Tiger by the Tail

Tiger by the Tail(2015/3/12)

(Next Magazine, 2015/3/12, A002, Second Opinion, Bill Stacey)

The Hong Kong Monetary Authority (HKMA) is concerned about the risks in the property market in Hong Kong. They see the sharp rise in prices owing much to the “unconventional” monetary policies and zero interest rates in the US. Warnings from Norman Chan explain their policies:“normalization of interest rates in the US will be a positive development for Hong Kong as our interest rates move in tandem. The most important task is to ensure our financial system will be able to withstand the shocks arising from volatile fund flows in this process. In this regard, the HKMA has launched six rounds of countercyclical macro-prudential measures to tighten residential mortgage lending…”

“Macro-prudential” policies are all the rage amongst central bankers today. Not that they know where in the economic cycle we are. Seven years on from financial crisis and recession, US economic surprises have weakened sharply in the last 3 months and some think that rather than a slow recovery, another downturn may not be far away.

Meanwhile growth is moderating in China.The risk is that far from being “counter-cyclical”, the HKMA will in the end simply disrupt the housing market. The new 60% loan to valuation ratio just may reduce risk for banks, but this is at the cost of higher risk for the people of Hong Kong borrowing to buy a home.

Ironically, at a time when the HKMA sees risks in the mortgage market, their answer is that households investing in the property market should put more of their equity in that market. Requiring more home equity, borrowers will have to reduce their holdings of other assets.

Their investments will be less diversified and more concentrated on the local property market.The measures will also lead to a higher concentration of wealth on low return bank savings as people save for a larger down-payment while cutting back on consumption.

These savings weigh on banks that have limited domestic opportunities to lend.Honk Kong’s banks might as a result have less mortgage risk in Hong Kong, but does that mean that they have less risk overall? It does not. Banks have responded to reduced lending opportunities in the comparatively low risk domestic mortgage market by massively increasing their exposure to other parts of China.

This massive increase in lending and structural change to the balance sheet of banks has been “pro cyclical”, lending more as the China economy peaked.The impact on the people of Hong Kong is no less of a concern than the impact on banks. “Shadow” borrowing from other family members or finance companies grows as people scramble to find a down-payment. More people will be induced to rent than buy, stressing that part of the property market.

The measures penalize the young by requiring higher levels of cash – typically saved by people who are older. This adds to intergenerational tensions. Moreover, couples are likely to delay both marriage and child rearing given the importance culturally of home ownership. This adds to the demographic challenge that we face.Another perverse result of restricting access to the property market is an increase in demand for public housing and the resumption of the HOS schemes of subsidized housing.It is said that generals fail by fighting the last war. Hong Kong banks lost very little money during the dire property market from 1998-2003, when prices fell more than 60% peak to trough.

This market has not been like the US with mortgage lending for more than the value of the property at origination. Far from a “macro” focus the HKMA is myopic. These bureaucrats see their own responsibilities only by turning a blind eye to the broader risks and consequences of their actions. They have grabbed the tiger by the tail, as their macro-prudential polices have no exit strategy. If they succeed in avoiding a property market collapse, then these highly undesirable measures can never be removed without reigniting speculations in the housing market.

Bill Stacey