[Opinion] The Fear of Household Debt Spreading Like Wildfire

Seojun Sik, Professor of Economics, Soongsil University

A recession is a situation where households fail to properly consume the goods produced by companies. Household loans were created to overcome this recession. Around 1900, the Second Industrial Revolution marked the beginning of the mass production era. To stimulate consumption of the produced goods, financial institutions actively developed household loan products such as installment financing and secured loans. While humanity enjoyed unprecedented prosperity, it also continuously faced crises fearing the collapse of capitalism. The main culprit of these crises was always household debt.

The Great Depression of 1929 and the Global Financial Crisis of 2008 were the most shocking events in the history of capitalism. Their biggest commonality was the rapid increase in household debt before the crisis erupted. Before the Great Depression, household debt surged through real estate secured loans and installment financing, and before the financial crisis, it surged through subprime real estate secured loans. Just before the financial crisis, U.S. subprime mortgage loans reached a record high of $9.294 trillion (over 1 quadrillion won).

Even when loans surged rapidly before the crises, the outward appearance seemed to show no major problems. Ordinary people could borrow money to enjoy consumption, and real estate owners could fall into the illusion of wealth due to the bubble in real estate prices. The problem lies in the fact that when asset prices rise, making others’ economic situations appear better while one’s own income or wealth growth seems insufficient, speculative tendencies among people increase significantly. This means that people tend to invest by borrowing blindly, following others, in assets already in a bubble price situation.

Another commonality of the two crises was that to cool down the overheated real estate market, monetary tightening policies such as interest rate hikes were inevitably implemented, which ultimately triggered the bubble burst. The real estate market overheating is subject to much stronger government or central bank control than stock market booms. This is because rising real estate prices increase asset values for owners but raise costs for the majority who do not own property. In the long term, the negative effects on the national real economy far outweigh the positive functions. Even Milton Friedman, a leading figure in free-market economics, said, "Among taxes, the least bad tax is the property tax," showing that real estate issues are the only topic on which economists from all eras and political spectrums agree.

The government must slightly cool down the real estate market with tax policies or loan restrictions whenever it starts to heat up. Nevertheless, if the market becomes too hot, it inevitably has to pour cold water through monetary tightening. A few months before the Great Depression, the U.S. sharply raised the benchmark interest rate to curb the rapidly increasing household loans. Before the financial crisis, the U.S. Federal Reserve raised the policy rate from 1% in 2004 to 5.25% in 2007. When large-scale household debts could not withstand monetary tightening and became non-performing, over 9,000 banks went bankrupt during the Great Depression. During the financial crisis, giant financial institutions like Lehman Brothers collapsed. Consequently, the stock market and real economy also collapsed.

Recent news that South Korea’s household debt has exceeded 1,700 trillion won is shocking. It means that even if households earn well in the future, the principal and interest of 1,700 trillion won cannot be connected to consumption. The current difficulties faced by small and medium-sized local merchants should be seen as a result of shrinking effective demand (money connected to consumption) due to the enormous household debt accumulated over several years. This difficulty can only grow worse, which is terrifying. It is not something to watch passively like a distant wildfire. As the proverb says, "In autumn debt, even an ox is eaten," the power of loans spreads uncontrollably like a wildfire, eroding effective demand and causing uncontrollable real estate bubbles.

The Bank of Korea should take action by raising interest rates slightly while issuing a stern warning to the market. The government and political circles must realize "what is more important." It is time to devise measures to reduce household debt, even by injecting government finances. We must prevent the household debt problem from exploding and requiring astronomical government spending in advance. To emphasize once again, major economic crises in all capitalist countries have originated from household debt.

Seojun Sik, Professor of Economics, Soongsil University (Author of 'Investor’s Humanities Library' and 'Rewriting the Stock Investment Textbook')