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Hongkong: Still trapped in property delusions

SCMP October 7, 2002

The fever never abates. Hongkong's leadership still seems to think that economic salvation lies in property prices. Now Antony Leung is to make another market rigging effort. For whose benefit, one must ask?

The property obsession of our leaders should not of course come as a surprise. Not only do first generation tycoons such as Li Ka-shing owe their wealth to a quarter century of property price inflation. Second generation ones, including Tung Chee-hwa, moved much of their fortunes from the likes of shipping and textiles into what looked an easier way to make money - and one where they did not have to face international competition. Look at the list of assets of Hongkong's legislators and one finds the same pattern of multi flat ownership. As for Mr Leung, he made a career in retail banking, an activity now dominated by mortgage lending rather than trade finance.

So one can understand where these people are coming from. But what are they trying to achieve? Maybe the coming measures will have some short term effect. The previous market props - cessation of land sales, tax relief for home mortgage payments, cutbacks in HOS sales etc - probably did stem the fall. However they did so at the cost of further major deterioration in the fiscal situation, which is tolerable only in the short term, and delay in the adjustment of the rest of the economy.

There are only two serious arguments to be made in favour of trying to stabilise prices at what are still at very high levels by any standard, let alone a city whose "world class" status is being questioned. The first - and one which does apply in Japan - is that property price falls have been the main cause of the bad loan situation which is at the heart of Japan economic problems.

However, there is no particular reason to believe that Hongkong banks are anywhere near facing a similar situation. The home price spike was relatively short lived and occurred partly because of a shortage of new supply. It is only since the bubble deflated that loan to valuation ratios have been raised to levels could be viewed as potentially risky.

Given the sharp decline in interest rates since 1998, negative equity has not led to a steep rise in distressed loans. The only real threat to the banking industry would be if interest rates rose sharply and homeowners were no longer able to service their loans. Such a rise looks unlikely in the medium term. However, it is a possibility so long as the Hongkong currency is pegged to that of the US rather than allowed to respond to Hongkong's own domestic and trading circumstances.

It is ludicrous for the government to try on the one hand to push up property prices while on the sticking with a currency policy which does not permit interest rate flexibility. It is likely that were the dollar to be floated it would move down. The peg to a strong dollar after most of Asia ( led by China) devalued during 1995-97 is an albatross. A 15-20% decline would make Hongkong assets cheaper for foreign investors and thus provide a lift to values in local currency terms.

However, even if a float were not to lead to some depreciation, interest rates at least could be cut further, which would provide some stimulus to the economy generally and probably to asset prices. Hongkong banks are flush with cash, savings are high, loan demand very weak. There is every reason for cheaper money - except the peg.It is not even certain that lower interest rates would mean a weaker currency. Thai ones are lower than the US, yet the Baht has been quite firm.

The second argument for official attempts to prop up real estate is that declining asset prices have fuelled a deflationary spiral which in turn has caused a negative wealth effect. People feel poorer so they save more and spend less. There is certainly some truth in the negative wealth effect. But it is unquantifiable. Attempts in other countries to track it have been only partly successful.

It is surely easy to exaggerate in Hongkong. Home owners deep in negative equity are a noisy lot but still quite a small group compared with the numbers who bought before 1993 or after 2000 and are either still sitting on large unrealised profits or are near enough to break-even not to worry too much. The majority of home owners have been enjoying higher real incomes because of the fall in mortgage rates.

A far larger reason for lack of consumer and home buyer confidence is the level of unemployment and general sense of job insecurity. Instead of trying to push up land and property prices it would be better to set our goals for housing standards rather higher than they are now. Hongkong needs more construction not less. Lower prices should lead to more demand. Mr Leung seems to want to stand economics on its head, aiming to increase demand by raising prices!

The government's goal seems to be to get people back into the habit of believing that property is the surest store of wealth and prices always rise. This is foolish both in economic and social terms. Firstly, people deserve better housing - which means a lower land to construction cost ratio. Secondly, the property fixation means that savings are shifted to asset price increases (an uneven form of wealth re-distribution) rather than to new investment whether in new businesses or in buildings and related infrastructure.

In Hongkong's case there are two further arguments against a policy of trying to boost asset prices. Firstly, it probably will not work because demographics are against it. The rate of new household formation is continuing to fall and the only source of population growth - migrants from the mainland - mostly lack the resources to be home buyers. Secondly, limiting land sales to a trickle does more harm than good to its revenue. In the short run the government badly needs land revenue to reduce its deficit. In the longer run it needs to get away from its over-dependence on property related revenue generally - something it has been talking about for years but done nothing.

The problem anyway is not so much confidence in assets as a weak economy generally. It is noteworthy that rentals have fallen only a little more slowly than property prices even though interest rates have plummeted. So attempts to bolster asset prices when demand by end users is weak looks destined to fail.

It is also worth noting that government data probably exaggerates the degree of deflation in Hongkong. The consumer price index is heavily weighted towards private sector rentals although in practice few people live in private rented accommodation. Most are either home owners or live in public rental housing. Labour costs, the main ingredient of most service industries, has been stable and import prices have stopped declining.

The property market, like the stockmarket, is not an end in itself. Its prosperity should be the result of demand for goods and services throughout the economy. Any rise in asset prices should only come well after the economy and rental demand have picked up. An attempt to put the cart before the horse will merely delay recovery, inhibiting the adjustment of Hongkong's service sector to the realities of life in post-crisis Asia. ends .