There are good reasons for Hong Kong to feel confident about the stability of its financial system with the linked exchange rate mechanism backed by a prudent fiscal policy and more than ample reserves.

But financial stability can be disrupted by upheavals in the capital market and wide swings in asset values. The latest meltdown that wiped out the values of many stocks listed in the Growth Enterprise Market, or GEM, has shown up the fragility of a regulatory environment once held up to be a shining example. Of even greater concern is the seeming helplessness of the government and the de facto central bank in deflating the property market bubble before it bursts.

The integrity of the regulatory environment is widely considered to be a key factor in enabling the capital markets to attract stable long-term investment from overseas investors. The presence of these funds has given Hong Kong a distinct advantage over its regional competitors in enticing the listings of enterprises from the Chinese mainland and elsewhere.

Although the real benefits of all these new stock listings are never ascertained, Hong Kong has always taken pride in being an IPO capital of the world. Such an accolade seems to be taken as an affirmation of its status as the region's premier financial center. But in the last debacle, what has become known as the "penny stock bloodbath", has raised nagging doubts about the integrity of the capital markets. Although the fallout is limited only to the GEM board and affected mostly overseas investors, mainly on the mainland, it is commonly believed that the alleged trampling on the market rules should never have been allowed to happen at all.

The Stock Exchange of Hong Kong, HKEx, which owns the government-granted monopoly, has said it would investigate the matter. It is hard to imagine that the alleged abuses in the GEM could have gone unnoticed for so long without raising the suspicions of the authorities.

It has been widely reported that the crash in prices of some stocks listed on the GEM was touched off recently by a false notice from a mainland stock brokerage firm, which said Hong Kong authorities had ordered the delisting of the so-called "zombie" stocks. The report was quickly withdrawn. But it stressed out many speculators, kicking off a stampede to sell.

Long before the sell-off, market observers had alluded to rampant abuses on the GEM, including corporate disclosure irregularities and stock price manipulations. Indeed, many Hong Kong investors have learned to avoid this segment of the market. But this is not a good excuse for the stock exchange and watchdog agency to be doing nothing for so long.

In contrast, the government has been making great efforts to resolve the housing problem affecting the livelihood of many Hong Kong families. But even the threat of rising borrowing costs has had little impact on dampening the surge in home prices.

Property market analysts said that the great property rush has been driven by the public's lack of confidence in government's efforts to increase the supply of homes. They seem to have even less confidence in the government's low-cost housing program. Despite warnings about the bursting of the property bubble, developers have tried to keep the market on the boil with easy credit in contravention of the Hong Kong Monetary Authority's strict guidelines to banks. The bursting of the property bubble would no doubt make housing more affordable. But it would also wipe out a large part of the household wealth of many families who bought homes in recent years. What is more, the fallout from the property price crash could pose a threat to the banking system and further undermine public confidence in the establishment.

Fortunately for Hong Kong, the public's anxiety seems to have subsided since new Chief Executive Carrie Lam Cheng Yuet-ngor restored some confidence by indicating she will encourage greater public participation in addressing the housing issue which has become a major source of social discontent. Demand for new homes has eased while prices are showing signs of leveling off.

Property analysts at banks and other financial institutions are predicting a decline of average housing prices as early as this month. That could be the beginning of the long process of deflating the property bubble, allowing prices to adjust gradually in a normal downward cycle unfettered by excessive anxieties from buyers.

Hong Kong needs more than the fixed currency regime and solid bank balance sheets to assure its financial stability. The government has made a good start in reducing the threat posed by a property bubble. It must also address the capital market's shortcomings to preserve the reputation of Hong Kong as an international financial center.

The author is a veteran current affairs commentator.

(HK Edition 07/14/2017 page1)