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Action needed on debt

Published: 27 May. 2011, 21:36

Household debt has long been a ticking time bomb. Foreign analysts and the media warn of the potential danger. Quick action should be taken as household debt reached an all-time high of over 800 trillion won ($734 billion) as of March. It jeopardizes the economy.

Moody’s Investors Service warned that Korea’s fast-rising household debt is a risk that can place the bank sector in crisis. Foreign analysts demand Korea raise interest rates in order to contain consumer debt.

Monetary authorities have carried out four key rate hikes from July last year, raising the benchmark interest rate by 1 percentage point. But they failed to slow the rise in household debt. Banks, having little else to invest in, resort to easily collateralized mortgage financing.

Despite the raise in the benchmark interest rate, borrowing rates on mortgages remain at the 4 percent level. But many of the borrowers who bought homes at relatively cheap rates, nevertheless, can barely keep up with interest payment.

According to Hyundai Economic Research Institute, 39 percent of people that took out a mortgage are incapable of repaying the principal.

When left unattended, household debt could rock the entire economy if an economic slowdown or plunge in housing prices were to take place. For now, more than 80 percent of those who took out collateralized mortgage loans only pay interest, as they were taken out with a grace period.

Once the grace period ends, they would have to pay both the principal and interest - and the squeeze will likely further dampen overall consumption. The Bank of Korea would then hesitate in raising the interest rate, despite inflationary pressure.

We have seen catastrophic consequences of unrestrained household debt. Japan’s housing bubble and the United States’ subprime mortgage loan debacle both arose because authorities overlooked brewing dangers of household debt.

Monetary authorities should continue with a gradual tightening cycle to dampen ballooning household debt.

Financial authorities should also contain banks in their reckless consumer lending practice. Consumers should seek fixed-rate products as protection against a potential uptick in interest rates. Everyone should be on full alert and remain attentive to household debt before it threatens the economy.