[The Korea Herald] Is Korea at risk of a housing bubble?

By John Power

The property market is stagnant and needs a jolt. At least, that’s the view of the government, which on May 10 announced measures to boost house sales, particularly in affluent areas of southern Seoul such as Gangnam, Songpa and Seocho.

Within days, however, real estate agents and market observers had labeled the measures, including lowering transaction taxes and easing lending rules, too modest to be effective.

If boosting weak property values is today’s concern, very different fears dominated discussion on real estate until relatively recently. This month two years ago, Hyundai Economic Research Institute warned of a catastrophic collapse of an inflated market without immediate government action. Economist Kim Kwang-soo, the head of think tank KS Economic Research Institute, made similar predictions, claiming that mortgage debt and speculative buying had led to a huge bubble the government could only hide for so long.

Real estate in Seoul’s Gangnam, one of the most expensive property areas in the country. (Yonhap News)

There is no single definition for what constitutes a bubble. Yale economics professor Robert J. Shiller, however, has defined it as an unsustainable rise in prices based on “exaggerated expectations of future price increases.”

Threat 

Although housing crashes tend to be more gradual than those on the stock market, they are more prolonged and cause more economic damage, according to a 2003 report by the International Monetary Fund. Heightening the threat is that a bubble is difficult to identify until well after it has burst.

In the midst of the dire predictions, house prices in 2010 were falling sharply, accelerating a downward trend that had begun in 2009. The growth in prices had peaked in 2006, when Seoul prices rose almost 20 percent, prompting the Roh Moo-hyun government to impose tighter lending rules and higher capital gains taxes to cool the market.

Park Moon-seo, an associate professor at the department of architecture of Seoul National University, said these measures were only partially successful, and could in fact end up contributing to a bubble and crash.

“Anti-speculation policies of the previous government were a half-success,” he said. “They were successful in terms of decreases in housing prices. At the same time, they were unsuccessful, as they have suppressed housing demand with non-natural market control, which accumulates its abnormal energy. Thus, they may result in a sudden rise of housing prices or bubble collapse in the future.”

Kim is much more forceful: There cannot be doubt that the market is already grossly inflated and heading toward a bust. When the bubble pops, he warned, the results could be even more catastrophic than the current situation in the United States or Greece.

“It is indisputable that there is a housing bubble risk in Korea,” said Kim. “The bubble first began with the sudden change in interest rate policy after the foreign exchange crisis in 2001, which caused a rise in speculation. And in order for banks to fund the boom in lending ―- due to speculation ― they borrowed foreign capital, causing a rise in household debt. And more debt means that people want to sell their houses. So, the government has ― in vain ― tried to solve this problem by investing vast amounts of money borrowed to fund its stimulative policies.”

Underscoring the severity of the situation, Kim said, is the fact that Korea’s disposable income-to-household debt ratio, at 165 percent, is the highest in the Organization of Economic Development and Cooperation. That house prices have been falling for several years and about two-thirds of the 50 biggest construction firms have gone bankrupt or are on the verge of bankruptcy is proof the collapse has already begun.

“Once a bubble has been created, the bursting of the bubble cannot be deterred,” said Kim. “It is an inevitable phenomenon, which was seen in the subprime mortgage crisis of the U.S., and in other nations as well such as Japan. These nations did not suffer from the bubble because they lacked expertise or money. And the same is taking place in Korea after the bubble was created.”

Evidence

What the government must do, according to Kim, is allow the bubble to burst naturally, at which point the government can provide financial assistance to those hit hardest, and wait for the market to correct itself.

Other observes make starkly different assessments. Kwon Joo-an, a researcher at the Korea Housing Institute, doesn’t believe the evidence points to a massively inflated market at all.

“When we look at the movement of house prices, the prices do not go down rapidly, which means that it is not a bubble or (is only) a little bubble,” he said.

Kwon sees the country’s high real estate prices as a consequence of high population densities in urban areas and a demand not met by supply. In his view, reinvigorating the moribund market should be the short-term priority of the government and the Bank of Korea, rather than resolving household debt.

In contrast to the previous government, the Lee Myung-bak administration has consistently tried to prop up the property market. This began in 2009 with the government purchasing 5 trillion won ($4.2 billion) worth of land and newly built unsold housing. The following year, lending rules were eased, tax exemptions extended and regulations on total debt-payment ratios in non-speculative areas abolished.

Last year saw further measures, with the lifting of a ban on quick sales in highly sought-after areas and a reduction in the levies on profits made on house sales by multiple property owners.

Park thinks that lower capital gains taxes as implemented by the current government should have a positive effect on the present market.

“Depending on the market situation, such a tax policy would effect either positively or negatively the market. Nowadays, it is believed that it is time to revitalize the market and increase the transaction volume. In this sense, lower taxes can have a positive effect on the market.”

Financial strife

In Kwon’s opinion, the lower capital gains tax policy is likely to have little effect on the market, for good or bad. Both Park and Kwon agree, however, that the market must be allowed to self-regulate to some degree.

“Demand management policy has faced its limit in effectiveness and the government must face the fact that the market has to be free in order to remain stable,” said Kwon.

With the cost of purchasing property closely related to the cost of borrowing, monetary policy is another significant variable in the movement of prices. Lower interest rates from the central bank typically boost housing demand, while higher rates do the reverse. On the BOK’s rate-setting policy, too, experts disagree.

“The Bank of Korea’s low interest policy is surely intended to boost the nation’s economy and housing market. As for house prices, such a policy can provide low incomers with a chance to buy their own house and at the same time fuel up speculation. Although monetary policies cannot be evaluated by simple mathematics, the current BOK policy seems to be appropriate, at least for the housing market, judging from the recent decreases in house prices,” said Park.

Kim sees it very differently: The BOK has only added fuel to the fire.

“The more the BOK or government tries to deter the bursting of the bubble, the worse the situation will become. Since 2008, the BOK has printed 150 trillion won. What began as household debt has become government debt and financial strife of public companies as well.”

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