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The HKMA’s counter-cyclical prudential measures and financial stability


The age of a “blazing hot” property market in the 1990s: a time almost too painful to recall

"On the final day to register for subscription for flats in Carmen’s Garden in Tsim Sha Tsui, more than a thousand potential buyers fought to grab this last chance.  The over-subscription rate was 186 times, setting a new record.   The demand for subscription tickets was so great the asking price was as high as HK$2 million, while the number three ticket was sold for a record high of HK$2.3 million."  This was the newspaper front page story in January 1997.

Several months later, around March, I was lunching in a restaurant in Central when my attention was drawn to a group of five diners who were talking loudly at the next table. They might work in the real estate related sector and were obviously enjoying a few bottles of expensive wine, when one of them unexpectedly snapped, “The developer of the new property promised to reserve me five flats, but in the end he only gave me three. As a result, I earned $1 million less!”  He continued to curse loudly while his colleagues tried to calm him down by reminding him, “There’s no need to be so angry, you are $500,000 richer every morning when you wake up.  Isn’t that pretty good already?”

These stories were almost commonplace in 1997, just before the property bubble burst and many people may still recall them.  My memory will always be the painful adjustments in Hong Kong’s economy and property market in over six years following the bursting of the property bubble alongside the onset of the Asian financial crisis.

I was certainly not exaggerating about the adjustments being “painful”.  Property prices fell around 50% in the 12 months from the peak in the third quarter of 1997, and then continued to register annual decreases, resulting in a cumulative drop of almost 70% from peak to trough.  Many properties were left in negative equity with property owners getting stuck with “underwater” mortgages.  Personal bankruptcies soared.  Domestic demand and investment were hard hit by the negative wealth effect associated with the sharp property downturn.  Indeed, the chain reaction triggered by the property market clearly shows that it is either the most important driver of the economy or an economic drag.  The unemployment rate increased from 2.1% (or full employment) in 1997 to 8.5% in 2003.  GDP contracted by 8.9% from the fourth quarter of 1997 to the fourth quarter of 1998.  An even more damaging phenomenon was that Hong Kong experienced serious deflation amid the sluggish domestic demand and difficult economic environment.  The CPI fell by 16.4% during the period from July 1998 to July 2003.  The companies that managed to survive in such adverse conditions had to lay off staff and cut salaries, while the Government recorded huge budget deficits, and was forced to pass legislation imposing a pay cut on the Civil Service to reduce expenditure.  These painful memories may not resonate with the younger generation today, and even those who were there at the time may not want to recall them too clearly, lest they be reminded of the hardships they endured.

Hong Kong people should be familiar with the ups and downs of the property market.  However, too often our memories are short-lived. Whenever the market is buoyant we tend to believe it is supported by strong fundamentals and the upward trend would continue, thus we consciously choose to ignore the warning signs even when property prices surge to unaffordable levels.  For example, during the market boom prior to 1997, buyers who invested everything they had into the property market insisted prices would not fall.  Their rationale: Hong Kong was densely populated with inadequate land and housing supply; there would not be any shocks with the approaching transfer of sovereignty over Hong Kong; emigrated residents were returning thus showing their confidence in the future; Mainland China was continuing its reforms and opening up policies, leading to rapid economic growth, with more and more Mainlanders willing and able to buy property in Hong Kong for their own use or for investment.  Ironically, while there was nothing wrong with their rationale, the property market still experienced a severe six-year downturn.

But we were not alone in this predicament. Although the timing was some years apart, a similar situation occurred in the US which experienced a major property bubble between 2000 and 2006 when property prices in 20 major cities nearly doubled unprecedentedly.  At the time, most Americans thought there was nothing to worry about in the belief that they were “different”, and that the surge in housing prices was due to population growth, a buoyant economy and continuing increases in household income.  Yet, the US property bubble burst in 2007, leading to the global financial crisis.  Several years have passed, but the US is still struggling with the consequences of an overheated and out-of-control property market and the bursting of the bubble.

The Root Cause – Over-leveraging

It therefore comes as no surprise that highly volatile housing prices invariably, and significantly, hurt the economy and people’s livelihood. So, what should we do to tackle the cyclical nature of the property market?  Crucially, the root cause needs to be addressed. That means adjusting the supply of land and housing to meet the demand arising from demographic changes as well as industrial and commercial developments.  This can only be possible if we build up a land bank of adequate size. Especially for Hong Kong, one of the most densely populated places on the planet, efforts should be devoted to expanding land resources.  However, exuberance in the market coupled with “irrational herd behaviour” can create a distraction.  Because of the long lead time from land formation to completion of property developments, a severe supply-demand mismatch can result in the near term, pushing property prices even higher and creating a property bubble. This becomes clearer if we look at Ireland’s example. Although Ireland has a much larger land area (69,000 square kilometres) and a relatively small population (around 4.6 million), a giant housing bubble was formed in recent years, leading to a banking crisis after the bubble burst.

But some may ask, what’s new? Indeed, over the past three to four centuries, major financial crises have occurred – some were mainly triggered by the property market, while others were associated with the equity market or some strange commodities – for example, the Dutch tulip bulb bubble in 1637 and the South Sea Company collapse in England in 1720.  While the main causes of these crises may differ, they had something in common – the investors or speculators were highly leveraged.  This is driven by human greed and the pursuit of maximum possible profit.  This familiar episode often ended with bursting of bubble which inflicted heavy losses on the speculators and those who financed the speculative activities, leaving many families in misery.

It’s true to say that conditions in Hong Kong’s property market during the 1990s were no different.  Most people borrowed heavily whether they bought homes for their own use, for investment or for speculative purposes.  Banks had been granting residential mortgages with a loan-to-value (LTV) ratio of not more than 70% since the early 1990s.  Even with property prices continuing to rise, this ratio remained in place, thus enabling existing homeowners to refinance their mortgages for further investment in the property market.  In addition, to encourage sales, many property developers would offer top-up mortgages of up to 20% of the purchase price to buyers.  In other words, homebuyers only had to pay a 10% down payment to get a loan for the remaining 90% of the property price.  The gearing ratio was nine times and the return on capital would reach 100% even if property prices only rose by 10%.  Taking advantage of this lucrative prospect, buyers who did not own a home rushed to purchase one, while those who did repeatedly refinanced their existing mortgages through banks or finance companies to pay for the down payment on even more properties.

As in every previous financial crisis, the main factor fuelling the asset bubble was leverage, and the source of leverage was credit.  In Hong Kong’s case, credit mainly comes from banks.  During the upward cycle of the property market in the 1990s, although banks in principle adhered to the 70% LTV limit, they tended to be lax towards property valuation.  As a result, the actual LTV ratio of mortgages very often exceeded 70%.  But this was not the biggest problem: the lack of a credit reference agency that would allow banks to share the credit information of borrowers caused the property market to rise further.  Speculators took advantage of this defect in the system and applied for mortgages from different banks, claiming they did not have any other properties or outstanding mortgages.  There was no way banks could verify this information even if they wanted to do so.  As the euphoric property market sentiment continued, most banks were eager to do more business in order to maintain their market share.

And the upward spiral continued to feed on itself. The more mortgage loans secured from banks, the higher the level of leverage and the more heated the property market became.  As property prices climbed still higher, more and more refinanced funds were invested back into the property market, aggravating the property bubble.  And we all know what comes next – the bigger the bubble, the greater the damage when it bursts.  Hong Kong people experienced first-hand the scale of such devastation in the six years that followed the third quarter of 1997.  The number of residential mortgages in negative equity, or, as many would agree, the “index of pain”, peaked at 105,000 in June 2003.  But still, this did not completely reflect the actual situation as only mortgages offered by banks were included (and most of these were first mortgages or refinanced mortgages with LTV ratios not exceeding 70%).  The figure would have been much worse if top-up mortgages extended by developers or finance companies had been included.

Déjà vu: How should Hong Kong position itself?

By the second quarter of 1997, property prices had risen beyond the means of genuine homebuyers and were totally disproportionate to Hong Kong’s economic fundamentals.  However, Hong Kong people still believed the buoyant market was the fruit of their hard work and would continue. But, as we all know now, a crisis was looming, waiting for the right moment to strike. And, as with typical asset bubbles which burst at the least expected and least convenient time, the property bubble in Hong Kong was pricked alongside the onset of the Asian Financial Crisis in July 1997.  At first we thought we were different from other Asian economies, that we could be shielded from the fallout given our macroeconomic strengths and robust financial system.  But, as the bubble burst, the local economy plummeted, putting great stress on the financial system and capital outflows.  Hong Kong also became a target of speculative attacks by international finance market predators looking for big gains from exchange rate and stock market swings.  If it had not been for an unprecedented stock market operation launched by the HKSAR Government and HKMA in August 1998 and changes in the global market environment, Hong Kong may well have fallen to the operations of the predators.

In the 1990s, the rapid expansion of mortgages by banks was adding fuel to the fire amid a blazing property market.  However, following the property market crash and the concomitant economic downturn, the banks, in an about-face, sought to suppress property lending and other credit, which only added to the economic woes.  This pattern was obviously “pro-cyclical”, and tended to exacerbate the swings in asset prices and movements in economic cycles and posed a threat to financial and economic stability.  Learning from past experience, I have come to the conclusion that to minimise the damage triggered by the bursting of asset bubbles (mainly property bubbles in Hong Kong’s case), we must focus on the level of leverage.  This calls for a “counter-cyclical” approach to contain the supply of banking credit as soon as we see a potential bubble in the making.

As the term suggests, “counter-cyclical prudential measures” involve putting in place specifically tailored supervisory measures to regulate the availability of mortgage credit having regard to the evolving cycle of the property market.  Simply put, it means tightening mortgage supply during the upward cycle and relaxing it in a downward cycle.  There are a few key points to note:

(i) Changes in the property market are cyclical in nature.  This we must understand and accept.  As indisputable as this simple rule may seem, it is easily forgotten when homebuyers become overly excited every time property prices shoot up.  They convince themselves and those around them with dubious theories and the illusion that the only way for the market is up.

(ii) The purpose of introducing counter-cyclical measures is only to reduce the speed and magnitude of increases in the upward cycle of the property market.  They do not and cannot destroy the cycle per se, unless ultra-drastic measures, such as a complete ban on mortgage lending, are used.  On the other hand, if prolonged inaction has allowed the upward trend to develop unchecked, reaching new peaks and about to drop, any tightening introduced at that stage might only be as effective as shutting the stable door after the horse has bolted and exacerbate the momentum of the fall.

(iii) Based on the rationale in (ii) above, the HKMA is mindful that counter-cyclical measures should be introduced in the earlier stages of the upward cycle, with subsequent fine-tuning of the magnitude of the tightening in line with the actual changes in the market.  In October 2009, when I took office as the Chief Executive of the HKMA, Hong Kong was facing a shortage of housing supply and the quantitative easing by the US that had resulted in local negative real interest rates and massive fund inflows into the Hong Kong dollar.  Envisaging an obviously rising risk of the property market overheating, I decided the time was right to act.  On 23 October 2009, the first round of counter-cyclical supervisory measures was introduced to lower the LTV ratio for mortgage lending.  Due to the myriad factors affecting the property market and the highly complicated interaction between them, it is not possible to predict the number of rounds of measures required or the duration of the upward cycle.  Nevertheless, we will continue to monitor the developments of the cycle and adjust the measures as and when required.

(iv) Once the property market’s downward cycle can be confirmed, the supervisory measures introduced earlier can be relaxed as appropriate.  But here again, we must not forget the complex and changing dynamics of the myriad factors at play.  There is no way we can foresee the start of the downward cycle nor its speed or magnitude. Nor can we be certain whether any fall is only a brief respite or indeed a market turn. Therefore, we will closely monitor market developments and deploy appropriate measures to adjust the supply of mortgage credit by banks.


The concept of counter-cyclical prudential measures is not a complicated one, although it’s quite another matter when put into practice.  From a political economy perspective, taking action to cool the market when everyone is having fun has been likened to spoiling the party by taking away the punch bowl, or, as a local saying goes, “frustrating one’s plans to get rich”.   In addition, with homeownership a major aspiration of Hong Kong people, counter-cyclical measures risk upsetting the plans of many households.  The HKMA is always mindful of this aspiration, especially the needs of first-time homebuyers, when we devise our counter-cyclical measures.  After six rounds of tightening so far, buyers can still borrow bank loans at a maximum 70% LTV ratio for properties worth $6 million or less (including the so-called “starter homes”).  Eligible buyers can even borrow as much as 90% of a property’s value by taking out mortgage insurance at the Hong Kong Mortgage Corporation.

Having said this, counter-cyclical measures invariably affect property buyers – whether for self-use, investment or speculative purpose – and banks.   However, the HKMA’s task is to maintain Hong Kong’s banking and financial stability and the introduction of counter-cyclical measures is the result of us heeding the painful lessons from previous property boom-and-bust episodes.  Our goal is to reduce homebuyers’ ability to borrow, minimise banks’ risk and reduce the leveraging of the financial system as a whole during the property market’s upward cycle.  And, the latest figures speak for the effectiveness of these measures.  The average LTV ratio of new residential mortgage loans dropped by 9 percentage points to around 55% in recent months as compared with 64% in September 2009 before the first round of the measures was introduced.  The debt servicing ratio also fell six percentage points to 35% in recent months from 41% when it was tightened in August 2010.  The annualised growth in outstanding residential mortgage loans by banks dropped to 4.2% since the second quarter of 2013, compared with 8.7% since 2010.  These figures show the growth in mortgage loans has been brought under control, especially since the introduction of positive mortgage data sharing in 2011, which plugged previous loopholes for concealing outstanding mortgages to secure more bank loans for speculative purposes.  Overall, the resilience of homebuyers and banks to face any downward trend in the days ahead has been greatly enhanced.

This leads me to ask the questions on the minds of many people: Has Hong Kong’s property market entered a downward cycle?  How long will the downward cycle last?  What will be the magnitude of any property price correction?  All these are subject to huge uncertainties.  As I said earlier, a confluence of complicated factors are affecting the property market.  In addition to housing and land supply, local interest rates are directly affected by the pace and magnitude of the interest rate normalisation process in the US, which in turn can influence the future path of the local property market.  However, the real challenge for Hong Kong lies not in the magnitude of our property correction, rather it lies on whether we can hold our position in the face of shocks from any correction in the property market and the economy, and whether we can quickly pick ourselves up, regain our strength, and avail ourselves of the new opportunities that lie ahead.


Norman T.L. Chan
Chief Executive
Hong Kong Monetary Authority
14 July 2014

Last revision date: 14 July 2014
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