Tinkering with loan controls won't help property market
It seems there has been some confusion recently in Hong Kong's policymaking circles.
Just four weeks ago, Financial Secretary John Tsang Chun-wah was still worried about the dangers of a property market bubble, telling Legislative Council members that prices had not yet fallen to a 'satisfactory level'.
Two weeks later, he changed his tune, suggesting that the Hong Kong Monetary Authority was preparing to relax some of its restrictions on bank mortgage lending in response to softening prices.
Then last week he backtracked yet again, declaring that the property curbs introduced by the government and the HKMA 'have helped safeguard macroeconomic and financial sector stability'.
'We will continue with this overall strategy,' he promised.
All this flip-flopping appears to betray a belief that the authorities can micro-manage Hong Kong's property prices by occasionally tweaking lending controls. If officials do believe they can steer the market like this, they are mistaken.
The purpose of lending restrictions is not to manage property prices, but to reduce systemic risk in the banking sector.
According to the HKMA, they have done this rather well. Before 1991, banks could make mortgage loans of up to 90 per cent of the underlying property's value.
With more than 20 per cent of the banking sector's outstanding loans consisting of residential mortgages, that meant the city's banks were heavily exposed to any fall in property prices.
To reduce this risk, in 1991 the HKMA introduced a maximum 70 per cent loan-to-value ratio for mortgages. In other words, buyers were required to come up with at least 30 per cent of the purchase price of their new home in cash.
Clearly, this restriction did nothing to stop prices soaring as the 1997 property bubble inflated. But it did help protect the city's banks when the bubble eventually burst. According to the HKMA, the mortgage delinquency ratio during the Asian crisis would have been twice as great if it had relaxed the 70 per cent loan-to-value limit, and reverted to a 90 per cent cap.
But while loan-to-value limits reduce banking sector risks, there is little evidence they have much effect on property prices. A working paper published by the HKMA in February examined the impact of loan curbs on property markets in Korea and Singapore, as well as in Hong Kong. The monetary authority's researchers concluded that only in Hong Kong was there any 'mild evidence of a dampening effect' on property market activity. There was none at all in the other two markets.
Two more working papers published this month by the International Monetary Fund support this conclusion.
One paper examined the effectiveness of curbs implemented across different markets and found that 'over the short term, changes in loan-to-value ratios do not appear to significantly affect the rate of residential property price inflation'.
It went on to add that 'a tightening of maximum loan-to-value limits in Hong Kong appears to have little effect on total mortgage lending'. In the second IMF paper, the fund's researchers attempted to determine what exactly drives property prices in Hong Kong.
They found that the supply of domestic credit - that is the availability of mortgages - was the weakest and least important of the factors that they examined.
They concluded that tightening loan-to-value ratios (and raising stamp duties) would at most only slow a rising trend in property prices, not reverse it.
Instead, the biggest influence on property prices is, not surprisingly, the health of the Hong Kong economy, measured in real gross domestic product per capita. The next most important factor is the supply of building land, followed by interest rates and construction costs.
It would make no sense for the government to try and reduce GDP per capita in order to bring down property prices. And officials have little control over interest rates or construction costs.
But the government does control the supply of building land. As the IMF's researchers conclude, 'policy should focus on raising land supply to restrain property price increases'.
That seems obvious. The trouble is that increases in land supply take two to three years to affect prices. As a result, government officials are terrified that if they raise the land supply now, they will risk exacerbating a downturn in prices in a couple of years time, possibly bringing the city's middle classes out on the streets in protest.
That means we will see little effective action to make housing more affordable. But we will hear a lot more confused talk about tinkering with restrictions which have little effect on property prices anyway.