Korean Subprime Crisis - Coming to Korea?

The Youido Institute, affiliated with the ruling New Frontier Party, held a policy forum to discuss the current situation of the Korean economy on June 21. At the forum, KS Economic Research Institute director Kim Kwang-soo said that the Korean housing market was about to witness a bubble burst. He has raised the possibility of the housing market collapsing on several occasions and reiterated his stance that day saying, “No country has been successful in preventing the collapse of the bubble in its real estate sector and Korea is highly likely to do the same unless the economy recovers rapidly.”

Korea’s real estate market has been swayed heavily by government policy. Past administrations tightened or loosened regulations depending on conditions. What is different now is that such policies do not work anymore. The incumbent government has launched a total of 18 sets of policies designed to revitalize the property market, only to ultimately fail. Furthermore, the number of apartment transactions has decreased since the May 10 announcement this year. According to the Ministry of Land, Transport and Maritime Affairs, housing transaction volume in the metropolitan and regional areas declined 20% from the previous year.

On June 18, the government came up with another set of policy measures to abolish or weaken almost all of the regulations introduced by the previous government, e.g. a price ceiling for new apartments, housing resale restrictions, reconstruction charges and floor area ratio limitation in reconstruction projects. However, the market has not reacted well.

LTV Ratio Losing Its Strength

Every time concerns about the household debt and housing bubble issues are raised, the government and banks insist that Korea is free from risks thanks to the LTV, or loan to value, ratio.

They claim that non-performing loans would not surge to cause a financial crisis even if home prices were halved because banks lent housing purchasers only 40% to 60% of the collateral value. The problem is that things have begun to change as the property market slump continues and some houses’ value falls 40% or more from their record high.

In several cases in the outskirts of Seoul, the LTV ratio shot up to 70% or 80% when calculated on house prices adjusted downward. Even apartments with an LTV ratio of 100% or higher are found in auction houses from time to time, which means the bank loans for the houses cannot be fully repaid even when the houses are sold.

“Back in 2007 before the Lehman Brothers shock, the average LTV ratio stood at 50% to 60%,” said a local bank executive, adding, “Since then, prices have plummeted, lifting it to 80%, 90% and even 100% in some regions.”

If property prices continue to fall, such cases will be more common and the bad debt ratio will climb. Then, the subprime mortgage crisis of the United States will be repeated in Korea, following the steps of a housing market bubble burst, non-performing mortgage loans, insolvent banks and financial turmoil.

As of August last year, the nationwide LTV ratio was 47%, which was acceptable. However, an ominous shadow is cast over apartments in some regions, portending the Korean version of the subprime crisis.

Consumption Declining for Debt Service

Currently, the total amount of mortgage loans in Korea is 305 trillion won, with 46% of it scheduled to mature or being subject to principal repayment between 2012 and 2013. The amount to be redeemed in a lump sum by the end of this year at five major commercial banks -- Woori, Kookmin, Shinhan, Hana and NH -- amounts to 23.8 trillion won. No less than 2.38 trillion won is due, assuming that the banks tell borrowers to repay, for example, 10% of the principal due to the fall in house prices.

As is expected, an increasing number of borrowers are failing to follow their repayment schedule. The mortgage loan default rate was 0.89% as of April, the highest in 62 months. Outstanding household debts increased 900 billion won in that month alone, with 400 billion of it related to home mortgages.

According to Hyundai Research Institute, the number of so-called “house poor” in Korea runs to 1.08 million households, with approximately one-third unable to redeem their principal and interest unless the repayment period is extended. These house poor are spending more than 40% of their disposable income on debt services. If house prices continue falling, thus imposing a heavier burden on them, household consumption will shrink rapidly, triggering an economic recession. In fact, household consumption growth fell short of income growth for four consecutive quarters until Q1, 2012.

The house poor are suffering more than ever as the real estate market slump lingers on. Their houses are becoming cheaper while the repayment deadline is approaching. However, they cannot sell their homes right away as the housing market is frozen. Therefore, their only option is to tighten their purse strings.

Increase of House Poor Poised to Trigger Economic Downturn

Under such circumstances, department stores and major supermarkets are taking a direct hit. The average per capita purchase at the three major department stores dropped 18% between January and May this year, leading them to conduct summer sales since late May, earlier than in previous years. Although their sales that month increased 1% year-on-year thanks to such events, net profit declined almost 20% due to the large discounts.

Mega supermarkets such as Emart, Homeplus and Lotte Mart have also seen their sales decline across all items they deal in, with the only exception being sports-related goods. In particular, food product sales fell 6.5% from a year earlier to record the biggest drop in 16 months. Per capita purchasing decreased 15% from 50,733 won during the same period.

The stock market is also losing steam. Between January 1 and July 11, the daily average trading value of the KOSPI remained at just 3,801.2 billion won. The total had never dipped below four trillion won for five years and four months since March 2007. Customer deposits also plummeted from 20 trillion won to nearly 16.5 trillion during the seven months. “The current economic situation is so uncertain that both households and enterprises are concentrating on lessening their debts instead of making investments,” said Shinyoung Securities analyst Im Il-sung.

The corporate sector is refraining from new investment owing to the housing market slump and the decrease in consumption it caused. As such, the majority of companies are becoming pessimistic about the future outlook. Experts are pointing out that any fiscal policy or interest rate cut will be of no use unless the frozen consumer sentiment is dealt with properly.

The shrinkage of investment and consumption may deliver a staggering blow to the Korean economy, which is losing its growth momentum in the wake of the European financial crisis and global recession. “The Korean economy would be mired in a Japan-style recession if the government fails to break the vicious cycle of deteriorating consumer confidence caused by household debt and the blocking of new investment and growth,” said researcher Lee Joon-hyup from the Hyundai Research Institute. More and more experts are giving warnings about the heavily indebted domestic real estate market.