[Chatham House]④ Should 'Yeongkkeuljok' Be Rescued... Government Intervention "Yes vs No"

Is a PF-Triggered Financial Crisis Really Coming?

Editor's NoteAsia Economy's economic and financial think tank, 'Asia Economy Chatham House,' has been launched. On the 1st, at Lotte Hotel in Sogong-dong, Jung-gu, Seoul, an in-depth discussion was held under the theme 'Will a Crisis Arise from Project Financing (PF)? - An In-depth Diagnosis of Korean Finance,' featuring Gwak Young-kwon, Executive Director of Meritz Securities, Kim Dong-won, former invited professor at Korea University, Park Jae-ha, former Deputy Director of Korea Institute of Finance, Lim Jin, Director of the Korea Chamber of Commerce and Industry's Sustainable Growth Initiative (SGI), and Cho Won-dong, former Blue House Economic Secretary (in alphabetical order). The participants forecasted that "the current economic recession will not reach the level of the past International Monetary Fund (IMF) foreign exchange crisis." However, opinions diverged on the extent of the government's role in overcoming the crisis. There was a sharp debate between those advocating proactive and aggressive policy responses and those arguing that government intervention might hinder the market's natural structural adjustment. Many also pointed out that preparing for the deepening polarization and super-aged society after 2023 is more urgent than immediate market instability. Asia Economy Chatham House follows the 'Chatham House Rule,' disclosing the list of participants but anonymizing each speaker's remarks. The full discussion will be published in several parts.

On the 1st, participants are sharing their opinions at the 1st Asia Economy Chatham House event titled 'Is a PF-Driven Crisis Coming?

◆ Moderator = Lee Jeong-jae, Director and Editorial Advisor of Asia Economy Economic Media School

(Reference)

PF-triggered Financial Crisis, Is It Really Coming?

"Korea Electric Power Corporation (KEPCO) is a bottomless pit, electricity rates must be raised"

"Next year's economy will be L-shaped rather than V-shaped... Preventing the worst is the best" continued

"Overheated real estate must be allowed sufficient adjustment"
"A country with no hope for young people who can't buy homes with their salary"

The essence of the current PF problem is that the previous government did not address structural issues but only took short-term measures, which inflated the real estate bubble, and in turn backed the increased shadow banking, which has now burst. The current government must not repeat the same mistakes; this is the key takeaway.

Earlier, Mr. D mentioned that if real estate prices adjust by 30%, 10% would be nominal adjustment, and the rest would be naturally adjusted through income growth and inflation, which also counts as adjustment. But if you look closely, real estate prices did rise excessively during the previous government, right? If they rose excessively, they must be allowed to adjust sufficiently. I don't think it's a big deal to panic over falling real estate prices. Real estate has already become a political issue. Especially when listening to young people, it has become a country with no hope. When real estate prices rise two or three times compared to salaries, young people lose hope of buying homes. At this point, real estate is not an economic issue but a political and social issue, so while I don't advocate neglecting it to the point of abandonment, I think it is necessary to allow prices to adjust. It's difficult to know where the appropriate level is, but in any case, sufficient adjustment is needed. To the level of before the previous government or around there. Of course, during this process, measures should be taken to prevent the market from collapsing.

Korea's economic vulnerability lies in household debt. The PF crisis theory is also connected to household debt. When real estate prices plunge sharply, household debt issues ignite in earnest. So, to what extent can we tolerate a decline in real estate prices? For example, in 2008 and 2012, the Korea Institute of Finance conducted bank stress tests, concluding that a 30% drop was tolerable. The banking system could withstand up to a 30% drop in real estate prices without problems. Savings banks and credit card companies might be forced out, but the overall financial system could be maintained. This was possible because we tightened LTV (Loan-to-Value) regulations. But what about now? Can we still endure a short-term plunge of about 30%? Since the speed of decline for overheated real estate can be much faster, how should we view this? Can we estimate the level the system can withstand?

Since real estate prices rose, it's natural for them to fall. I agree that this is an opportunity to carry out corporate restructuring sufficiently. However, regarding bond restructuring, I want to emphasize that we should not indiscriminately discard all non-performing bonds. We must prevent companies that can be profitable from going bankrupt due to short-term liquidity shortages. Even if we support non-performing bonds, the government cannot just hand out money to all companies. What I mean is that we need clear criteria to prevent profitable companies from going bankrupt.

Regarding real estate regulations, this government has even loosened LTV. One of the things this government does very well is adjusting regulations to fit the market; they are loosening them significantly. Adjusting the issuance of KEPCO bonds and government bonds to stabilize the market was also appropriate. However, I believe more proactive government measures are needed concerning household debt. When real estate prices fall, household debt inevitably becomes a core issue. The current decline is much larger than expected. For example, in May, apartments in Gimpo were around 20 million KRW per pyeong, but now prices have dropped by 20-30%. The sharp decline in real estate prices can escalate the PF problem into a household debt problem. Now is the time to consider some proactive regulatory easing beyond just LTV.

I agree. Especially for young people who leveraged heavily during the previous government, tailored micro-measures seem necessary. Due to the previous government's wrong policies and hype, many took on excessive debt to buy homes, and with interest rates rising sharply, their burden has become enormous. This is not just a real estate issue but a matter of survival. I think it is the government's responsibility to prevent this. We need to consider specific methods.

On the 1st, participants are sharing their opinions at the 1st Asia Economy Chatham House event titled "Is a PF Crisis Coming?

"Excessive policy responses cause structuralization of insolvency"
"Those responsible for PF insolvency must be held accountable"

Even so, I believe excessive policy responses should be restrained. The link that causes cyclical problems to become structural and entrenched is insolvency. Let's review the COVID-19 situation. The government injected a lot of money in support, but none was recovered. This remains as government debt and is unresolved. The same applies to PF insolvency. When bad loans arise, the question is how to handle them. Ultimately, who will bear the burden? It could be individuals?"You made a mistake, so you bear it." Or financial companies?"You also made mistakes in lending." Or the government?"The government should help; if policies were good, this wouldn't have happened."

In the end, when insolvency occurs, who bears it is key. Looking at the previous government's policies, it was like "The government will bear everything; you live comfortably." Such policies accumulate and lead to structural insolvency. In fact, this PF crisis concerns capital companies and savings banks. The scale is not that large. The truly risky assets are just over 10 trillion KRW. This is a problem that banks can solve by supplying sufficient funds.

Therefore, the claim that this will lead to a financial crisis underestimates the government's policy response capabilities. However, if the government solves it through banks, the public ultimately bears the insolvency, which is problematic. I think capital companies and savings banks, as parties responsible for insolvency, should bear some responsibility. They should either increase their capital or be liquidated. That is my first point.

Second, regarding the forecast that this economic cycle will lead to a long-term recession, there is room for debate. It is true that Korea's economic growth potential and dynamism are declining. But whether dynamism has weakened in all sectors is another matter. The dynamism of traditional manufacturing sectors has certainly declined. However, sectors like batteries, bio, and electric vehicles, which are newly growing, have considerable dynamism.

For example, if we break up national monopolies, market innovation and dynamism can be stimulated. Just as breaking up the telecommunications monopoly led to innovations by KT, SKT, and others. The KEPCO issue is similar. Electricity rates can be structured like mobile phone plans. Households that use a lot of electricity from 6 pm to 10 pm could choose cheaper electricity plans during those hours. By breaking up national monopoly markets like this, the energy market can be restructured, and growth dynamism revived.

Therefore, it is difficult to definitively say that Korea's growth potential has declined based on traditional manufacturing sectors alone. In that sense, I find it hard to agree with forecasts of a long-term recession after next year. The 4th Industrial Revolution era is an era driven by data. In the 3rd Industrial Revolution era, dynamism was visible through cars and smokestacks, but such visible dynamism does not fit the 4th Industrial Revolution era. The issue is how we respond well to the 4th Industrial Revolution, not that dynamism is declining and causing a long-term recession. Of course, as Discussant A said, our economy is currently in a major transformation. So how we lead this is important. (To be continued, see: "Economy is Politics... Economic Logic Alone Cannot Solve It")