Policymakers downplay household debt threat, but are they putting lipstick on a pig?
A potential homebuyer checks property listings at a real estate agency in Yangcheongu, Seoul. A dramatic fall in house prices since the 2008 Lehman Brothers collapse has trapped millions of homeowners in negative equity and worsened personal indebtedness. / Yonhap
By Kim Tong-hyung
Even as Korea’s household debt mountain threatens to overtake the country’s entire annual economic output, government officials continue to dismiss apocalyptic talk and claim personal indebtedness is under control. But their attempts at keeping things calm ultimately just delays the day of reckoning, according to one influential economist.
``Korea has a nasty habit of denying the existence of a problem, which actually feeds the problem and makes it bigger. Only when the problem bloats to a point where it could blow up for everyone to see will bureaucrats budge and throw an enormous amount of taxpayer money at it to extinguish the threat. I think this is happening with the household debt situation,’’ said Gongpil Choi, senior economist at the state-run Korea Institute of Finance (KIF), in a recent telephone conversation.
``There should be absolutely no debate that the debt problem is serious and must be dealt with urgently. We have already missed out on the window to nip the problem at the bud. Yes, the cleanup will require assertive involvement by the government and a massive amount of public funds.’’
Choi’s expression of urgency contrasts with the comparatively casual comments of policymakers like Financial Services Commission (FSC) Chairman Kim Seok-dong and Bank of Korea (BOK) Governor Kim Choong-soo, who insist that household debt has yet to pose a considerable threat to the country’s financial stability.
The household debt mountain is currently scaled at above 1 quadrillion won when the liabilities of families and self-employed businesses are taken into account, essentially matching an entire year’s gross domestic product (GDP). Officials at the FSC and BOK, however, prefer to focus on the fact that the collective value of personal financial assets is still roughly double the sum households owe.
Choi argues that, while the numbers don’t lie, they don’t always tell the whole story. The core of the problem, he says, is that around 80 percent of Korea’s private-owned assets are in real estate. Of course, the property market has been stinking since the collapse of Lehman Brothers in 2008.
The freefall in home prices has trapped millions of Koreans in negative equity, paying heavily for their borrowing binge during the mid-2000s housing boom. There is now an easy escape from the sea of debt as subduing economic activity, hurt by worsening global conditions and a decaying job market rule out the possibility of a broad boost in incomes.
To restore the health in consumer activity, it is critical to convert real estate assets into buying power, Choi said. However, property market fragility and precarious family finances suggest that households may not have the mettle to withstand a process of deleveraging.
``The deleveraging could trigger a dramatic fall in asset values, which then may paralyze the country’s financial system and batter the real economy into a long-term recession. The negative feedback on asset holders will be significant and the implosion could result in a wealth polarization much worse than the actual difference in income,’’ Choi said.
He claimed that Korea is facing an increasing possibility of a balance sheet recession, where the plunge in asset prices damages balance sheets severely and shifts the priorities from asset owners from profit maximization to debt minimization. This perhaps is already a reality for many Koreans, who have seen the value of their properties erode but the loans used to purchase them remain.
``In a balance sheet recession, macro-economic policies like quantitative easing cannot be regarded as an effective strategy, not when the private sector is crushed by debt repayment burdens and maxed out on its capacity to take on more debt. There aren’t really many policy options for us, as we are a developing economy that is dependent on the state of the world economy,’’ Choi said.
To combat the disastrous vortex of softening economic activity and spiraling debt, Korea is in desperate need of political honesty. It’s inevitable that the government will have to become deeply involved to purge the toxic family finances and the repeated denials of the severity of the problem has already pushed up the cleanup bill unnecessarily, Choi says.
Korea could do much worse than follow Sweden, which managed to defuse its dangerous household debt problems in the early 1990s with an aggressive government that was able to identify and isolate bad debt swiftly, according to Choi.
A more recent model can be found in the Private Public Investment Program for Legacy Assets and the Large Scale Asset Purchase plan adopted by the United States in the fallout of the 2009 subprime crisis. Under the schemes, government and private actors collaborated effectively in pricing and processing distressed assets.
``The government needs to take up an active role in cleaning up the mess as the problem has become too big for private banks to take all the burden,’’ Choi said.
``Leaving everything up to the government, however, would risk inefficiency and moral hazards. A public-private partnership model would be ideal. A quick price discovery and write down of private-owned assets would be the first and most critical step of the cleanup job, and these jobs are done better by private actors than the government.’’