The Second IMF Crisis is Coming, Who Bears the Greatest Responsibility? We Must Stop Printing Money. (Park Eun-jung, Certified Appraiser Part 2)
Shin Ji-eun: In Part 1, we covered the outlook for the real estate market in the second half of the year from a broad perspective. From Part 2, I will ask some more detailed questions.
Interest rates have risen quite a bit compared to a few years ago. Looking over several decades, they are still considered low, but currently, the U.S. interest rate is about 5.5%, and South Korea’s is maintained at 3.5%. What is your view on this policy direction of a 5.5% U.S. base rate and a 3.5% Korean base rate?
Q. How Will the U.S. and South Korea’s Base Interest Rates Affect the Real Estate Market?
Park Eun-jung: First, we need to think about why interest rates have risen. Why did rates go up?
Because a lot of money was pumped into the economy, the ultra-low interest rate environment lasted for quite a long time. However, there was no significant real inflation. In the past, even if money was pumped in and demand increased, the supply side could respond well. But after experiencing the COVID-19 pandemic, the globalized market environment itself collapsed, supply chains broke down, and countries started consuming domestically first. In other words, there was a problem on the supply side. If supply had not been blocked, there would have been no problem, but the COVID-19 crisis made this a reality. From the Federal Reserve’s perspective, the entity that pumped in a lot of money started to withdraw it, initiating tightening. They would have liked to keep the party going indefinitely if possible, but since that was not the case, they chose to raise interest rates, leading to this tightening situation. Now, the U.S. has raised the base rate to 5.5%, and the outlook is that it will either hold steady or raise it once more because inflation is not subsiding.
But looking at inflation, the environment for it to subside is difficult to maintain. One reason is agflation.
* Agflation: A portmanteau of agriculture and inflation, referring to the phenomenon where agricultural product prices rise, causing general price inflation.
Due to abnormal climate phenomena, war in Russia?the largest wheat exporter?and India restricting rice exports, domestic consumption of agricultural products is overwhelming, so exports are being reduced. This means there are already problems on the supply side. Also, on the oil front, as the economy restarted after COVID-19, production surged, increasing demand for oil that had been blocked, causing oil prices to fall, but oil-producing countries are now cutting production. This could cause oil prices to rise again.
Therefore, the U.S. is maintaining a tightening stance to curb inflation. In South Korea, the Korea-U.S. base interest rates have inverted. If the U.S. experienced severe side effects from raising rates, they would not have done so. But the U.S. has a very solid financial system, and if consumption dropped or employment weakened or other negative economic signals appeared, they would hesitate to raise rates, but that is not the case now. Inflation is worsening, so they are raising rates to curb inflation on essential goods that most affect people’s survival and reducing the money supply in the market.
However, we cannot do that now. The reason is that we are facing stagflation, with the economy in recession. Raising rates now could further shrink the economy, so we cannot raise them. Another reason is that the debt burden is too large; even at the current rate level, many cannot endure it, causing rising delinquency rates, bankruptcies, and restructurings.
People already feel that even the low 3.5% rate is restrictive; the market itself cannot endure it, so rates cannot be raised. Also, due to financial instability, raising rates further would increase delinquency rates, worsen financial soundness indicators, lower our credit rating, and make it harder to obtain funds in a drying market. Therefore, the only choice is to hold rates steady.
But now the Korea-U.S. base rate inversion has reached 2%, an unprecedented gap. This means that a much safer and economically growing country is offering higher rates. From a foreign investor’s perspective, South Korea is still a divided country with various risks. Given the risks, would investors put money into a market with low rates or a more stable market with higher rates? The flow of money is inevitably clear. That is why the Korea-U.S. base rate inversion is concerning. To keep dollars in South Korea, the country traditionally maintained slightly higher rates than the U.S., but now the situation is risky.
Q. The Seriousness of Real Estate PF Loan Defaults
Shin Ji-eun: Recently, with talk of economic recession, real estate PF loans have been frequently mentioned, including the Saemaeul Geumgo issue. The biggest problem in the real estate market is entangled with PF loans. How serious is this problem?
Park Eun-jung: Although rates are held steady, market interest rates are rising. This means that when raising funds, regardless of our base rate, we follow the U.S. rate trend. Everyone wants money in this drying market. The scale maintained by continuously pumping money requires continuous inflows. But in a drying market, money flows selectively, and when we raise funds, foreign capital competes, so our borrowing costs rise.
As mentioned earlier, a lot of loans were given, including PF loans. Because the real estate market was booming, a lot of money was lent for real estate development projects. Loans were given to buy land and build buildings, assuming that sales would recover the money over several years. PF loans are settled only when the project progresses and sales bring in cash. But the real estate market has declined. When assessing project feasibility, the current land price may not support the project, and the structure does not allow raising sales prices. Land was bought expensively, and construction costs are rising.
Moreover, these projects are financed considering financial costs, and interest rates have risen. The projects are in a very difficult state to sustain. Money flows to safer places with higher interest rates, so many projects in the PF market will selectively survive or fail. Currently, short-term RP or similar instruments are used, extended every 6 months or a year, just to get through this period, but it is very doubtful whether this will all improve. This also means financial institutions that lent money are facing problems.
The Saemaeul Geumgo crisis arose because PF delinquencies are about 5%, and securities firms exceed 15%. The problem of PF loan defaults is becoming a reality. Additionally, there have been many construction defects by builders, which lowers their creditworthiness, leading to higher borrowing costs or refusal to lend. This is a very serious situation. Financial institutions must set aside reserves to handle these defaults and maintain soundness, but to do so, they need funds. Recently, Saemaeul Geumgo offers over 7%, and savings banks offer 4.5-5%, reflecting the need to raise funds. Banks must issue bonds, but bond market inflows are limited, so they must offer higher rates competitively. As deposit rates rise, lending rates also rise. Most people with household debt?about 80%?have variable-rate loans, so they are directly affected by rising rates.
Q. Will the Second IMF Crisis Really Come?
Shin Ji-eun: From what you have explained, the situation looks difficult. Some say the 2008 financial crisis was caused by real estate, and now with real estate PF issues, some warn the economy might collapse and a 'Second IMF' could come. Do you think it is really at that level?
Park Eun-jung: Since we experienced such a crisis before, we are taking preemptive measures to prevent it. The 1.3 real estate measures are part of this. For example, the Dunchon Jugong PF project, despite being a highly desirable apartment complex, had unsold units. This shows that the real demand to buy at that price was insufficient. Yet the projects were financed entirely by loans, and lenders refused to extend loans, causing an immediate PF crisis. To resolve this, the government expanded the Channel Fund, selectively using government funds only in very stable places. The government intervened to save Dunchon Jugong and prevent the PF problem from exploding.
Shin Ji-eun: The government was indeed in a hurry.
Park Eun-jung: Because even such prime projects could not secure funds, the ripple effects would be huge. To preemptively block this, the government invested money and gathered the five major banks to lend funds. This allowed overcoming the crisis. HUG provided guarantees, and PF guarantees were introduced to prevent a collapse. These measures are ongoing. Since the COVID-19 pandemic, loan volumes have become too large to resolve easily. To revive the real estate market and prevent PF problems, people were encouraged to buy homes with loans. But many cannot endure rising loan rates, so nearly half of the funds were used for refinancing. The rest was used to buy homes, but these funds have already been exhausted.
About 40 trillion KRW was planned, but it was all used up by May. Can the government continue to provide such policy funds? The government offers low rates despite high market rates to encourage home buying, but someone must bear the loss of the difference, which is the government.
Shin Ji-eun: Ultimately, the public bears the burden.
Park Eun-jung: Yes. Issuing more government bonds means more debt. Government debt is increasing exponentially. The 'Second IMF' scenario is not about having no money at all but about reaching a point where one cannot manage the debt, causing companies to go bankrupt. The IMF crisis was caused by short-term liquidity shortages, but households had capacity then. Now, households have debt equal to 105% of GDP, and measured by disposable income, it is about twice that of the U.S.?meaning debt that cannot be repaid even over a lifetime.
Shin Ji-eun: Households cannot endure this level now.
Park Eun-jung: Correct. Moreover, government debt ratio was about 36% before COVID-19 but has now risen to nearly 50%. The government borrowed heavily to overcome the COVID crisis. Everyone is in a tough situation, and preemptive measures are being taken to prevent collapse. But can this continue? The exchange rate is also a problem. Since we rely mostly on exports, which are dollar-based, and import most materials, when the exchange rate rises, costs rise but selling prices cannot, causing continuous deficits. This is the structure leading to trade deficits. The 'Second IMF' scenario is discussed because economic recovery depends heavily on external factors, mainly China and the U.S. China’s economy is weak due to real estate and local government debt problems, consumption is shrinking, inventories are piling up, and they are not importing from us, so we cannot recover. We must endure until they improve, but the exchange rate must be stable. However, with the Korea-U.S. base rate inversion, the exchange rate keeps rising.
Shin Ji-eun: There is little to rely on.
Park Eun-jung: There is nowhere to lean on, and we are slowly using up our cards. Whether we can endure the second half of the year is uncertain. The fundamental problem is the flawed structure of lending people more money than they can handle. The younger generation, having only seen house prices rise during ultra-low interest rates, thinks it is natural to borrow heavily. People with combined incomes of just over 100 million KRW borrow 300-400 million KRW without concern. They have not fully realized the weight of this. The government should have managed household debt size and imposed regulations, but loans were given freely.
Shin Ji-eun: Everyone thinks it is normal to have debt and that buying a house with debt is natural, but borrowing beyond one’s means will ultimately be a problem for all of us. With a heavy heart, we will end Part 2 here and continue the discussion in Part 3.
!["A Market Where Taking 300-400 Million Won Debt to Buy a House Is Normal"... Could a 'Second IMF' Really Happen? [Apartment]](https://cphoto.asiae.co.kr/listimglink/1/2023082516101052645_1692947410.jpeg)
Park Eun-jung, Certified Appraiser
- Worked at Korea Appraisal Board from 2003 to 2017
- Certifications: Certified Appraiser, MAI (Member of Appraisal Institute, USA), Licensed Real Estate Agent, Specialist in Maintenance Project Management
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