Floating Rate Mortgage in Hong Kong Is Setting Up a U.S. Style Housing Market Crash

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I don’t know how many of you were in the US during 2003 when Greenspan lowered the Fed funds rate to a historically low 1%. I recall distinctly seeing mortgages offered that were linked to 1 month Libor and reset monthly. The then-current mortgage rate was of course obscenely low. However, I also remember that this kind of mortgage was mostly offered to the financially savvy few, instead of the mass market. In the US, a majority of the mortgages were still in fixed rate, despite a substantial increase in adjustable rate mortgages (ARM). The ensuing events in the US housing market of course need no explanation here.

Fast forward to Hong Kong today, because the HKD is pegged to the USD, the overnight HIBOR rate is, like Libor, effectively 0 now. Mortgages that are offered in floating rate form, typically HIBOR + 0.8% to 1.5%, will in lowest case, have less than 1% mortgage rate. The reset however is 3M, 6M, or 12M HIBOR. But guess what, there is no fixed rate mortgage in Hong Kong, everything is floating, with the longest reset period being 1 year.

Hong Kong has seen a strong recovery in the property market, especially in the high end luxury sector. But even more convincing than statistics, it is the return of the frenzy that is visible everywhere. The long winding lines at new apartment building openings, the real estate agents who would risk their lives by throwing themselves in front of your moving vehicle in order to pass you their brochures and biz cards, the everyday bombarding newspaper headlines about another new sales price record… What is behind all this? The record low mortgage rate.

I'll give you a simple example. HK’s luxury apartment rental yield is about 3-4% (thanks to the tax dodging Australian expats who live on obscene housing allowances). A 1% mortgage rate can make a person suddenly feel like he is 3-4 times richer than before as he can suddenly own a property that was in the past 3-4 times outside his budget. It's not hard to imagine that most of these people are local HK residents. Much of the current property run-up is from so called move-up buyers who now want to live in bigger and fancier apartments.

Of course, one cannot forget the Hong Kong banks for bombarding the mass market every day with headlines and promotions of the low mortgage rate. If you live in HK and read Chinese, then every day in local newspapers you can find large ad space devoted to the promotion of the latest low mortgage rate. The competition between banks on offering low rate mortgages is fierce. It's not entirely an accident that most of these banks are the local and regional banks, such as HSBC (HBC), Standard Charter, Hang Seng, and the HK branches of the mammoth Chinese banks. I found it even more unbelievable that banks promote their mortgage plans by offering calculations on their websites, which use the 1% mortgage rate to calculate the 30% service/income ratio.

Recipe for disaster is complete. The result can be much more dramatic than that seen in US since the entire HK housing market is built on this type of short reset mortgage as opposed to 20-30% in US.

(If you wonder what happened to HK during 2003 while rates were historically low at that time, and if all of this has happened in the past, well, HK was in the thick of SARS in late 2003. And it was like today's swine flu. People were dying, I mean really dying, entire families got wiped out. The first priority of Hong Kong at the time was not their beloved pastime of betting on property, stocks or horses, or getting the best financing from banks. It was life or death.)

Disclosure: no position