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[EDITORIALS]Rate hikes and real estate

Published: 13 Jun. 2006, 21:31

Lee Sung-tae, governor of the Bank of Korea, said he would take preemptive measures to subdue inflation. Before the pressure of inflation again surfaces, the government plans to raise interest rates to prevent damage from excessive liquidity, he said. It is fortunate that the central bank is gearing up to tackle interest rate issues after reflecting on past errors in managing those rates.
The problem, however, is that attracting capital by raising interest rates has the potential to cause unexpected side effects. The primary source of that fear is household debt, which has snowballed over the past years.
Seoul wanted to boost the economy through its recent low-interest-rate regime of long standing, but the excess liquidity that policy has led to has been directed more to households than to local enterprises. As a result, household debts as of late in the first quarter stood at 528.8 trillion won ($550 billion), exceeding 500 trillion won for the first time in Korean history. Of that amount, an estimated 220 trillion won is connected with mortgage-backed loans.
An abundance of capital has led the financial sector to rush into housing loans, and households have indiscreetly taken up the offers to go further into debt at attractive prices. More liquidity amounting to 400 trillion won may also have originated from the rise in household debt.
Further hikes in interest rates will make local households feel the burden of the debts they have taken on; that pain has been stifled because of the low interest rates. The number of delinquent borrowers will increase rapidly, as will the number of people who cannot afford to repay even the loan principal. In addition, if housing prices drop, lenders will scramble to call in loans based on housing values. Then the vicious circle continues: People unable to repay loans will put their apartments on the market, further depressing prices. The result could be grim.
If interest rate hikes are unavoidable, the government should be prepared to handle the worst-case scenario immediately. First of all, the monetary authorities should watch the market carefully and decide when to adjust interest rates and by how much. And financial supervisory authorities should tighten their supervision of banks and other financial enterprises so that panic-stricken lenders do not call in loans en masse.
What is most important is that households themselves do the calculations that apply to them to realize the danger of higher interest rates and start reducing their outstanding debt.