Hong Kong’s home mortgage market has remained among the world’s most stable. Supervisory authorities point to the 70 percent loan-to-value policy.Mortgage loans ; Housing - Prices ; Hong Kong

Jeffery W. Gunther

Sophia Tsai

Ying Guan

English

Research Papers in Economics

Insights from the 
FEDERAL RESERVE BANK OF DALLAS
EconomicLetter
VOL. 5,  NO. 6
JUNE 2010   
Hong Kong’s home 
mortgage market has 
remained among the 
world’s most stable.   
Supervisory authorities 
point to the 70 percent 
loan-to-value policy.
P
ledging their properties as collateral for home loans makes buy-
ers more creditworthy and allows them to obtain financing at 
better terms. This practice also leaves credit markets vulnerable to house 
price swings, which can affect loan quality and access to credit.
When real estate prices rise, they enhance collateral values, boost bor-
rowers’ repayment capacity and protect lenders from losses. But when real 
estate prices fall, the results are reversed, often leading to loan losses and, 
in severe cases, lender insolvencies.  
The scenario associated with falling real estate prices occurred recent-
ly in the U.S. and many other countries. Sinking home prices precipitated 
massive home-mortgage delinquencies and foreclosures, nearly collapsing 
the global financial system. This wasn’t the first boom-to-bust real estate 
cycle to cause financial ruin. Over the past several decades, souring real 
estate loans, both residential and commercial, have played a central role in 
numerous credit cycles around the globe.  
Given the frequency of these real estate crises—and the magnitude 
of the one just encountered—it may be time to ask whether real estate 
lending can be made less risky. Does a counterexample exist to the recent 
widespread susceptibility of mortgage markets to the boom-to-bust real 
estate cycle?
Hong Kong is one place with a remarkable degree of mortgage-market 
stability. Beginning in 1997, Hong Kong housing prices fell dramatically, 
declining more than U.S. prices did in the aftermath of the 2006–07 hous-
ing bust (Chart 1). Nevertheless, Hong Kong’s home mortgage market has 
remained among the world’s most stable. Supervisory authorities point to
a key feature of the Hong Kong credit system—the 70 percent loan-to-
value policy.
 
Cycle-Resistant Credit Systems: 
Learning from Hong Kong’s Experience
by Ying Guan, Jeffery W. Gunther and Sophia Tsai	 EconomicLetter	 FEDERAL RESERVE BANK OF DALLAS 2 	 FEDERAL RESERVE BANK OF DALLAS  EconomicLetter
The Credit Cycle
Real estate loans provide many 
benefits. Most important, they allow 
households to purchase homes and 
accumulate equity as they repay the 
borrowed money. However, this lend-
ing can also generate extreme credit 
cycles. The most disruptive financial 
crises—those that severely impair 
the banking system for an extended 
period—tend to involve loans backed 
by real estate. 
The energy-related banking cri-
sis of the late 1980s worsened when 
prices fell for many types of real estate 
collateral. New England’s banking trou-
bles of the early 1990s resulted from a 
boom-to-bust real estate cycle. So did 
Japan’s financial crisis of the 1990s, 
as well as episodes afflicting several 
other East Asian countries toward the 
end of the decade. More recently, the 
financial crisis enveloping much of the 
world for the past three years primarily 
reflected falling house prices and sour-
ing home mortgages.             
In all these cases, rising real estate 
prices lured droves of buyers wishing 
to capture some of the price increases. 
To fund their purchases, the buyers 
needed credit, and lenders, noting 
the appreciation in real estate prices, 
became increasingly accommodative. 
Lenders loosened credit standards, 
requiring lower and lower down pay-
ments on real estate purchases and 
offering repayment schemes that fea-
tured low monthly repayments early 
and higher ones later. 
By the time real estate prices 
peaked, many property owners were 
highly leveraged, owing as much, or 
nearly as much, as the market value of 
their properties. 
The booms then turned to busts 
as real estate prices fell. The owners, 
rather than building equity, became 
increasingly insolvent as the prices of 
their real estate fell further and further 
below their loan amounts. Worse yet, 
owners often faced increasing monthly 
payments on their loans as the peri-
ods of low initial monthly payments 
expired.
Absent safeguards, boom-to-bust 
credit cycles are likely to recur, with 
rising real estate prices once again 
luring buyers and lenders into over-
extended positions. Once so many 
highly leveraged positions are allowed 
to develop, the system’s vulnerability 
can’t easily be undone and the prob-
ability of a crisis keeps rising. The 
best hope for making real estate-based 
credit systems more resilient lies in 
preventive mechanisms to hold down 
highly leveraged speculation during 
booms. 
Loan-to-Value Policy
Firm to the mast with chains 
thyself be bound,
Nor trust thy virtue to the 
enchanting sound.
If, mad with transport, free-
dom thou demand,
Be every fetter strain’d, and 
added band to band.
—The Odyssey by Homer       
    (translation by A. Pope)
A longstanding policy goal has 
been to create a system of rewards 
and penalties that provides lenders and 
borrowers with incentives to secure, 
almost automatically, a degree of over-
all financial stability consistent with 
sustainable economic growth. Thus far, 
such an incentive-based system has 
remained out of reach.
An alternative approach would 
involve simply precluding, as a matter 
of policy, the extreme forms of risk 
taking that have proven most harmful. 
Such an alternative would supplement 
incentives with constraints—just as 
Odysseus had himself bound to the 
mast, knowing he would otherwise fall 
prey to the Sirens’ song.  
In essence, that’s the strategy 
the Hong Kong Monetary Authority 
(HKMA) uses in supervising its mort-
gage market. As an international finan-
cial center and one of the world’s 
freest economies, the Hong Kong 
Special Administrative Region experi-
ences notable fluctuations in business 
activity and housing demand. At the 
same time, the region ranks as one of 
the world’s most densely populated 
places, so the supply of land is limited. 
Because swings in housing 
demand aren’t easily accommodated 
by new construction, Hong Kong’s 
housing prices can be extremely cycli-
cal. In response, supervisory authori-
ties, together with the Hong Kong 
banking industry itself, have sought to 
cycle-proof the home mortgage mar-
ket, relying heavily on a loan-to-value 
policy.
The HKMA, with the general sup-
port of the banks it regulates, stipu-
lates that banks lend no more than 70 
percent of a home’s value. As long as 
the home’s price doesn’t fall more than 
30 percent, a loan remains fully collat-
eralized, minimizing risk to the bank.  
An exception is credit extended 
under the mortgage insurance pro-
gram of the government-owned Hong 
Kong Mortgage Corporation (HKMC). 
This program allows qualified buyers 
to obtain loans up to 95 percent of 
their home’s value. Even in this case, 
Chart 1
Hong Kong Housing 
Prices Fell Steeply
Peak = 100
30
40
50
60
70
80
90
100
24 22 20 18 16 14 12 10 8 6 4 2 0
Quarters after peak
United States (2006)
Hong Kong (1997)
SOURCES: S&P/Case-Shiller national home price 
index; private domestic units price index, Rating 
and Valuation Department, Government of the 
Hong Kong Special Administrative Region; authors’ 
calculations.	 EconomicLetter	 FEDERAL RESERVE BANK OF DALLAS 	 FEDERAL RESERVE BANK OF DALLAS  EconomicLetter 3
however, the lending bank is exposed 
to only 70 percent of the property 
value because the HKMC insures the 
remaining 25 percent. Moreover, the 
HKMC applies conservative and strictly 
enforced qualifying standards.  
In some cases, homebuyers can 
obtain cofinancing from developers 
and other sources outside the bank-
ing system, allowing them to borrow 
more than 70 percent of the sales 
price. They can also take out loans 
above 70 percent through a second 
mortgage program run through HKMC-
authorized banks.
As with mortgage insurance, such 
practices could partly erode the stabi-
lizing benefits of the loan-to-value pol-
icy by reducing buyers’ initial equity 
position. But the direct credit exposure 
of the Hong Kong banks is still mostly 
limited to 70 percent in the first lien. 
To be effective, Hong Kong’s 
loan-to-value policy requires careful 
calibration and vigilant supervision. 
For example, the HKMC must ensure 
that while promoting homeowner-
ship in Hong Kong, it also maintains 
prudent credit standards and eligibility 
criteria for its special programs. 
In addition, the various govern-
ment bodies face the task of confirm-
ing the accuracy of the real estate 
values used to construct loan-to-value 
numbers. Moreover, the HKMA must 
be mindful of any indirect channels 
through which bank exposure might 
rise above the 70 percent rule, such 
as bank loans to developers extending 
second mortgages.     
Under Hong Kong’s strict policy, 
average loan to value has remained 
comfortably below 70 percent. By 
contrast, significantly higher credit 
amounts were granted to U.S. home-
buyers during the recent housing 
boom—even buyers known to pose 
the highest credit risk. At the peak in 
2005–07, at least half of U.S. subprime 
mortgage originations on new pur-
chases had a cumulative loan to value 
of 100 percent or more (Chart 2).  
Even with a loan-to-value rule 
of 70 percent, an extreme housing 
downturn like the one that began 
in 1997 can still leave homeowners 
owing more than their houses are 
worth. Despite widespread restruc-
turings, roughly 25 percent of Hong 
Kong’s residential loans were under-
water by the time the 1997 downturn 
had run its course—a calculation 
based on conservative estimates.
But the number would have been 
much higher if not for the conservative 
loan-to-value rules applied at origi-
nation. Once housing prices turned 
around, the share of underwater 
homeowners quickly subsided, under-
scoring the resilience of Hong Kong’s 
home mortgage market.
Credit System Stability
The U.S. home mortgage delin-
quency rate has climbed to nearly 
10 percent. In contrast, Hong Kong’s 
mortgage delinquency rate never rose 
above 2 percent—at least according to 
survey data from the HKMA, first avail-
able in mid-1998 (Chart 3).
Besides high homeowner equity, 
several economic and institutional 
influences have helped Hong Kong 
achieve this stability, including sub-
stantial lender recourse in the event of 
default and a general tendency toward 
financial conservatism. However, Hong 
Kong supervisory authorities attribute 
special significance to their 70 percent 
loan-to-value policy, instituted in 1991.   
In assessing how Hong Kong’s 
banking system managed to avoid the 
global financial crisis, the region’s chief 
bank regulator had this to say:
   “We also seem to have achieved 
a good balance in the relationship 
between the supervisor and the bank-
ing system. An excellent example of 
how that balance has contributed to 
banking stability is the 70 percent  
loan-to-value policy for residential 
mortgage lending by banks. This 
policy … has survived strong politi-
cal pressure for relaxation and market 
pressure for innovative credit risk 
transfer through securitization. The 
Chart 2
Loan-to-Value Ratios Low in Hong Kong
Percent
0
20
40
60
80
100
U.S. subprime
median (purchase)
2007 2006 2005 2004 2003
Hong Kong average
(purchase and reﬁnance)
U.S. subprime
median (reﬁnance)
NOTES: U.S. data are combined loan to values including both first and second mortgages. Hong Kong data exclude second 
mortgages provided by developers or other colenders. Currently, less than 10 percent of Hong Kong first mortgages, by 
value, are known to be coupled with a cofinancing plan.
SOURCES: “The Rise in Mortgage Defaults,” by Christopher Mayer, Karen Pence and Shane M. Sherlund, Journal of 
Economic Perspectives, vol. 23, no. 1, Winter 2009, pp. 27–50; Residential Mortgage Survey, Hong Kong Monetary 
Authority; authors’ calculations.EconomicLetter  is  published  by  the 
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policy—now nearly two decades old—
fits in well with the macroprudential 
approach which, particularly in the 
light of the recent crisis, supervisors in 
other jurisdictions now consider to be 
essential to banking stability.”1
Hong Kong isn’t the only region 
to institute a conservative loan-to-value 
policy. For example, Canada has been 
successful with its version. Prior to 
the global financial crisis, federal law 
required mortgage insurance for home 
mortgages with a loan to value above 
75 percent, with eligibility criteria that 
were highly regulated and conserva-
tive. Correspondingly, Canada has so 
far avoided this housing bust, though 
relaxation of these rules in recent years 
could lead to less resiliency.   
Given that a conservative loan-to-
value policy has played a positive role 
in other countries, such a policy might 
prove beneficial in the U.S. However, 
several obstacles could stand in the 
way.  
Some might see a loan-to-value 
rule as contrary to the longstanding 
policy goal of increased homeowner-
ship because it makes qualifying for 
a loan more difficult. However, to the 
extent increased homeownership is a 
goal, alternative approaches could be 
explored that don’t involve the aggres-
sive lending strategies that put the 
financial system at risk.  
Others might view a loan-to-value 
rule as the government becoming 
overly intrusive. Because credit system 
malfunctioning can greatly disrupt the 
broader economy, however, some 
form of regulatory intervention to 
prevent excessive risk taking is pru-
dent. Focusing on the reasonableness 
of loan underwriting seems like an 
appropriate task for supervisors. 
Guan is a financial industry analyst and Gunther 
a vice president in the Financial Industry Studies 
Department of the Federal Reserve Bank of Dallas. 
Tsai is a student at Stanford University and was a 
summer intern in the department.
              
Note
1 Speech by Joseph Yam, chief executive of the 
Hong Kong Monetary Authority, at the joint Hong 
Kong Association of Banks–Hong Kong Institute 
of Bankers dinner in honor of his retirement from 
the post, Hong Kong, Sept. 28, 2009.                               
Chart 3
Mortgage Delinquencies Stay Below 2 Percent
in Hong Kong
Percent
0
2
4
6
8
10
Q3
2009
Q3
2008
Q3
2007
Q3
2006
Q3
2005
Q3
2004
Q3
2003
Q3
2002
Q3
2001
Q3
2000
Q3
1999
Q3
1998
Hong Kong
United States
SOURCES: Serious delinquency rate: National Delinquency Survey, Mortgage Bankers Association; delinquency ratio: 
Residential Mortgage Survey, Hong Kong Monetary Authority; authors’ calculations.

Cycle-resistant credit systems: learning from Hong Kong’s experience

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Cycle-resistant credit systems: learning from Hong Kong’s experience

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