[Initial Insight] Legoland Butterfly Effect

[Asia Economy Reporter Ji Yeon-jin] A woman entered a hospital lobby. After checking the consultation time, she sat in the waiting room, and when a ‘beep’ sound was heard, she witnessed a scene where a dozen other waiting people stood up and sat down. After a moment of confusion, following several more ‘beep’ sounds, she also stood up and sat down repeatedly along with the others. The interesting point is this: even after everyone in the waiting room had left, she continued to stand up and sit down every time the ‘beep’ sounded, and later arrivals followed her. This video, created by National Geographic, was a hidden camera experiment to observe conformity. Although humans are thought to make rational choices at every moment, they are easily influenced by their surroundings.

Conformity phenomena have often appeared in the capital markets. The impact is especially greater in the case of sudden adverse events. A representative example is the massive crash in the domestic stock market in March 2020 when the COVID-19 pandemic began. As an unprecedented infectious disease emerged, market participants literally engaged in ‘panic selling’ out of fear, causing the stock market to plummet.

The recent credit market freeze that started at a theme park in Chuncheon, Gangwon Province, is similar. Last month, bond trading volume sharply declined by about 100 trillion won compared to the previous month, marking the lowest trading volume since January 2009, right after the global financial crisis. This was due to market participants’ reluctance to invest in bonds following the default declaration one day before the maturity date of the 205 billion won Project Financing (PF) Asset-Backed Commercial Paper (ABCP) issued by Governor Kim Jin-tae of Gangwon Province on the 28th of last month to develop Legoland. Bonds worth about 200 billion won, guaranteed by local governments, became worthless, swallowing up 100 trillion won in funds.

Although Gangwon Province belatedly pledged to repay the Legoland ABCP, the frozen bond market shows no signs of thawing easily. After the government announced plans to mobilize more than 50 trillion won, the bond market, which had been calming down, has recently been easily shaken by even small rumors.

Typically, interest rate hikes negatively affect the bond market. Newly issued bonds offer higher interest rates reflecting the increase, which reduces the attractiveness of existing bonds. Amid the interest rate hikes, the default declaration of Gangwon Province’s Legoland ABCP served as a trigger that raised awareness about real estate PF risks, freezing the entire bond market.

The crisis caused by real estate PF defaults has not even begun yet, but the market is already preemptively reflecting a sense of crisis. As the real estate market shows signs of stagnation, rumors of bankruptcies among some construction companies and securities firms have circulated, and the past ‘experience’ of real estate PF defaults escalating into an economic crisis has fueled conformity among bond market participants. When the 2008 U.S. subprime mortgage crisis triggered the global financial crisis, the domestic real estate market was hit hard. About 40 construction companies went bankrupt, and 31 savings banks with large real estate PF loan portfolios were suspended from operations. It was revealed that some savings banks allowed VIP customers to withdraw deposits just before the suspension, and former and current financial authorities who overlooked the savings banks’ insolvency were hauled into hearings.