[OVERSEAS VIEW]Real estate loans should be restrained

After strengthening the regulations on the loan-to-value ratio at financial institutions last year, the government is poised in March to expand the imposition of the debt-to-income ratio, which has been limited to banks, to cover all mortgage loans at all financial companies. The purpose of the debt-to-income restriction is to reduce the amount of loans so that the payments are at a certain level of the borrower’s income (for example, 40 percent) to stop real estate speculation and prevent bubbles. The move is intended to prevent the fall in mortgage value from leading to insolvency by basing the calculation of one’s debt repayment capability on actual income.
The problem of real estate bubbles is not limited to South Korea.
After the information technology bubble died down in the United States in 2000, the Federal Reserve Bank of New York reduced interest rates on several occasions to prevent an economic recession. As a result, oversupplied financial liquidity flowed into the real estate market ― even in developing countries such as China, not to mention those of advanced countries ― creating real estate bubbles on the international level.
Accordingly, major advanced countries have recently started to take measures to prevent real estate bubbles by raising key policy rates. Already, real estate prices in some major cities in the United States, the United Kingdom, Australia and China have started to fall. Korea also suffers from an overflow of financial liquidity to real estate, but increasing the policy rates or redirecting domestic liquidity toward overseas investment is not the proper solution, particularly because our economic conditions are different from those of advanced countries.
The measures taken by the governments of the United States and Japan to address real estate bubbles were clearly distinctive. When the real estate market overheated in the United States in the 1980s, the government lowered interest rates on bank deposits so people would put their money into mutual funds or short-term investment trusts.
Thus, by reviving the securities and bonds market, the United States prevented the recurrence of a real estate bubble. That is, the U.S. government highlighted stocks and bonds as an attractive means of fund management that could replace real estate speculation. The reason the real estate bubble did not recur despite low interest rates in the United States was because both businesses and individuals did not have money to spare for real estate speculation, as the traditional industries were struggling in the mire of a recession. Nevertheless, financial speculators such as hedge funds and free riders started to emerge en masse, as the capital market got overheated. Thus, the government measure spawned bigger problems, including the contraction of traditional industries and the middle class, the expansion of economic polarization and rampant materialism and hedonism.
On the other hand, the bubbles in real estate and the stock markets in Japan burst simultaneously due to sudden interest rate increases in the 1990s. Both Japanese financial companies and businesses were affected by the burst and the country fell into a long-term recession. The negative effects that the interest rate increase would have on Japanese banks had already been anticipated, because they were putting too much weight on real estate mortgage loans and investment in securities. Interest rates were raised despite these predictions because the demands of companies and individuals on real estate speculation showed no sign of calming down amidst the brisk activities of almost all industries. However, the interest rate increases worked as an additional burden on Japanese banks and companies that had already been burdened with large amounts of foreign exchange losses caused by large-scale investments in real estate and stocks abroad. The experience of Japan, with the country having lost 10 years due to the real estate bubble that subsequently burst, has loomed large in the background of the decision by the Korean government to restrict loans to value and on debt to income instead of raising rates.
As was shown by the Japanese example, bubbles have bigger side effects on the economy when they are created than when they are destroyed. There is a high chance that Korea will follow the pattern of the United States, where real estate and stock bubbles consecutively appeared and disappeared. In this regard, there seems to be a relatively low possibility that Korean industries will fall into a long-term recession like Japan. However, Korea is similar to Japan in that there is a high risk of large-scale losses from a burst bubble, since our banks rely heavily on real estate mortgage loans and securities investments.
Therefore, it is fortunate that the financial authorities set forth to prevent a real estate bubble and the insolvency of financial companies by restraining loans and lending.
However, to ensure a soft landing for the real estate market and the economy, special precautions should be taken so we do not disadvantage genuine real estate buyers and depress the economy, while trying to root out speculative investors.

*The writer is the head of the financial system and policy division at the Korea Institute of Finance. Translation by the JoongAng Daily staff.

by Kim Dong-hwan