• Thu
  • Dec 25, 2014
  • Updated: 11:36pm
PUBLISHED : Tuesday, 07 May, 2013, 12:00am
UPDATED : Tuesday, 07 May, 2013, 7:45am

Why the HKMA should fret over consumer debt

The coming housing crisis in the city after the Fed raises US interest rates is going to plunge many Hongkongers into negative equity

Only last week my esteemed colleague Jake van der Kamp was complaining that there is altogether too much consensus among the Business Post's columnists. Commentators are not meant to be a harmonious society.

Well, Jake, you've got your wish for a healthy dose of adversarial scrappiness, because today the back page is going to pick a fight with the front page.

In his column today, Jake pours a bucket of cold water over the boss of the Hong Kong Monetary Authority, Norman Chan Tak-lam, who warned last week that Hongkongers were in danger of trying to live beyond their means.

Among other things, Chan is worried that private consumption is growing faster than incomes, and that the city's level of household debt is rising, climbing to 61 per cent of Hong Kong's gross domestic product.

Jake takes issue with this warning, pointing out that debt is a stock measure while GDP measures flow. Over recent years, he points out, household debts have actually declined as a proportion of total loans.

I am not so sure he should dismiss the debt-to-GDP measure so lightly. After all, the ratio of a country's household debts to its national income clearly affects its people's ability to service those debts.

Even so, compared with other developed economies a 61 per cent debt to GDP ratio is hardly excessive. It puts Hong Kong on a par with the frugal Germans, behind Japan or South Korea, and well below wastrels like the Americans, now on 85 per cent, and the British, whose household debts stand at 90 per cent of GDP.

What is more, I don't buy into Chan's assertion that debt has risen because of a credit-fuelled consumption binge. As the chart shows, three-quarters of the rise in Hong Kong's household debt over the past five years consists of the increase in mortgage debts. Mortgage debts, naturally enough, have risen because homes have got more expensive, while mortgages are cheap.

That does not mean we can relax, though. On current trends in US unemployment, at some point around the end of next year, the United States will begin raising interest rates.

That will mean dearer mortgages in Hong Kong, and very likely a major correction in the local property market.

Granted, thanks to modest leverage levels among home loan borrowers, the correction would have to be really big to push many families into negative equity, where the size of their mortgage debt exceeds the value of their homes.

According to Monitor's estimate, if prices fell by a third, putting them back where they were in mid-2010, only around 1,000 families would find themselves under water.

But if prices were to fall by half, dropping back to their January 2009 level, the number of borrowers in negative equity would soar to almost 60,000.

Many market-watchers are sanguine at this prospect, pointing out that almost twice as many households fell into negative equity at the bottom of the last big slump in 2003, when prices fell by two-thirds.

But even at the worst of that bear market the proportion of borrowers who got more than three months behind with their payments never climbed above 1.5 per cent.

That sounds reassuring, but alas, there is a crucial difference between that correction and the one that is coming.

Last time around, the property market crashed at a time of falling interest rates. Between the height of the bubble in late 1997 and the depths of the slump in 2003, the US Federal Reserve spent most of its time in easing mode.

HSBC's prime lending rate, the benchmark for local mortgages at the time, duly followed, falling from 9.5 per cent to just 5 per cent.

As a result, the cost of servicing a mortgage relative to household income tumbled, which meant that few households defaulted on their payments, even though the number in negative equity shot up to more than 100,000.

Next time around, the interest rate environment will not be so benign. Today, with home loans available at interest rates of just 3 per cent, the cost of servicing a mortgage typically eats up around half of household income.

When the Fed begins raising interest rates, that cost burden is going to rise, plunging many families into financial hardship - and some into default.

As a result, Norman Chan is right to be concerned about household debt levels. And Jake, admirable chap though he is, is wrong.



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This article is now closed to comments

Exactly. Leverage is not the dangerous one in HK's property market. Affordability is, in particular servicing costs. Well put and spares me a comment on Jake's View, who, as usual, misses the boat while driven by his desire to criticise those with authority no matter what, when or why.
Did you read the piece and the part where it addressed the post-1997 property market as well as the interest rate environment then?

And yes, waking away from debt in HK doesn't happen much. Because you can't. Mortgages are full recourse here.

Post-1997 people could stick it out yes. Because as long as the bank doesn't force your hand, and the interest rate stays stable/declines, your monthly mortgage servicing costs are sustainable, provided you don't loose your job. Negative equity is after all just an accounting concept, not affecting cash flows.

But now we have a very different risk: rising interest rates. Monthly servicing costs will rise. Substantially, since we are coming from near zero. This is when many will realise that the debt servicing will begin to eat up too much of their incomes. They will choose to sell, and go back to renting. Rents have not kept pace with prices, and rental yields are incredibly low (another sign of skewed affordability). That, by the way, also means that many investors will just start putting money in the bank again when interest rates normalise. This, instead of putting money in property that they rent out for a paltry 2 pct or less net yield, especially when for them too, debt servicing costs will rise and the squeeze.
Americans are not "wastrels" by choice. The debt system has been rigged against americans by the Fed and the complicent lawmakers and judicial system. If america can fix its consumer debt situation, perhaps it benefits everybody on the planet since americans need to work less hours to service their debts, meaning they won't be consuming as much of the world's resources.
The american debt cycle is such a vicious cycle and there is no way off. Higher and higher debt via penalties, fees and additional interest rate charges simply adds to the angst you have described as wastrel. Fix america's consumer debt rights and issues, and the world will can follow.
For instance, americans have NO DEBT SUSPENSION RIGHTS of any kind, and two, 2% monthly minimum payments on credit cards are the entry level debt addicting drug from which there is no return.
This is a HUGE property bubble; the end will be VERY UGLY.
No, not exactly. Since you're putting a fine point on others' comments let's paint yours with the same brush. The risk of rising interest rates to mortgage debt service and housing prices is inextricably bound up with leverage in HK where all mortgages are floating rate. At the individual level, the higher the LTV ratio, the more that total interest payments increase for a given rise in the benchmark rate. This is by no means trivial. For the system as a whole, more leverage and thinner equity means a greater incentive for speculators to sell sooner and limit their losses. The post-97 scenario included plenty of such sales to accompany those who "stuck it out": ask anybody who owned DB at that time.
Well, respectfully, I disagree.

If I have a mortgage debt of HKD 4m with some 20~25 years to go at -currently- an effective pa interest rate of about 1.5~2.0% (HIBOR+1~1.5%, not an unusual deal back in 2009/2010 for instance), my servicing costs are about HKD 14~16k per month. Assuming a monthly household income of about HKD 40k (that already takes us up to the 80th percentile of household income in HK!), that is about 35% of my income and affordable.

Yet, if US interest rates in the coming years begin to normalise, with HIBOR moving in lock-step, things change rapidly. Without going into more extreme scenarios, let's say that HIBOR goes back to 2%. Now my effective mortgage rate is 3~3.5%. The interest on my HKD 4m mortgage has doubled. My servicing cost is now in the 18k~21k pm range. Without a substantial increase in income, the affordability picture is now going south, as I am paying in all likelihood 50% or more of my income in debt servicing.

What the LTV is on my property is largely irrelevant. The property could be worth 8m (50% LTV), or 10m (40% LTV) (given the price increases in recent years). It doesn't alter the fact that I am facing radically higher debt servicing costs. In fact, a lower LTV makes it a lot more attractive to take the equity out, even if the market is going down. Why would I continue paying increasing (who knows how high US interest rates may go..,) mortgage costs while the market does down?

And that is a fairly benign example...
Rising interest rates in the US will indeed put borrowers in a difficult position in Hong Kong. However, we went thru something similar in the post-1997 property crash that dropped values by up to 70% putting many mortgage holders under water with negative equity. During this crash default rates remained low as people simply stuck it out. The same would happen if there was another major correction. People in HK simply do not have a history of walking away from their debt so anyone alarmed by the levels of consumer debt needs to relax.


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