Hong Kong's housing market is in a desperately sorry state. Unfortunately, things are going to get an awful lot worse over the coming months. Home prices have suffered a triple blow since they hit a 10-year high back in March. The plunge in the stock market has eroded the disposable wealth of property investors. Fears over the worsening economic outlook have unnerved potential buyers. And banks have tightened lending standards in response to the credit crunch, making mortgages harder to come by. As a result, market activity has evaporated. According to the Hong Kong Monetary Authority, the value of mortgages approved in October was down 40 per cent from the same month last year. The knock-on effect has been dramatic. On Tuesday the Land Registry announced that the number of home purchases last month fell to just 3,264. That's down 31 per cent from October's level and a whopping 79 per cent below the number for November last year. Perhaps more significantly, it's also fewer deals than were struck either at the worst of the Asian crisis 10 years ago or in the depths of the 2003 Sars scare. Understandably, prices have been hammered. According to the Centaline property agency, home prices have now fallen 22 per cent from their high in March, with around two-fifths of that drop occurring in the last month (see the first chart below). To compound matters, on Tuesday Hong Kong's dominant mortgage lender, HSBC, jacked up the interest rate on the majority of its home loans by 0.5 of a percentage point to 3.5 per cent. At first it seems blatantly unfair that mortgage rates should be rising when the HKMA has cut its base rate from 6.75 per cent last September to an all-time low of just 1.5 per cent now. But with job losses mounting and incomes under pressure, HSBC's bankers feel compelled to raise mortgage rates to cover themselves against the increased risk that borrowers will default. Similarly, with the outlook for property prices deteriorating, mortgage banks have reduced the average amount they are prepared to lend to just a shade over 60 per cent of purchase value, from more than 65 per cent when prices were still rising. Of course it could be argued that the banks' fears are self-fulfilling. The combination of higher mortgage rates and lower loan to value ratios deters buyers, further depressing prices. So far, however, the pain inflicted on home-owners by falling prices has been relatively mild. Thanks to the banks' conservative insistence on a sizable loan to value buffer, in September the number of households in negative equity - those with homes worth less than the mortgages taken out on them - stood at a modest 2,568. At just 0.5 per cent of outstanding mortgage-holders, that number is tiny compared with the level in June 2003 during the Sars outbreak, when 22 per cent of all borrowers - 106,000 households - found themselves under water. But if prices continue to fall, the number of households in negative equity will rise rapidly. Last week Monitor projected that the number could exceed 16,000 next year. That was a back of the envelope calculation, which seriously underestimated the extent of the likely damage. A more rigorous analysis extrapolating from HKMA figures for average loan to value ratios indicates that if home prices were to fall 40 per cent from their March peak, which many analysts believe likely, then all new mortgages extended between February and August this year could sink into negative equity. That's equivalent to more than 60,000 households. And if prices were to fall 50 per cent from their peak, as happened between 1997 and 1998, then all mortgages taken out since October 2007 would be under water, equivalent to 115,000 households (see the charts below). These estimates are necessarily flawed. They rely on average values and take no account of refinancings or early repayments. Nevertheless they are well within the bounds of possibility, and - alas - the outlook they project is grim indeed.