized by a variable interest rate and the bullet payment of the principal after a grace period, to the amortization of principal and interest at a fixed rate. The idea is to increase the stability of the mortgage lending structure gradually on the assumption that the loans will not go bad in a short period of time. As of now, anyone who changes from a variable to fixed interest rate in or after October last year does not have to pay the penalty for early redemption.

The Bank of Korea lowered the key rate by a quarter of a percent to 3.0% 13 months after having raised it on June 10, 2011. However, the market consensus is that the stagnation of the property market, global economy and domestic consumption and investment are so severe that a 0.25% interest rate cut will yield no positive results.

Of course, there is no doubt that the rate cut will stop the market slump from further aggravating itself. An additional downward adjustment is also expected since the central bank is focusing more on the recession than on consumer prices. There is also an opinion that extra measures for home buyers, such as the relaxation of the debt-to-income (DTI) ratio and acquisition tax reduction, may create some synergy with the interest rate policy.

Korean Housing Market Slump No Short-term Problem but Directly Related to Demography

Nowadays though, some experts have begun to claim that the government’s approach to increasing market demand through deregulation cannot resolve the fundamental problem.

The Bank of Japan’s Deputy Governor Kiyohiko Nishimura recently had an interview in Seoul and said, “Seoul’s housing prices are dropping whereas they are climbing in other regions, which is quite similar to Japan’s situation just ahead of the bubble burst.” He added, “Such movement is particularly worrisome since the household debt-to-GDP ratio is higher here than in Japan.”

According to him, the bubble in the Japanese housing market was formed when people, believing that their economic growth would continue forever, took out excessive loans to stockpile real estate assets, as well as the government’s expansion of fiscal spending. “Debt restructuring is indispensable to handle the consequences of such a buying spree and Western scholars used to think that financial and fiscal policy would show the effect they desired in no time,” he added, “Still, there is one drastic difference from the past and that is the demographic change. Up until recently, the size of the working-age population between 14 and 64 continued increasing to buttress economic growth, but we’re now entering an age in which the demographic structure is hampering it. The situation as of late is that the bubble collapse is unluckily coinciding with the transition.”

At the end of the day, it is growth that matters the most.