(Recast) News Analysis: S.Korea's three rate cuts, starting point of bubble collapse?

"Long-term low growth" is sometimes used by local news organizations to explain the South Korean economy. It has become a jargon characterizing the economy, which the Bank of Korea (BOK) bears most of the burden to stimulate with record-low interest rates.

The BOK kept its benchmark interest rate on hold at 1.75 percent Friday, after lowering it to the all-time low level in March. The bank cut it by a quarter percentage point in August and October 2014 to 2 percent, a rate equal to the bottom touched at the height of the 2008 global financial crisis.

The three rate cuts in the past 10 months were made to prop up the "eroded" confidence of consumers and firms. BOK Governor Lee Ju-yeol said during a press conference after the May policy meeting that the bank factored in a better consumer confidence as one of three major factors that resulted in the rate freeze.

Another factor was a rapid growth of household debts, which may drive the economy into the danger of housing bubble collapse. " Household debts are manageable now, but the recent pace of growth is very fast," Governor Lee said.

Household debts by banks reached 579.1 trillion won (530 billion U.S. dollars) as of end-April, up 8.5 trillion won from a month earlier. It marked the largest monthly increase in history. Mortgage loans jumped 8 trillion won last month, hinting that record-low interest rates and eased regulations on mortgages would bloat asset markets.

There are few people now in South Korea, who believe in the kind of "myth" that housing prices do never decline. Such belief led to a housing market boom in the 1980s and 90s, which had never collapsed thanks to fast growth of the South Korean economy.

Now, the economy is widely believed to have fallen into the trend of "long-term low growth," like the global trend of "new normal." The BOK said that the economic growth would stay below the potential, estimated at the mid-3 percent, for an extended period of time, indicating the "record-low" interest rate on hold over the "long-term."

One BOK policymaker opposed to the rate freeze in May and favored an additional rate cut for two months in a row, bolstering expectations among some of market watchers for further monetary easing in coming months.

In normal times, the greater availability of credit at record- low interest rates can lead households to consume and companies to invest, boosting aggregate demand and lowering unemployment.

The aggregate demand refers to total demand in an economy for goods and services from consumers, companies, government and exporters. The central bank cannot control demand from government and exporters.

Weak demand in South Korea from consumers was caused by structural factors, including low pay, high residence costs, aging population and massive household debts.

Amidst higher growth of mortgages, the ratio of household debts to disposable income gained to 166 percent in 2014 from 161 percent in 2013. A 6.6 percent increase in household debts in 2014 doubled the 3.3 percent gain of household income.

The rate of Jeonse deposit to home value surpassed 70 percent in February this year, which raised residence costs, as potential home buyers refrained from purchasing home on concerns over housing price falls. It reflected rising demand for Jeonse in contrast to its deficiency in supply.

Jeonse is South Korea's unique home lease contract between two households where a landlord grants the right of residence for two years to a tenant, who in turn lend a certain amount of money, or deposit, to the landlord. The Jeonse deposits, the de-facto mortgages for homeowners not included in official statistics, were estimated at 370 trillion won (340 billion U.S. dollars) in 2014, according to data by Nomura International. It indicates greater debts owed by households than the official figure.

The middle-aged and elderly delayed consumption to prepare for a post-retirement life amid the rapid population aging, and many companies are being criticized for paying college graduates a very small amount of salary in the name of "passion pay" to exploit youths who are suffering from landing jobs. The youth jobless rate among those aged 15-29 topped 10 percent in April. One out of two college students failed to find a job after graduation.

The BOK chief said the three rate cuts had positive effects on real estate and equity markets, but he noted that it had yet to lead to the effect stimulating the real economy such as private consumption and corporate investment.

Those structural factors cannot be tackled by the BOK, but politics placed most of the burden of stimulating weak demand on the central bank. The rate cut is an easier way of boosting the economy, but only temporarily, than progressive taxation targeted at the rich and a hike in corporate tax rate, which was lowered under the 2007-2012 Lee Myung-bak administration. South Korea's shortage in tax revenue relative to fiscal budget hit a record high in 2014, according to the Finance Ministry.

Under the current conditions, the greater availability of credit at record-low interest rates could result in housing bubble collapse instead of stronger aggregate demand. The bubble can be identified when considering the fragile debt-servicing capability among households shown in the relief loan program results.

In late March, the financial regulator released the "relief loan program" that allowed households with floating-rate mortgages to refinance their loans with fixed-rate ones at a lower rate of about 2.6 percent than 3.4 percent for variable-rate loans in the fourth quarter of 2014.

The regulator set a ceiling for the loans at 40 trillion won, but 345,000 households with a combined mortgage of 33.9 trillion won applied for this program. Despite the opportunity to reduce borrowing costs by a whopping 0.8 percentage point, many gave up the chance as the program required applicants to pay both principal and interest.

The results indicated a higher proportion of borrowers incapable of repaying principal. The prolonged record-low interest rates may delay the detonation or expand the size of a time bomb in the mortgage and housing markets.

South Korea has the world's highest percentage of interest-only mortgages, which requires interest payment alone. The rate of these loans was 74 percent in 2014, lower than 92 percent in 2011 but much higher than 14 percent in the United States, 33 percent in Australia and 55 percent in Netherlands. Endi