Household debt is the challenge of our time

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After a series of failed business ventures, Kwon Eui-moon decided to get rich in a more traditional way by taking out a mortgage in 2002 and waiting for house prices to soar. They haven’t.

After 10 years, Kwon still owes 112 million won ($103,810) on his 109-square-meter (1,173-square-foot) apartment in a southern Seoul suburb. His 5 million won in monthly living costs and debt payments is four times what he makes in a good month importing toys from China. The value of his home since he bought it hasn’t even kept pace with inflation.

The total household debt of Kwon and other Koreans rose to a record 937.5 trillion won in the third quarter, undermining Park Geun-hye’s election promise to expand the middle class after she takes over the presidency next week. The debt reached 164 percent of disposable income in 2011, compared with 138 percent in the U.S. at the start of the housing crisis, according to Royal Bank of Scotland Group.

“Park’s top priority in the domestic economy is a soft landing for the household debt issue, which has such big ramifications for the real-estate market and on individuals’ financial soundness,” said Kim Dong-yul, senior research fellow at Hyundai Research Institute. “It’s like managing South Korea’s high-blood pressure, which is high enough for a potential heart attack.”

Park has promised to usher in a “People’s Happiness Era,” bolstering the middle class to 70 percent of the 50 million population, from 67.7 percent now.

‘Happiness fund’

She proposed an 18 trillion won “happiness fund” to help avoid defaults by those with low incomes, saying it will be financed through spending cuts. She hasn’t addressed concerns that such cuts won’t be enough to pay for the fund as well as proposed welfare programs.

Park suggested state institutions could buy stakes in mortgaged apartments that have fallen in value, such as Kwon’s.

The stakes would then be used as collateral for asset-backed securities, using rent from homeowners to pay interest to investors.

Mortgages from banks, insurers and smaller savings banks accounted for about 45 percent of all household borrowing and credit purchases, according to the central bank.

Household debt is the biggest risk to South Korea’s financial system, according to the Bank of Korea’s January survey of 90 experts and fund managers.

“I voted for Park because her household debt relief pledges sounded most sincere,” Kwon said. “It’s been two months since she was elected and I haven’t heard a peep out of her on how she is going to realize any of them. Meantime, my interest payments are ballooning.”

Tax trouble

Kwon’s three-bedroom apartment in the Hosu Maeul Jayeon Desiang complex is now worth about 260 million won, compared with the 224 million won he paid a decade ago. The nation’s property prices have slid from a peak in 2006 after then-President Roh Moo-hyun’s government raised capital gains taxes to curb speculation.

Korean regulators have been working on a “soft landing” policy since June 2011, including limits on bank lending and tax breaks for homeowners switching to fixed-rate loans. About 85.8 percent of mortgages are currently adjustable.

Bank mortgages increased 3.5 percent last year to 316.9 trillion won, the slowest pace in five years. The average bank rate for new home loans stood at 4.16 percent in December, down from 4.19 percent in November, according to the Bank of Korea.

“The quality of household debt is worsening,” said Lee Eun-mi, senior research fellow at Samsung Economic Research Institute in Seoul. Park needs “measures to stymie the rising danger of a massive default crisis.”

Lending drop

Bank lending to households declined by 3.5 trillion won last month to 463.1 trillion won, the biggest drop since the central bank began compiling the data in 2003. The decline was largely due to a 2.3 trillion won drop in mortgage lending after a tax break for home-transactions expired at the end of last year. The National Assembly has yet to vote on a six-month extension of the measure.

Some borrowers have staved off default by taking out further loans to pay mortgage interest. Kwon received help from outgoing President Lee Myung-bak’s government, borrowing about 10 million won ($9,274) through the Financial Services Commission’s Sunshine Loan program, which offers an interest rate of about 12 percent to 13 percent, in comparison with the 40 percent or more charged by private lenders.

“I need the government to help me pay off my existing debt on my own, not offer more loans,” said Kwon, who owes 6 million won for the Sunshine Loan he got to finance his mortgage interest payments.

“I don’t expect my debt to be written off,” he said, “but I would like a grace period to buy me time.”

Bloomberg