Household debt time bomb

Consumer debt topped 1,000 trillion won ($918 billion) for the first time at the end of last year. Mortgage loans have surged in the first half of this year, growing nine times faster than the same period a year ago. Household debt data has reached an alarming level.

How serious is the household debt problem? There is no agreement on what level of household debt is dangerous against a country’s economic scale. Generally, debt level is deemed worrisome if it is 75 percent or more of gross domestic product. Korea’s consumer credit is nearing that threshold, hitting 73 percent of GDP last year.

Mortgage loans account for up 45 percent of the debt owed by Korean households. They are relatively secure because they are backed by solid collateral. But what’s concerning is borrowing by the self-employed. The loan debt of self-employed people amounted to 370 trillion won as of the end of June. The number of those who owe money to more than three financial institutions totaled 3.29 million as of September, with their combined debt reaching 323 trillion won. If economic recovery is further delayed, the self-employed, particularly those with debt in several institutions, could fail to meet their obligations.

The sudden increase in household debt came after the government eased mortgage-related regulations, such as loan-to-value and debt-to-income ratio requirements. The Bank of Korea encouraged more debt by cutting its key interest rate to record low levels. The government, which has been trying to revive the economy, has succeeded in bringing life back to the real estate market, with housing transactions growing by 18 percent in the first half compared to the same period last year. The new chairman of the Financial Services Commission said there was no reason to tighten mortgage-related regulations. Authorities wouldn’t dare to pour cold water on a real estate market that is showing some activity for the first time in many years. But the government cannot continue to rely on mortgage-backed loans to fuel an economic recovery. The recovery would be at the expense of surging household debt. How much consumer debt the country can withstand and what could happen if interest rates turn higher are scary thoughts.

The government for the time being wants to help restructure household debt instead of fretting over the total amount. It came up with a new loan program to help consumers restructure their bank loans to a longer maturity with installment payments on fixed interest rates. A total of 34 trillion won was spent to offer more affordable mortgages. But that made up 7.4 percent of the 460 trillion won in outstanding mortgage. What about the other 430 trillion won worth?

The household debt problem will ease only when income levels at home grow faster than debt rises. While disposable income at households rose 54 percent over the past 10 years, debt doubled. Last year, disposable income grew a mere 3.7 percent while debt rose 6.9 percent. As long as the government encourages mortgage loans as a policy tool to stimulate the economy, household debt will only worsen.

Business has been in a downward spiral for more than 40 months. Financial institutions so far have been able to collect their household debt. But loans tend to turn sour two years after they increase. Household debt could turn risky from the latter half of 2017, given the fact that loans have increased sharply from the second half of last year. If the economy remains slow, the risk could become bigger. This is the main reason behind concerns about household debt.

Increasing consumer debt through low rates and easing financial regulations is an effective stimulus. Politicians have demanded growth led by increased income, but it is not easy for the government to increase income. Spending also cannot be encouraged through tax policy unless the ordinary citizens are confident about their future. But deficit-based growth shows an immediate effect. The catch is that the side effects are bound to surface two years later.

It is why governments are easily tempted to choose debt-financed growth. But we have experienced debt-led growth and know that it carries a dear price. Credit-financed consumer spending growth during the Kim Dae-jung administration led to a credit card crisis in 2003. Domestic demand fell into a depression for the following two years.

Household debt has reached an alarming level. It is a ticking bomb that could explode anytime. The timing could be accelerated if the government encourages increases in debt. If the government does not want to leave a legacy of a debt-financed economy, it must end the debt-led growth policy. The bomb could explode before the administration’s tenure ends.

Translation by the Korea JoongAng Daily staff.

JoongAng Ilbo, April 17, Page 29

*The author is an economics professor of Korea University.

by Kim Dong-won