This is a brief excerpt from the upcoming book.
The housing loan structure of Korea is currently in a transition stage from mainly a short- term bullet-type of loan, in which the principal repayment is not included in the monthly interest payments, to a longer-term amortizing loan structure. This has been one of the biggest changes to the entire housing debt structure in Korea in the past several years. This transition stage is not likely to be pain-free. Rather it is likely to include much turmoil and many excruciatingly difficult policy decisions. In addition, the transition stage from the 2010 to 2012 period is likely to witness higher than expected interest rates globally, a threat that could make this transition stage quite painful.
The real test is likely to be from the winter of 2010 to 2012, when for many mortgages the continued delays of principal repayment can no longer be postponed and some of the household loan borrowers in Korea who have switched from bullet-type to amortizing loans need to pay much higher interest payments, as they are required to pay both the interest and principal repayments.
A significant number of households in Korea switched from bullet-type of loans of three years or less to longer-term amortizing loans from 2004 and afterward. The switch involved a bait, which was that the households could delay principal repayment by two to three years at the start of the switch from the bullet-type to amortizing loans. During this period, the borrower would need to pay only the interest on the household mortgage but not the principal. The massive increase in the interest payments resulting from the interest-only payment on household loans to interest-plus-principal repayment is approaching Korea like a thief in the night, catching the country unaware.
Saturday, January 16, 2010
Dangers of prolonged, sharply rising interest rates
The following is a brief excerpt from the book.
One of the reasons so much of the interest rate risk has been shoved to the households rather than banks is because of the growing power and influence of the major banks in Korea. In an environment of sharply rising interest rates, it will be the Korean households that will likely be most devastated by such a crisis. Banks will also be negatively impacted by such a crisis but not as much as the households, because the banks will simply raise their lending rates to offset the overall rising interest rate environment.
The large corporations in Korea suffered and learned in such a hard way during the Asian economic crisis that they have continued to pile on high amounts of cash and have reduced debt in the past ten years, vowing not to repeat the mistakes of taking on too much short-term debt without adequate protection.
Korea should brace itself for much higher interest rates in 2011 to 2013. Average mortgage rates in 2011 to 2013 could jump to as high as 8 to 10 percent, from the recent 5 to 6 percent. Corporations, financial institutions, and households should brace themselves for much higher interest rates and set aside adequate amounts of assets and cash to survive such a drastic rise in interest rates.
Given the extreme dangers of prolonged, higher rates for Korean households with high amounts of debt, why does the percentage of long-term maturity fixed-rate mortgages in Korea represent such a small percentage of household loans? One of the key reasons for this is because Korea lacks experience in the development of household finance, especially with regards to household loans.
A major reason long-term (twenty- to thirty-year) fixed rate mortgages are so common in the United States, for example, is because the United States went through the excruciatingly difficult period of the Great Depression from 1929 to 1930s. Prior to the Great Depression in the United States, the standard housing mortgages was mostly short-term. It took the Great Depression and massive personal bankruptcies in the U.S. to redraw the way people purchased houses. This included extending the terms of the mortgage loans and having most of these loans amortized at fixed rates, thereby reducing the overall interest-rate risk for the consumers.
Many people in the United States learned the hard way that having too much household debt on a short-term, floating-rate basis carries too much risk. As thousands of people in the United States filed for bankruptcies in the 1930s, Americans began to use more conservative fixed rates and longer-term mortgages after the Great Depression. Hopefully, Korean households may not need to learn the importance of conservative borrowing the hard way, by suffering like the people in the United States in the early 1930s who were devastated from severe hardships due to excessive leverage.
One of the reasons so much of the interest rate risk has been shoved to the households rather than banks is because of the growing power and influence of the major banks in Korea. In an environment of sharply rising interest rates, it will be the Korean households that will likely be most devastated by such a crisis. Banks will also be negatively impacted by such a crisis but not as much as the households, because the banks will simply raise their lending rates to offset the overall rising interest rate environment.
The large corporations in Korea suffered and learned in such a hard way during the Asian economic crisis that they have continued to pile on high amounts of cash and have reduced debt in the past ten years, vowing not to repeat the mistakes of taking on too much short-term debt without adequate protection.
Korea should brace itself for much higher interest rates in 2011 to 2013. Average mortgage rates in 2011 to 2013 could jump to as high as 8 to 10 percent, from the recent 5 to 6 percent. Corporations, financial institutions, and households should brace themselves for much higher interest rates and set aside adequate amounts of assets and cash to survive such a drastic rise in interest rates.
Given the extreme dangers of prolonged, higher rates for Korean households with high amounts of debt, why does the percentage of long-term maturity fixed-rate mortgages in Korea represent such a small percentage of household loans? One of the key reasons for this is because Korea lacks experience in the development of household finance, especially with regards to household loans.
A major reason long-term (twenty- to thirty-year) fixed rate mortgages are so common in the United States, for example, is because the United States went through the excruciatingly difficult period of the Great Depression from 1929 to 1930s. Prior to the Great Depression in the United States, the standard housing mortgages was mostly short-term. It took the Great Depression and massive personal bankruptcies in the U.S. to redraw the way people purchased houses. This included extending the terms of the mortgage loans and having most of these loans amortized at fixed rates, thereby reducing the overall interest-rate risk for the consumers.
Many people in the United States learned the hard way that having too much household debt on a short-term, floating-rate basis carries too much risk. As thousands of people in the United States filed for bankruptcies in the 1930s, Americans began to use more conservative fixed rates and longer-term mortgages after the Great Depression. Hopefully, Korean households may not need to learn the importance of conservative borrowing the hard way, by suffering like the people in the United States in the early 1930s who were devastated from severe hardships due to excessive leverage.
Will Korea control its debt or will debt control Korea?
This is a key question that I will attempt to analyze in depth in my upcoming book, Vortex of the Korean Financial Crisis. It should become available for purchase by next month.
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