By Cynthia Kim, Jihoon Lee and Yena Park
SEOUL, Aug 21 (Reuters) - It was a vision to give South Korea a stock market that reflected its true economic dynamism, by shedding regulatory taboos and encouraging bolder bets - instead, it created an investor trauma that could take years to shake.
The 30% decline in the KOSPI benchmark since its June 19 peak has hurt President Lee Jae Myung's government politically and turned the spotlight on an economic system that drove retail investors into poorly understood
leveraged products.
It has also raised questions about how South Korea, a tech powerhouse, can progress to developed market status when it hosts such extreme behaviour by retail investors, known locally as "ants" for their tendency to swarm into trades.
"Ultimately many who entered the market may have suffered severe losses, and a majority of them could become so traumatised that they lose interest in investing altogether," said Jeon Suk-jae, a YouTuber whose investment channel has 3.7 million subscribers.
In the two months since the market's peak, Jeon has seen the comments on his channel, which hosts videos like the one entitled "the entire nation is intoxicated by stocks," flip from euphoria to gloom, broadly tracking the national mood.
Beyond the losses - some realised, some still on paper - there is a psychological reckoning that the nation's leaders are dealing with.
Demand for psychiatric help is rising and other signs of stress are rattling the public. Police in Busan said they had arrested a man in his 20s who is suspected of attempted murder over the stabbing of a YouTuber he allegedly blamed for his stock losses.
MOVE FAST...
President Lee took office last year with a promise to eliminate the market's "Korea Discount," the tendency for local stocks to lag global peers due to the dominance of family-owned conglomerates and weak governance.
To close the gap, regulators began discussing more sophisticated products in January, including single-stock leveraged exchange-traded funds that use derivatives to multiply a stock's daily return.
Such products, popular with Korean investors trading abroad, had backing from the presidential office. "Why is something permitted on the NASDAQ not allowed in Korea?" Kim Yong-beom, the presidential chief of staff for policy, told the Hankyoreh newspaper then.
Such discussions became the catalyst for regulators' decision to allow the ETFs to launch on May 27. Concerns were internally raised over whether domestic investors understood the risk of heavy losses, but the products were still approved. The only barriers to entry were an hour-long mandatory training course and a 10 million won ($7,208.25) minimum deposit.
The presidential office and economic ministries said they reviewed the introduction of single-stock leveraged ETFs after thoroughly assessing risk factors.
"The government remains committed to maintaining market stability," the Blue House said in response to a Reuters request for comment.
The Financial Services Commission, South Korea's top financial regulator, said while there was no standardised procedure for reviewing risks, the agency "comprehensively examined various risk factors at each stage".
...AND CRASH THINGS
On paper, the timing looked perfect. The push to give markets a little more pep coincided with a global AI boom that made Korean memory chipmakers Samsung Electronics and SK Hynix both $1 trillion companies, firing up a leveraged domestic stock mania.
As markets surged, financial influencers and commentators turned investment into a national obsession.
Analysts called it a "once-in-a-generation" earnings surge. Sales of books on domestic stocks more than tripled between January and June, according to online bookstore Yes24.
Many retail investors who felt shut out of the AI windfall were now taking the biggest risks chasing quick profits.
To supercharge returns, investors took on debt, with margin loans for KOSPI investment jumping about 75% from the start of the year to 30 trillion won by late June.
Investors told Reuters they were driven by the belief that leverage was the quickest way to overcome odds stacked against them, amid the country's widest-ever wealth inequality.
"Even though reckless, leveraged or margin trading is the only way to climb the broken ladder, at least by just a little," said Kwon Soon-kuk, a 34-year-old investor who said he earned as much as 66% on his investment at the market's height.
Margin loan balances hit a record 29.8 trillion won on June 24, according to the Korea Financial Investment Association.
Park Jung-jae, an economics professor at Yonsei University, attributed the herd behaviour to past economic shocks that amplified fear of missing out, or FOMO.
Global investors, by contrast, pulled back through the rally as they rebalanced portfolios, even as the KOSPI surged 5% to 8% in a day on multiple occasions.
The leveraged ETFs launched just as the KOSPI, already more than doubled from October levels, crossed 8,000 points. Such funds must trade shares and derivatives to match the leverage, amplifying price swings in both directions.
The effect was magnified because SK Hynix and Samsung together account for over 53% of the KOSPI's total value.
Sentiment shifted in early July, when the VKOSPI volatility gauge — the "Korean fear index" — spiked to 97.99, its highest level since data collection began in 2009.
A Citi client note on July 28 estimated retail investors had lost $38.7 billion on leveraged ETFs.
Chun Wang, a director of multi-asset strategies at Leuthold Group in an August 7 note, likened Korea's long history of bad speculative bets to "Squid Game", the wildly popular Netflix drama.
"Episode after episode, ordinary people under intense financial pressure get lured into increasingly high-risk games by the promise of a life-changing payout, only to end up losing everything," he said.
SOUL SEARCHING
The fallout has been emotional and political. Park Jongsuk, a Seoul psychiatrist treating stock-related distress, said his caseload had dipped to seven or eight patients a day last year.
"But since June of this year, the numbers have exploded again. Currently I am treating an average of 11 patients a day," he said.
Some investors have instead turned back to Wall Street, with appetite for U.S. leveraged ETFs still strong, according to the Korea Securities Depository.
While politicians have apologised and authorities have imposed new restrictions on individual investment in such ETFs, investor confidence remains shaken.
Elevating the KOSPI to global index provider MSCI's developed market list has been a flagship goal for the Lee administration.
Some analysts said this will likely damage foreign views of the market even though measures to address the "Korea Discount" are still seen positively.
"However, because volatility increased too much before the achievements of corporate governance measures are fully established in the market, it will be difficult to make long-term investments for foreign investors," said Huh Jae-hwan, an analyst at Eugene Investment Securities in Seoul.
Some investors have lost faith in the Korean market — even though the KOSPI still trades more than double its October level.
"I've been a stock investor for 30 years but never experienced something like this before," said Dalbo Park, a retiree in his 80s who lost 35% of his investment in the rout. "I don't think I will ever invest in the KOSPI again."
($1 = 1,387.3000 won)
(Reporting by Cynthia Kim, Jihoon Lee, Yena Park and Hyeyoon Cho; Additional reporting by Heejin Kim, Kyu-seok Shim and Gregor Stuart Hunter; Writing by Brenda Goh; Editing by Sam Holmes)
