Scraping the Bottom

Hong Kong prides itself on being a bastion of laissez-faire commerce. But one of the pillars of the local economy—the real estate market—has long been a rigged game. The government, which owns most of the land, regulates the supply of commercial building lots through land auctions and also produces subsidized housing for the masses.

Not surprisingly, policy planners have a spotty track record when it comes to matching supply with demand. In the 1990s, strict government controls fed a speculative price bubble that made Hong Kong one of the world's most expensive real estate markets. When the bubble burst in 1997 during Asia's financial crisis, a deflationary spiral ensued, knocking prices down by some 60% and destroying much of the wealth of property owners and commercial developers.

With thousands of restive homeowners owing more on their mortgages than their property is worth and with no relief in sight, the government has decided on drastic action. Last week, Hong Kong's secretary for Housing, Planning and Lands, Michael Suen, laid out a new policy aimed at "restoring the public's confidence in the property market." Interestingly, the government has decided the best way to do that is to take itself out of the game, at least temporarily. Construction of state-subsidized apartments, except those for low-income families, will be suspended indefinitely starting next January and government land auctions will be frozen through the end of 2003.

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Indeed, prices keep sliding not simply because supply is out of whack with demand; Hong Kong has lost some of its global competitiveness. In its glory days, the city was the undisputed gateway to China, making it an attractive headquarters location for corporations, a boon to office rents. But with China's ongoing opening to the world, some of that allure has been lost to Shanghai and other Mainland cities. Analysts argue prices became so overheated during the bubble that the decline is actually healthy for the city—and the government should leave well enough alone. "Get the pain out of the way and let the market find the natural level," says Nicholas Brooke of Insignia Brooke property consultants. He estimates prices could drop by another 5-10%, absent outside interference. Brooke points to a similar, and ineffective, halt to government land sales in 1998 as evidence that the new policy is misguided. Indeed, past attempts to micro-manage the market seem to have done more harm than good. In 1997, Hong Kong Chief Executive Tung Chee-hwa embarked on a 10-year plan designed to increase home ownership in Hong Kong. But the subsidized housing scheme ran straight into the teeth of an economic recession, causing home prices to fall more steeply.

Suen, the secretary for housing, justifies the policy on the grounds that a revitalized property market is necessary for a broader recovery. His most vocal supporters are, naturally enough, large developers. They stand to gain the most in the short term, since the reduction in land supply will raise prices of new developments they build—and could help shore up their flagging stock prices on the Hong Kong bourse.

But the move could be costly in the long run. Land sales are a prime source of government revenue, and a reduction in proceeds stemming from the auction freeze will aggravate the city's budget deficit. Last year's shortfall was more than $8 billion, or 5% of GDP, and this year's is expected to be even greater. Hong Kong's $113 billion in currency reserves are not in any immediate danger of running out, but a chronic deficit could undermine the government's perceived financial stability. There is speculation that corporate taxes could be increased or a sales tax instituted to compensate for the auction freeze—further damaging Hong Kong's reputation as a haven for business. Still, with its future on the line, it may be time for the government to get out of the real estate business for good.