[News analysis] What’s behind S. Korea’s explosive increase in household debt?

Posted on : 2020-09-14 18:12 KST Modified on : 2020-09-14 18:12 KST
Breakdown of housing loan regulations spearheaded under Park Geun-hye administration
The amount of credit loans banks have issued to individual consumers has skyrocketed within the past few years. The photo shows a loan desk at a bank in Seoul. (Yonhap News)
The amount of credit loans banks have issued to individual consumers has skyrocketed within the past few years. The photo shows a loan desk at a bank in Seoul. (Yonhap News)

It has been around four to five years since the ratio of South Korea’s household debt to economic scale rose to become the world’s highest. In late 2014, the ratio of household debt to gross domestic product (GDP) crossed the 80% threshold, passing the US’ 79.7%; by mid-2016, it had surpassed the UK’s as well.

A direct contributing factor was a major loosening of housing loan regulations spearheaded by then Deputy Prime Minister for the Economy Choi Kyoung-hwan during the Park Geun-hye administration. In his inaugural address on July 16, 2014, Choi asserted the need to “quickly reform outdated real estate market regulations that are like wearing summertime clothes in the middle of winter.” A week later, he announced the so-called “July 24 measures,” key elements of which included raising banks’ loan-to-value (LTV) ratio for housing by 20 percentage points from 50% to 70% and loosening debt-to-income (DTI) ratio restrictions by 10 percentage points from 50% to 60%. This was the opening salvo for policies that encouraged people to rack up debt in order to purchase homes.

It was around the same time that South Korea’s household debt began approaching a critical point. Researchers at the Bank for International Settlements (BIS) have estimated that the ratio of household debt to GDP begins to exert negative influence on the economy once it passes 85% -- a level that South Korea’s passed for the first time in the third quarter of 2016. During the Roh Moo-hyun administration (2003-08), skyrocketing housing prices fueled a widespread perception that household debt had become a major issue, but even during that administration, the ratio was in the high 60-70% range. It would go on to pass the 70% threshold in the second quarter of 2008, before reaching the 80% mark six years later in the fourth quarter of 2014.

Household debt to GDP ratio of of advanced economies
Household debt to GDP ratio of of advanced economies
Debt continues to increase under Moon administration

The problem is that the trend of increase has continued even under the Moon Jae-in administration. In the time since Moon took office, the ratio has risen by nearly 10 percentage points. Starting at 88.3% in the second quarter of 2017, it passed 90% in 2018 as rising housing prices resulted in an increase in loans; as of the first quarter of 2020 it had reached 97.9%. Household loan demand has grown since the second quarter amid the combined effects of rising housing prices and the COVID-19 pandemic. With a negative economic growth rate predicted for the year, the ratio is very likely to pass 100% by year’s end.

The administration’s target has been to achieve a “soft landing” for household debt by keeping the current economic growth rate lower than the rate of increase in household loans. Its reasoning is that reducing loans in a short period of time could result in major side effects. Indeed, after reaching double-digit levels in the 11-12% range during 2015 and 2016, the rate of increase in housing loans had fallen to 5.6% in 2018 and 4% in 2019. But the eruption of the pandemic turned that situation around -- with a 6.2% rate of increase already as of August this year. This explains the level of newfound urgency surrounding household debt management.

Excessive household debt levels have a negative effect on economic growth as they lead to curtailed consumption. Deepening financial struggles for families faced with critical situations raise the likelihood of financial anxiety. An unanticipated domestic or overseas shock wave could serve to touch off a major crisis. Jang Min, a senior research fellow at the Korea Institute of Finance, observed, “Most global financial crises have been the result of a housing price bubble growing due to increased household credit, and an increase in household insolvency as that bubble collapses.”

Annual rate of increase in household debt
Annual rate of increase in household debt

Subprime mortgage loans the main culprit behind 2007-2008 financial crisis

A case in point in the financial crisis that erupted in 2007-2008, triggered by subprime mortgage loans. After passing the 85% mark in 2004, the ratio of household debt to GDP in the US had continued to increase, reaching 98% at the crisis’s peak in 2008. Only after that financial crisis had hit did the process of “deleveraging” begin. The ratio fell below the 90% mark as of 2011; by 2014, it was down below 80%. It was an intensely painful process that saw many people driven out of their homes as they were seized by creditors.

Financial authorities recognize the seriousness of the household debt issue, but insist that South Korea is “relatively safe” because the increase in debt has been centered mainly on people with high incomes and strong credit. But apartment prices in the Seoul Capital Area (SCA) have recently reached levels high enough to create a burden even on high-income, high-credit demographics. This means more people who would find themselves drowning in debt if an unexpected shock comes along from within or outside to send housing prices plummeting and interest rates rising.

By Park Hyun, staff reporter

Please direct comments or questions to [english@hani.co.kr]

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