[Debt Dilemma] ① Real Estate-Driven Household Debt... Growing Warnings of a 'Silent Financial Crisis'

'Quiet Financial Crisis' Shaking Banks Due to Household Debt
Household Debt Soars from Past Governments' Reliance on Real Estate
Growth at Risk... "DSR Increase Is the Most Dangerous"
Professor Soopy Chicago U "Korea Is Especially Concerning"

Editor's NoteDebt is borrowing future consumption and investment. Household debt is borrowing future consumption, and corporate debt is borrowing future investment right now. Because the government prioritizes the current economy, it is always tempted to borrow future consumption and investment. When debt becomes excessively large, crises occur. The 1997 foreign exchange crisis happened due to excessive corporate debt caused by the overexpansion and overinvestment of large corporations in the 1990s. Corporate debt deleveraging was carried out through corporate restructuring, including reducing corporate debt ratios to within 200%. Later, to stimulate consumption, credit card issuance was excessively promoted, leading even college students and low-income groups without repayment ability to use cards recklessly, resulting in the credit card crisis of 2002 that produced about 4 million credit delinquents. Card debt was deleveraged through measures such as the personal workout system for credit delinquents.

As banks focused more on household loans than corporate loans, it became easier for people to buy houses. Household debt greatly helped boost the real estate market. Since then, household debt has continued to increase, reaching the highest level among OECD (Organisation for Economic Co-operation and Development) countries. While many countries including the United States deleveraged household debt following the 2008 global financial crisis, South Korea did not undergo household debt deleveraging. The government faces a dilemma: household debt has grown so much that the burden of principal and interest repayment restricts consumption and thus the economy, but it cannot drastically reduce household debt for the sake of the current economy. Amid this, Kim Dae-gi, Chief of Staff to the President, warned on the 29th that "if a household debt crisis occurs, its impact will be several tens of times greater than the 1997 foreign exchange crisis caused by corporate debt."

Analysis suggests that South Korea's excessive household debt is jeopardizing the overall economy, including consumption, investment, and growth. Even if the household debt problem does not immediately lead to a large-scale financial crisis, it can gradually increase non-performing loans in the banking sector and reduce efficiency in employment and resource allocation, potentially leading to a 'quiet financial crisis.' The Presidential Office and government have belatedly begun to prepare countermeasures amid mounting concerns over household debt, but experts predict that without fundamentally reforming the longstanding practice of relying on real estate and household loans for growth, noticeable changes will be difficult to achieve.

Household Debt Ratio Declined?..."Trend Has Not Changed"

According to the Bank of Korea and the Bank for International Settlements (BIS) on the 31st, South Korea's household debt ratio to nominal Gross Domestic Product (GDP) stood at 101.7% in the second quarter of this year, ranking among the highest globally. Although slightly lower than the peak of 105.7% in the third quarter of 2021, this decrease is largely due to a temporary reduction in household debt caused by rapid interest rate hikes last year and the effect of changes in international accounting standards applied this year (excluding insurance policy loans from household loans), so it is difficult to assign significant meaning to it.

In fact, the long-term trend ratio of household credit to GDP compiled by the Bank of Korea was 106.3% in the second quarter of this year, steadily increasing without any decline since the third quarter of 2021 (101.4%). This means the trend of excessive household debt growth has not changed. Moreover, the household debt ratio to GDP rose from 101.5% in the first quarter to 101.7% in the second quarter this year, and with household loans from the five major commercial banks surging by 2.4724 trillion won this month, the household debt ratio to GDP is likely to increase further.

Academia has raised concerns that such household debt issues could quietly escalate into a larger crisis. Professors Matthew Baron of Cornell University, Emil Verner of the Massachusetts Institute of Technology (MIT), and Wei Xiong of Princeton University warned in a 2020 paper published in the National Bureau of Economic Research (NBER) titled "BANKING CRISES WITHOUT PANICS" that a reduction in bank capital due to debt problems can have significant negative effects on the economy without causing a panic, highlighting the possibility of a 'quiet financial crisis.'

Economic Erosion Without Panic...A 'Quiet Financial Crisis' Approaches

The paper explains, "Bank capital shortages can lead to credit supply contractions that reduce consumption and investment even without a panic," and "Historically, bank failures without panics have been quite common." Although South Korea's financial system still appears stable, recent increases in bank delinquency rates and ongoing concerns about non-performing loans in Saemaeul Geumgo (Community Credit Cooperatives), savings banks, and real estate project financing (PF) mean there is no room for complacency. The Financial Supervisory Service recently reported that the delinquency rate on won-denominated loans at domestic banks reached 0.43% at the end of August, the highest in three and a half years.

Professor Kang Kyung-hoon of Dongguk University's Business School said, "While banks' capital levels are still adequate, delinquency rates are rising rapidly across the financial sector, and some sectors are seriously troubled, making the realization of a 'quiet financial crisis' quite possible." He added, "Currently, some non-performing loans, such as those in Saemaeul Geumgo, are obscured by government support."

Following the 'Legoland incident' at the end of last year and the Saemaeul Geumgo bank run (massive deposit withdrawals) this year, the government eased real estate regulations to prevent banking sector failures, and the Bank of Korea reformed lending systems to provide support. However, these efforts may have concealed underlying non-performing loans. Although the paper does not directly mention South Korea, it notes that during a 'quiet crisis,' government intervention is hidden, and the absence of failures in other banks may give creditors the impression that the banking sector is sound. It warns that if losses occur in banks under such conditions, credit conditions could tighten further.

Reasons for Steady Increase in Household Loans...Each Government's Reliance on Real Estate

Unlike major countries such as the United States and Europe, South Korea's household debt has steadily increased without deleveraging, largely due to an economic growth model dependent on real estate and household loans. In fact, successive governments have primarily used real estate market stimulus measures to revive the economy. Professor Ha Jun-kyung of Hanyang University's Department of Economics said, "After the global financial crisis, most other countries reduced household debt and the government took on more debt, but South Korea's characteristic was that households mainly increased debt instead of the government."

The Lee Myung-bak and Park Geun-hye administrations focused on deregulation to revive the real estate market depressed by the US-originated global financial crisis. In particular, the Park Geun-hye administration promoted policies encouraging people to 'buy houses with debt,' contributing to the activation of mortgage loans and jeonse (long-term lease) loans. The Moon Jae-in administration significantly tightened real estate regulations to curb soaring house prices amid global low interest rates and liquidity expansion, but as a side effect, house prices rose further, causing household loans to surge.

Since the inauguration of the Yoon Suk-yeol administration, rising benchmark interest rates have slowed the rise in house prices and slightly reduced household loans. However, as financial market instability increased, the government quickly eased real estate loan regulations and introduced a special low-interest home loan program, again showing reliance on the real estate market. Recently, as the household debt problem worsened, the government announced plans to tighten regulations, but there are forecasts that if the economy becomes unstable again, the government will once more ease real estate regulations, showing a 'zigzag' approach.

Due to this government reliance on real estate, South Korea's total housing market capitalization surged from 3,019 trillion won to 6,209 trillion won since 2010, a 2.05-fold increase. This growth rate far outpaced that of the stock market capitalization (1.55 times) and nominal GDP (1.63 times) during the same period. Over the past decade or so, housing in the Seoul metropolitan area has served not only as living space but also as an investment asset, driving transaction and jeonse prices sky-high. This contributed to the 'gap investment' (buying with jeonse deposits) and 'Yeongkkeul' (borrowing to the limit) frenzy, shaping today's 'Real Estate Republic.'

"Particularly Concerning for Korea"...Household Debt Also Shakes Growth Rate

This government stance and the rising household debt trend have also become subjects of academic research. Amir Sufi, a world-renowned scholar and author of 'House of Debt,' pointed out the household debt problems tied to real estate in South Korea and China in a paper titled HOUSING, HOUSEHOLD DEBT, AND THE BUSINESS CYCLE published in July. Professor Sufi explained, "During housing booms, South Korea maintained persistently low interest rates on household debt, and banks had much lower requirements for mortgage loans compared to corporate loans." He added, "This helped promote mortgage loan growth and led to the expansion of a unique financial product called jeonse loans."

He particularly emphasized that his study of 16 countries from 1980 to 2015 showed that when the Debt Service Ratio (DSR) of household debt began to rise sharply, the household debt boom reached its most dangerous point, which is "especially worrisome for Korea." According to the Bank of Korea, the proportion of households with a DSR exceeding the regulatory cap of 40% surged from 28.9% in 2017 to 31.9% last year. Professor Sufi noted, "An increase in DSR negatively affects real GDP growth, and whether rising interest rates translate into reduced household spending is a key factor to monitor for assessing South Korea's future GDP growth."

There is a general consensus that the artificial economic stimulus method relying on real estate has its limits. Professor Seok Byung-hoon of Ewha Womans University's Department of Economics explained, "When household debt exceeds a certain level, the increased burden of principal and interest repayment shrinks domestic demand, raising the risk of recession during interest rate hikes." He added, "Some of the funds should be invested in corporations to serve as future growth engines for South Korea, but if they are concentrated in the real estate market, it can undermine economic growth potential."