Hong Kong: what can it teach us about property bubbles?

Despite reports, in Asia, loan to value lending caps have had only a transitory effect on property prices

As the Central Bank of Ireland introduces loan to value restrictions, it notes the successes of such policies in Asia. But how successful have these measures been in Asia, have they cooled escalating property prices, and what lessons can Ireland learn from Asia's experiences?

As an stockbroker who has been covering Asia for more than 20 years, I can see why the Central Bank has looked East. Much of what has happened in Ireland both pre and post-crisis has been similar in many respects to what happened in Asia.

Up to the late 1990s, Asia had enjoyed an unprecedented boom. That was until the Thai baht devalued in 1997 triggering a catastrophic collapse throughout the Far East in what became known as the Asian Financial Crisis.

What started as a seemingly isolated problem in Thailand swiftly ricocheted throughout Asia bringing a wave of asset price destruction. Property values dropped 60 per cent, banking systems teetered under the strain of multiple bankruptcies, currencies devalued, banks failed and the IMF was called in to rescue one economy after the next.


The similarities between the Asian and European crises extend even to the acronyms used in both collapses. Just as Europe had its PIGS, Asia had the TIPs (Thailand, Indonesia and the Philippines), China already had its Nama – the Asset Management Corporation or (AMC) – and more than a decade before the Federal Reserve introduced QE, the Hong Kong Monetary Authority launched an emergency program buying Hong Kong's stock market in an attempt to boost asset prices, defend the currency and fight deflation – in essence QE in everything but name.

As in Europe, some Asian economies endured more than others. The periphery economies of Thailand, Indonesia and Korea suffered most. Currencies devalued, companies with foreign debt were bankrupted, banks were bailed out and the IMF levied a catastrophic social toll on the local populations, prompting Harvard's Jeffrey Sacchs to dub the IMF as "the Typhoid Mary of emerging markets, spreading recession in country after country".

In Hong Kong overnight interest rates skyrocketed to 280 per cent and unemployment soared, lending shuddered to a halt and inflation morphed to deflation.

However there was one notable difference between Hong Kong and Europe – in spite of a 65 per cent collapse in Hong Kong’s property market, not one bank went bust. What made Hong Kong’s system so resilient?

One reason is that Hong Kong put safety valves in place to protect its banking system, such as the decision in the early 1990s to cap Loan to Value Ratios at 70 per cent.

The Hong Kong Monetary Authority was aware that, because of the “currency peg”, Hong Hong’s banking system was vulnerable to multiple boom-and-bust cycles, bank runs and currency crises. They knew of the acute risks inherent in an open economy with free mobility of capital when pegging your currency to another economy (from 1983, the Hong Kong dollar has been pegged within a range of HK$7.75 - HK$7.85 = $1).

So while Hong Kong’s growth engine is China (growing at an annual clip of more than 8 per cent for 20 years) its interest rates are determined by the US – a mature economy which, in a good year, grows 4 per cent.

As a consequence Hong Kong’s interest rates can be entirely inappropriate at particular stages of its economic cycle. In boom times, its interest rates can be set too low, further fuelling asset bubbles, and in times of crisis they can be too high, acting as a deadweight dragging the economy deeper into recession.

Cooling measures

The monetary authority believes that, to avert bubbles, central banks need to both move early and scale up measures over time. This is a view shared by Irish Central Bank governor

Patrick Honohan

, as is the belief that LTV caps reduce household leverage which, in turn, reduces mortgage default risk.

Critically however, the Hong Kong Monetary Authority does not believe LTV measures curtail property prices as they see “no clear evidence that tightening LTV caps dampens property prices”.

This stance is borne out when we look at the effect which successive rounds of cooling measures and LTV caps have had on Hong Kong’s property market in recent years.

In 2013, Barclays Capital published a report on the region’s property market. In it they analysed the impact of government measures on prices (see figure 1). They took 2009 as their starting point when the monetary authority first reduced LTV’s for luxury homes from an existing level of 70 per cent to 60 per cent. The market initially consolidated for 10 weeks and transaction volumes fell before prices started rising once more.

The government added a further nine measures and 12 initiatives to curb the market in April 2010, again transaction volumes fell – this time by 16 per cent and the market consolidated for six weeks before again moving higher.

The report went on to say that “with each subsequent measure, the effectiveness became progressively shorter such that even very punitive measures – like special stamp duty and buyer stamp duty introduced in October 2010 and November 2012 – failed to rein in prices”. In total, by 2013, some 27 measures and initiatives had been deployed and the market finally started to fall.

Most expensive home

At the time, there was a view that it was all starting to work but since then prices have moved higher again (see figure 2) despite further cooling measures including a reduction in LTVs for certain buyer categories to as low as 20 per cent. In fact, in 2014 Hong Kong advertised the world’s most expensive home with a price tag of €17,000 per square foot.

Clearly there are vast differences between Ireland and Hong Kong – no one expects to see 4,600sq ft homes selling here for €70 million any time soon. Ireland, as a small economy on the edge of Europe, contrasts with Hong Kong, the Manhattan of China, flooded with Chinese buyers and a burgeoning stock market boasting some of the world’s largest companies.

We do however share similar economic structures. Both countries are trading entrepots with low tax rates and free mobility of capital but, critically, in both economies, a larger external economic power determines interest rates and currency. In Ireland’s case, it is the ECB and in Hong Kong’s, it is the US Federal Reserve. So the choice to control the price and borrowing cost of money is simply not ours to make which can lead to distortions in inflation and asset prices.

What then are the lessons from Asia?

Firstly, LTV curbs alone won’t stem property prices. If anything, curbs could exacerbate Ireland’s property shortage. Unlike Hong Kong, Ireland’s crisis bankrupted all our leading developers and banks, creating a chronic undersupply of housing.

LTV measures will temporarily reduce transaction volumes which could in turn dissuade developers fearful of more tightening measures, further cutting supply (and creating an even greater supply/demand imbalance).

Secondly: if prices keep rising, we have been told measures will be scaled up progressively over time – creating dips which wealthy investors will see as opportunities to buy and making it more difficult for middle/lower income earners to buy homes.

Thirdly, it seems no matter how hard both the Hong Kong government and its monetary authority tried to cool their property market nothing has succeeded (excluding extraneous factors such as the Asian Crisis or the Global Financial Crisis). Why is this? Why have all cooling measures failed?

The reason lies in the “peg”. When Hong Kong linked itself to the US dollar in 1983, it surrendered all control over its monetary policy – just as we did when we joined the single currency. No longer could it raise interest rates or in other words the cost of money. So with an abundance of cheap money and rising inflation, asset prices soared.

If this is the case, then the biggest lesson for an open economy, with no independent monetary policy and free mobility of capital, is that there is little one can do to cool rising asset prices. All the more so if the ECB increases money supply through QE and maintains low interest rates over a sustained period of time.

Irish politicians say there’s no way they will allow a return to the days of booming prices. But prices are already booming. The past three years have seen Irish properties rising 50 per cent, equities 60 per cent and our economy is growing faster than any in the euro zone.

Now with the introduction of QE and an increasing number of negative yields in various asset classes across Europe, what will happen in our property market when banks start competing with each other for loans through price wars and mortgage rate cuts, or when foreign banks and interest-only loans return to the market?

Perhaps the most salutary lesson from the East is that whilst LTV caps have protected banks from property collapses, their impact on prices has only been transitory. So politicians shouldn't lull us into to a false sense of security because until the ECB tightens monetary policy, it will be difficult for anyone to control prices. Bill O'Rahilly is director, Ireland with Edison Investment Research and formerly head of markets at Citi, Ireland and has worked as an stockbroker specialising in the Asian market for 20 years. The views expressed are personal.