EDITORIAL from the Korea Times on Aug. 20

Shock therapy for debt
Borrowers must brace for worst-case scenario

Korean financial regulators adopted a ???shock therapy??? approach in asking banks to suspend fresh lending to households. This extraordinary anti-market practice has led to confusion and anger among loan applicants. This illustrates the alarming pace in the increase of household loans.
Regulators have asked banks to keep the household-loan increase within 0.6 percent from the previous month.
The guideline, effective till this month, was inevitable as Koreans have become some of the most indebted people in the world. Average household debt was 152.7 percent of disposable income last year, higher than the OECD average of 134.1 percent and the U.S. average. Koreans have also become some of the world's lowest savers. Household savings was 2.8 percent of income last year, far lower than the OECD average of 7.1 percent. The statistics show that Koreans have little capacity to reduce their debt.
It is the consensus of economists and policymakers that household debt has reached a dangerous level. It is a ticking time bomb which might trigger a financial crisis similar to the one in 1997 or a Japan-style recession.
What's noticeable is that many households take out loans to bridge the gap between spending and income. For the past three quarters, household income has either fallen or stagnated despite economic growth as inflation is rising. They borrow money to pay interest on their growing debt. Worst of all, some consumers borrowed money to invest in stocks. The recent rise of interest rates is also burdening borrowers. The double-digit increase in home rental prices has also contributed to the problem.
Despite steps to reduce this debt in June, measures proved ineffective. Adding woes to borrowers is the long stagnancy of the property market. In the real estate go-go years of 2002 to 2006, consumers borrowed heavily on the assumption that home prices would rise automatically and indefinitely. This didn???t happen. Housing prices have fallen by up to 30 percent from their peak prices. Trading has also remained stagnant.
Korea likely won???t face a U.S.-style mortgage debt crisis, as maximum lending is within 60 percent of home collateral. In other words, should housing prices fall by up to 40 percent of their peak, banks may not be in jeopardy.
The Bank of Korea has warned that household debt is already at a dangerous level which, unless reduced, might disrupt the financial system.
The freezing of lending will force desperate individuals to tap the secondary financial companies and even the curb market. This might trigger a vicious cycle of burdening borrowers, increasing consumer debt and shaking the financial system.
Although painful, regulators have no choice but to curb the growth of household loans in the future. This should be done within a tolerable range, however. A prolonged curbing would produce many side effects, including reduction of consumer spending, further downturn of housing trading and increased personal bankruptcies.
It is time for policymakers and borrowers to think of the worst scenario.