The bubble will burst

What has long been dreaded is becoming a reality. The ultra-loose monetary binge is coming to an end, and the payback time has arrived. The government has announced comprehensive measures on household debt to contain further rises and ease the financial burden on low-income borrowers. Under its outline briefed to the ruling party, the government proposes to tighten financing for multiple home owners from January and from the second half next year apply the debt service coverage ratio in all loans so that borrowers would have to pay back the principal as well as interests on all type of loans.

Lift-off in interest rates from record-low levels was triggered by the United States. The U.S. Federal Reserve officially stopped its massive bond purchase program, dubbed quantitative easing, in 2014 and began to normalize its interest rates from the zero percent range in the following year. It raised the fed fund rates twice this year and indicated another one in December, which would put the rate in the 1.25 percent to 1.50 percent range, above Korea’s current policy rate of 1.25 percent.

The Bank of Korea can no longer put off a hike in the benchmark rate so as not to risk a flight of foreign capital from local markets. There is one monetary policy meeting left in the BOK calendar this year, in November. Therefore, the interest rate can either go up next month or in January at the latest.

Floating rates have already begun to shake to reflect the upward movement in market yields. Mortgage lending rates at commercial banks have entered the 5 percent range this month. If a home owner borrowed 200 million won ($176,913) to buy an apartment in Seoul, a hike of 1 percentage point in the interest rate would increase the interest burden by 2 million won a year. But this is only the beginning. The Fed is expected to put the rates near 3 percent by 2019. The looming rate reality has sent chills to the housing market. Apartment trade volume in October sank to 20 percent less than a year ago.

The government has dithered in action while household debt ballooned to reach 92 percent of the gross domestic product. It now has to clean up the mess because it lost the timing to tighten the loose lending regulations.

The government must fully ready the buffer against financial tightening. The most hard-hit will be low-credit and income debtors. It will become harder to manage 3.9 million individuals who borrowed from more than three financial institutions. These institutions would be sitting on 159.2 billion won of debt with the risk of going sour.

The tightening process could be painful and harmful. Authorities must make sure higher rates do not weaken the financial system. Japan’s lost 20 years began when the bubble burst in home prices due to a tightening in loan regulations and monetary policy.

JoongAng Ilbo, Oct. 24, Page 34