[Opinion] A House Built on Debt

Atif Mian, a professor of economics at Princeton University, made an appearance in Korea. He was the keynote speaker (via video) at the 26th anniversary conference of the Korea Capital Market Institute held on the 22nd. The topic of his speech was "Debt and Interest Rates." He is a leading expert on debt research. The book he co-authored in 2014 with Amir Sufi, a professor at the University of Chicago Booth School of Business, titled House of Debt, remains a classic. The subtitle encapsulates the book’s main argument: "How debt caused the Great Recession and what to do to prevent its recurrence."

Excessive debt combined with a decline in asset prices produces a destructive effect known as a "levered loss." For example, consider person A who buys a house worth 1 billion KRW with 200 million KRW of their own money and 800 million KRW in loans. If the house price falls by 20% to 800 million KRW and the house is sold, the bank recovers the full 800 million KRW loan without loss, but A’s equity drops from 200 million KRW to zero. While the house price fell by 20%, A’s assets were wiped out by 100%. The leverage multiplier of asset loss is five times. Excessive debt combined with a housing price crash delivers a direct blow to borrowers.

In August, household loans in Korea’s banking sector reached 1,075 trillion KRW, increasing by 6.9 trillion KRW from the previous month. This marks the fifth consecutive month of growth, reaching an all-time high. This is excessive. If asset prices start to fall, the "levered loss" time bomb will explode, leading to a contraction in consumption and an uncontrollable economic recession. You might ask if the opposite case?rising house prices?exists. Certainly, it can happen. But that is not a resolution of the crisis; it is merely an extension of the time bomb. Fundamentally, debt restructuring is urgently needed.

In his keynote speech on the 22nd, Professor Mian warned, "Korea experienced a rise in household debt from 2015 to 2021 that is unparalleled in other countries. This increase in household debt was used to boost aggregate demand to counter negative external issues, but it will make Korea’s monetary policy, including interest rate hikes, more difficult." He emphasized that debt restructuring is urgent for Korea to avoid a credit crisis.

There are several canaries in the coal mine signaling the crisis. The International Monetary Fund (IMF) pointed out that Korea’s household debt-to-GDP ratio (101.7% in Q2 this year) ranks fourth highest in the world and urged a review of household loan policies. The Bank of Korea expressed concern that "household debt is at a level that threatens macroeconomic and financial stability." Professor Sufi also weighed in, warning in a recent article that Korea’s very high debt service ratio (DSR) will inevitably lead to reduced consumption and slower economic growth due to excessive debt.

Earlier this week, Deputy Prime Minister and Minister of Economy and Finance Choo Kyung-ho rebutted these concerns. He stated that the total household debt in the financial sector has been managed stably since the absolute amount decreased for the first time in Q1 this year. His earlier declaration that "there is no crisis in September" aligns with this view. The economy is driven by sentiment. Preventing market panic in advance is important. However, behind the scenes, meticulous work to defuse this time bomb must be underway. Just hearing the name is unsettling: House of Debt.

This content was produced with the assistance of AI translation services.