S Korea's bet on expected income

SEOUL - In economics, an expected value theory was once used as a rule of choice. The rule said that if people face a gamble in which the probability of getting 100 won is 1 in 4 and the alternative gets nothing, they would choose the 100 won-or-nothing gamble rather than a guaranteed 20 won as the expected value of this gamble is 25 won.

The currently-accepted expected utility hypothesis added preferences for risk to the expected value criterion. Risk-lovers would opt for the 100 won-or-nothing gamble due to their strong appetite for risk, but risk-averters will not join the gamble as they prefer the guaranteed cash to the risky outcome. People get different utilities from the same expected value.

South Korea's financial regulator made a risk-loving choice by betting on the expected income of younger wage earners. Financial Services Commission (FSC) Friday eased a rule on mortgage loans to home buyers under the age of 40 without home ownership.

Under the eased regulation, the debt-to-income (DTI) ratio ceiling for younger wage earners will be raised to a different extent according to the expected income over the next 10 years. For example, a 35-year-old wage earner with a monthly income of 3 million won ($2,643) can borrow up to 224 million won in mortgage loan under the current rule, but the eased rule will increase the limit to 260 million won on the assumption that his or her future income will grow 31.8 percent over the next 10 years. The eased rule will apply the expected yearly income of 41.72 million won instead of the current 36 million won of yearly income when calculating the DTI ratio.

FSC Chairman Kim Seok-dong had reiterated that the DTI ratio would not be lifted to boost the real estate market, stressing that the regulation was introduced to enhance the financial soundness of lenders. Regarding this, FSC director general Koh Seung-beom told foreign correspondents late last month that there were irrational parts in the rule, saying there would be no change in the basic framework.

Despite his denial, there must be a change in the FSC's policy direction as seen in the eased DTI ratio. The change came as concerns deepened over the country's slumping property market. Residential property trading volume in Seoul and surrounding areas dropped 38 percent for the first four months of this year compared with the same period of last year, while housing prices in Seoul and near cities fell 0.9 percent and 1.1 percent each in the first half.

Bank of Korea (BOK) cut its key policy rate on July 12 for the first time in more than three years, helping the government's efforts to stimulate the sluggish real estate market. The nation's anti-trust watchdog recently launched a probe into deposit certificate-rigging, leading to a fall in the benchmark rate for banks' lending.

Along with these actions, the eased rule by the financial regulator may help reinvigorate the flagging property market to some extent, but it will not be a big booster as the FSC failed to consider the preference for risk in the real estate market.

Risk lovers almost disappeared in the local property market amid weakening expectation for future home prices and the continued fall in the proportion of real estate against asset portfolios of the wealthy. An expected income that the FSC adopted to ease the rule is an expected value, a function of probability and value that do not factor in the preference for risk.

"Eased rule on the DTI ratio may not have a big impact compared with the past given the weakened expectation for home prices, the persistent reduction of real estate in asset portfolio of the wealthy and the delayed action by the government," Lee Kyung-ja, an analyst at Korea Investment & Securities in Seoul, said in a report.