The Hong Kong Monetary Authority (HKMA) reacted swiftly to the Federal Reserve's third phase of quantitative easing (QE3) by immediately tightening mortgage lending. Some people think that this is just a gesture to show the government's determination in curbing home prices. However, the timing of HKMA's action seems to have another reason.

The main function and responsibility of HKMA is to supervise banks and maintain the stability of the finance system. Mortgage loans account for a large portion of bank lending and a very significant part of their balance sheets. Even a slight fluctuation in home prices may lead to significant changes in the asset side of lenders' financial statements, thus eventually affect the institutions' stability. QE 3 signals the influx of more liquidity into the market, a fairly large part of which are expected to flow to global markets as hot money, based on the experience of the previous two quantitative easing.

As hot money is flowing into emerging markets, seeking for opportunities to speculate, both the financial and property markets are facing some uncertainty, with the latter being the most vulnerable to a bubble risk. The Fed has declared its intention to keep interest rates at an extremely low level until 2015, a move that will add upward pressure on Hong Kong's property prices due to the dollar peg. The higher the home prices, the more vulnerable the banks are when home prices correct. In view of this, the HKMA swiftly adopted the precautionary measure to help maintain banks' stability while helping to curb home prices from soaring.

The government has stepped up land sales two years ago to ease tight supply which is the main reason behind surging home prices. But the new homes's supply won't increase significantly until 2015 or 2016 because of the time lag.

With little room to maneuver in the supply side in the short term, the government had had to turn its attention to demand management. There are three types of flat buyers in Hong Kong: occupiers, investors and speculators. The government has already implemented the Special Stamp Duty (SSD) to contain speculative activities, and it did have some effect. As rents have been rising in recent years, the investment demand for houses cannot be ignored. Low interest rates make the rental business more attractive. Though the SSD may constrain speculation, if buyers purchase flats and rent them out for two years before re-selling them, they can easily avoid the SSD.

The HKMA's new measures mainly target property investors. Mortgage applicants will face restrictions if they have an unsettled mortgage loan. If the new measures can help successfully control investment demand while the SSD help reduce speculative activities in the Hong Kong property market, then we can see how big the fundamental demand for homes is.

The author is associate professor at Department of Finance & Decision Sciences of Hong Kong Baptist University. The views expressed here are entirely his own.

(HK Edition 09/21/2012 page2)