SEOUL — At a time when much of the advanced world is unloading its debt, South Koreans are still borrowing at a feverish rate that economists say is unsustainable — and potentially dangerous.
It's the lesson of the 2008 global economic crisis that such runaway borrowing often ends with disaster. The problem builds quietly as households take out loans backed by the prices of their homes and then explodes as home prices drop, people default en masse and banks cannot recoup their money. The government increases its own debt load, buying up the sour loans or bailing out the financial system.
But South Korea is a rarity among the world's major economies — it largely sidestepped the 2008 financial crisis. The trauma was so short-lived here that it prompted none of the belt-tightening seen elsewhere. The worst-case scenario now — though it is not immediately likely, government authorities say — is that South Korea will find itself in the devastating cycle other major economies went through several years ago.
South Korean regulators are instead trying to pull off what they describe as a "soft landing," using policy to make people more cautious about how they spend — before a crisis does. The plan, rolled out in June 2011, includes a wide range of limits on bank lending, as well as tax breaks for homeowners who switch from adjustable-rate to fixed-rate mortgages, lessening the blow of a potential interest rate shock. (About 95 percent of mortgages are currently adjustable.) The government has also asked banks to toughen their scrutiny of borrowers' creditworthiness.
Austerity actions
The regulations mark South Korea’s first move toward austerity, and they are controversial because they could choke off growth, particularly in the housing market. Some critics say the country would be better off loosening the reins and allowing borrowers more freedom in the hopes that it would spur growth and drive up incomes. If incomes rise, those critics say, the debt-to-disposable-income ratio drops — and the debt problem is solved without the pain of de-leveraging.
Kim Tae-hyun, a policy expert at the Financial Services Commission, Seoul’s regulatory agency, acknowledged the conflicting arguments about how to handle the debt problem.
“But if we waited until it rose any further,” Kim said, “it would be harder to control.”
Recent signs suggest optimism: South Korea’s total household debt fell slightly during the first three months of 2012, the first quarterly drop-off in three years, according to the Bank of Korea. But regulators caution that borrowing always skews low at the start of a year, and they say it is too early to evaluate whether the new measures are working.
Either way, South Korea's debt level alarms officials here because it mirrors the pre-crisis levels of major economies that were bound for trouble. In 2007, for instance, U.S. household debt stood at roughly 140 percent of disposable income, according to the International Monetary Fund. (It is down to 120 percent.) In Spain, the pre-crisis ratio topped out at about 130 percent, according to the McKinsey Global Institute.
The Japanese debt-to-disposable-income rate is around 120 percent, according to the IMF. In China, the rate stood at 17 percent in 2010, according to Forbes, largely because few families take out mortgage loans.
South Korea’s extreme borrowing is partly owed to the country’s long-booming economy, but it also reflects this society’s hyper-emphasis on achievement. To help their chances at success, people shell out money for tutors and elite colleges. To show off their success, they buy luxury handbags and new apartments.
South Korean authorities say they are tackling the household debt problem before it poses a major risk. The delinquency rate on household loans is less than 1 percent, and tight restrictions have long made South Korea's major banks relatively conservative lenders. Even in the event of another global economic crisis — sparked, for instance, by sovereign-debt problems in Europe — South Korea's banking system would emerge unscathed, according to a recent analysis from the Bank of Korea. It's not the banks that would be underwater, but the people themselves.
Rise of ‘non-banks’
South Korea used to be a nation of savers. But that changed after the 1997 Asian financial crisis, which wiped out some of the country’s largest conglomerates and necessitated an IMF bailout. As part of the recovery plan, the government loosened controls on interest rates, and the number of home purchases boomed.
As South Koreans have borrowed more, they have turned increasingly to “non-banks,” institutions that offer money far more freely, sometimes at exorbitant interest rates. The non-banks have targeted low-income borrowers, and in a recent report, South Korea’s central bank raised concern that borrowers would encounter “serious difficulties” in repaying their debts in the event of a major shock, such as a drop in housing prices.
The vast majority of non-banks are regulated only by local governments, not by the central government’s Financial Supervisory Service. By law, they can charge a maximum interest rate of 39 percent, as opposed to 4 percent or 6 percent at major banks. But those that want to charge even more simply hand in their licenses and continue to operate.
“About 1,000 every year are essentially going back to the black market,” said Lee Jae-sun, general manager of the Consumer Loan Finance Association, which represents 250 of the larger non-banks. He added that there were 18,500 registered non-bank companies in 2007; now there are 12,000.
The government recently launched a task force to crack down on the loan sharks, who it says sometimes visit borrowers homes at night and threaten physical assault. A few loan companies, the government said, have set up women with prostitution services so they pay back their money.
The non-banks have proliferated for a key reason. In South Korea, it is hard to get a sizable mortgage loan from a major bank. Typically, mortgage loans cannot exceed half of a home’s value. Meanwhile, annual payments for the principal and interest typically cannot exceed 40 percent of a borrower’s income.
In the United States, by comparison, mortgage loans were often nearly the size of house prices, meaning that borrowers would go underwater with just a slight drop in the real estate market.
South Korea’s lending restrictions are a “risk bible for banks,” said Kwon Joo-an, senior research fellow at the Korea Housing Institute. A recent IMF working paper said South Korea’s limits have proved to be “effective tools to tame real estate booms and contain the associated risks.”
Troubled borrowers
After the government announced its measures last June, debt continued to soar for half a year — and then it dipped. Meanwhile, the number of people failing to pay back their loans is at the highest level in 51 / 2 years. Four out of five troubled borrowers who show up at the nonprofit Credit Counseling and Recovery Service center in downtown Seoul do not fully pay back the money they owe.
The center, administrators say, deals mostly with low-income earners with multiple small loans — for tuition, for homes, for medical emergencies, for businesses. Counselors in orange polo shirts sit in a row of cubicles, and a banner along the wall reads, “Let’s start over!”
Wang Eun-young sat with a counselor on a recent afternoon and said her “situation was out of control.” She had loans with seven banks, she said, and owed about $60,000. Her husband, a taxi driver, owed an additional $13,000.
“I came here so my husband and I can recover,” Wang said.
A counselor, Kim Min-ji, listened as Wang talked about her three children, her two in-laws with cancer, a failed kitchenware business she had invested in.
Kim said she would help. She would negotiate with the lenders, restructure Wang’s loans and give her the best odds of finally unloading her debt.
Yoonjung Seo contributed to this report.
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