Negative Equity In HK - A Precursor & Benchmark

The number of Hong Kong homeowners in negative equity quadrupled to nearly 11,000 in the last quarter of 2008 as the financial crisis took its toll on property prices. And analysts expect the figure to double this year as property prices fall by a widely expected 10 to 15 percent. Residential mortgage loans in negative equity increased to 10,949 at the end of December from 2,568 at the end of September 2008, according to the Hong Kong Monetary Authority.

What is negative equity: it means the amount you would still be owing after you sell the property and pay off your mortgage. For example, if you bought a house for 600,000 and you borrowed 500,000, which meant that you paid 100,000 as downpayment. Now the house is only worth 450,000 hence your negative equity would be 500,000 - 450,000 = 50,000. Negative equity is 50,000 but in actuality you have already lost 100,000 (downpayment) + 50,000 = 150,000 (not including the many monthly payments may have already made on the property).

HKMA chief executive Joseph Yam Chi-kwong said the increase was anticipated and that it will continue. "But I don't expect the situation will be as bad as in 1998 to 2003. Property prices are tending to remain stable at a certain level," he said.

While the developments are to be expected, what is more important is to see the negative equity figure as a benchmark as a severity of the recession. We must remember that Hong Kong saw a peak of 105,697 negative equity cases in June 2003 amid the SARS outbreak. So 11,000 is still very acceptable. But the the flip side is that the number in negative equity will rise exponentially and very swiftly if property prices were to slide in greater quantum for the next 6 months. Possibly another 10% slide in price would bring the negative equity figures close to the 2003 SARS level.

Pan Asian Mortgage Advisory economist Alvin Ho predicts the number of negative-equity homeowners will increase to more than 20,000 this year if property prices continue to decline. Real estate prices in the secondary market dropped 20 percent to an average of HK$3,410 per square foot in the fourth quarter from last year's peak of HK$4,251 psf, according to Midland Realty. The HKMA said the aggregate value of mortgages in negative equity rose 313 percent to HK$24.8 billion in the fourth quarter from the previous quarter. The unsecured portion of these loans rose to HK$2.7 billion. The loan-to- value ratio of the loans increased to 112 percent from 107 percent. The three-month delinquency ratio of negative equity mortgages fell to 0.05 percent from 0.08 percent.

Meanwhile, Yam said companies in Hong Kong have more than HK$100 billion in syndicated loans that are due to expire this year. The HKMA will take appropriate action and "the government should keep an open mind" to help financing, he said. "Foreign banks based in Europe and America may have to handle their own problems at headquarters by deleveraging. Their foreign business will then be affected." However, Chinese University associate finance professor Raymond So Wai-man warned that the government will come "under great pressure if it helps companies refinance debt."

Yam said there is a risk that protectionism could spread from trade to finance. As an example, countries are no longer buying US Treasury bonds. The HKMA intends to cancel its temporary provision of additional funds to banks at the end of March but will review the facility at that time to decide if it needs to be extended.

Amidst all the planning and forecasting, HK should remember that its monetary policy, property price and hence stock market are tied to their currency peg. The USD has been injected with a huge array of new "fundamentals" over the last 6 months - HKMA should really reconsider the HK dolar peg because the "integrity, outlook and volatility of the USD" going forward will be more like a horror movie. You cannot have your currency tied to highly risky, highly indefensible monetary expansionary policies somewhere else... the USD by virtue of their actions over the last 6 months have basically sentenced the dollar to a long drawn out period of weakness and losing stature as a reserve currency.

The Missing Legacy - HK Wake Up!

Recently, a gwailo passed away without much of a mention in HK papers. Now, I have to say that I am biased as I think the majority of the bunch of British expats being posted to HK basically had a holiday for the past 50 years. HK did become a financial center and its citizens benefited enormously for the last 30 years. It put HK on the map. Property prices went through the roof. HK became an international city. However, HK would NOT be where it is (economically) if it were not for a guy name John Cowperthwaite (JC). JC was HK's financial secretary from the crucial formative years of 1961-1971. He passed away on January 21, 2006 at the ripe old age of 90. The sad thing is that HK media and HK people in general, failed to give due credit to this man. Sure, HK people worked hard to get to where they are, but as we all know, the structure and gameplan must be there to allow "good things" to happen in an economy. In his first budget speech he said: "In the long run, the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralised decisions of a government, and certainly the harm is likely to be counteracted faster."

JC, very much a disciple of Adam Smith and not a modern monetarist, put in the structure and rules to promote HK's now famous laissez-faire economics. Britain at that time was moving towards a more socialist and welfare state, and it would have been very easy for JC to replicate that for HK. Can you imagine that - having a bunch of whinging "me,me", unionised, welfare dependent Chinese in Asia!? Instead, JC took it upon himself to do "less" by eliminating tariffs, lowered the tax rate to a maximum of 15%, cut the bureaucratic red tape that stifles business. He called his policies "positive non-intervention". To have the courage and political will to do that for HK - that should mean the world to the people of HK. In 1960, the average per capita income in Hong Kong was 28 percent of that in Britain; by 1996, it had risen to 137 percent of that in Britain. Now the per capita income of HK almost mirrors that of the US.

Sir John Cowperthwaite was knighted in 1968, and what he did for HK should be taught in schools and universities in HK. I wonder how many roads, libraries, scholarships or university halls are named after JC? After the Asian financial implosion in 1997, HK suffered and stuttered particularly when compared to Singapore. It looks like Singapore has taken a leaf from the handiwork of JC - less is more. Instead, HK powers to be have put in more legislation and rules, which combined, have put HK on the backfoot. Two examples, the rise and rise of hedge funds in Asia - Singapore has managed to attract a lot more of them than HK, ask any fellow professionals why. The other is the rise and rise of REITs, and though HK has had a headstart, Singapore is putting in the right moves, making REITs dividends non-taxable. Again, we can expect more international REITs to come to list in Singapore in the months ahead.

HK has to learn from its mistakes but also gain lessons on things it did right before. A good way to start is to fully appreciate the things Sir John Cowperthwaite did for HK's economy, and replicate that. The fact that his passing was largely ignored in HK says a lot about where HK's economy is headed.