Japanese asset price bubble

The Japanese asset price bubble (バブル景気, baburu keiki, lit. "bubble economy") was an economic bubble in Japan from 1986 to 1991 in which real estate and stock market prices were greatly inflated.^[1] The bubble was characterized by rapid acceleration of asset prices and overheated economic activity, as well as an uncontrolled money supply and credit expansion.^[2] More specifically, over-confidence and speculation regarding asset and stock prices had been closely associated with excessive monetary easing policy at the time.^[3]

By August 1990, the Nikkei stock index had plummeted to half its peak by the time of the fifth monetary tightening by the Bank of Japan (BOJ).^[2] By late 1991, asset prices began to fall. Even though asset prices had visibly collapsed by early 1992,^[2] the economy's decline continued for more than a decade. This decline resulted in a huge accumulation of non-performing assets loans (NPL), causing difficulties for many financial institutions. The bursting of the Japanese asset price bubble contributed to what many call the Lost Decade.^[4]

Background

Early research has found that the rapid increase in Japanese asset prices was largely due to the delayed action by the BOJ to address the issue. At the end of August 1987, the BOJ signaled the possibility of tightening the monetary policy, but decided to delay the decision in view of economic uncertainty related to Black Monday (October 19, 1987) in the US.^[5]

More recent research supports an alternate view, that BOJ reluctance to tighten the monetary policy was in spite of the fact that the economy went into expansion in the second half of 1987. The Japanese economy had just recovered from the “endaka recession” (日本の円高不況, Nihon no endakafukyō, lit. “recession caused by appreciation of Japanese Yen”), which occurred from 1985—1986.^[5] The “endaka recession” has been closely linked to the Plaza Accord of September 1985, which led to the strong appreciation of the Japanese yen.^[6]

The strong appreciation of the yen, however, eroded the Japanese economy since the economy was led by exports and capital investment for export purpose. In fact, in order to overcome the “endaka” recession and stimulate the local economy, an aggressive fiscal policy was adopted, mainly through expansion of public investment.^[2] Simultaneously, the BOJ declared that curbing the yen’s appreciation was a “national priority”.^[6][7] To prevent the yen from appreciating further, monetary policy makers pursued aggressive monetary easing and slashed the official discount rate to as low as 2.5% by February 1987.^[2]

The move clearly to curb further appreciation of the yen, appreciating from 200.05 ¥/U$ (first round monetary easing) to 128.25 ¥/U$ (end of 1987). The course only reversed by the spring of 1988, when the US dollar began to strengthen against the yen. Some researchers have pointed out that "with exception of the first discount rate cut, the subsequent four are heavily influenced by the US: [the] second and the third cut was a joint announcement to cut the discount rate while the fourth and fifth was due to [a] joint statement [of] either Japan-US or the G-7".^[2][7] It has been suggested that the US exerted influence to increase the strength of the yen, which would help with the ongoing attempts to reduce the US-Japan current account deficit.^[2] Almost all discount rate cuts announced by the BOJ explicitly expressed the need to stabilize the foreign exchange rate, rather than to stabilize the domestic economy.^[7]

Later, BOJ hinted at the possibility of tightening the policy due to inflationary pressures within the domestic economy. Despite leaving the official discount rate unchanged during the summer of 1987, the BOJ had expressed concern over excessive monetary easing, particularly after the money supply and asset prices rose sharply.^[7] Nonetheless, Black Monday in the US triggered a delay for the BOJ to switch to a monetary tightening policy. The BOJ officially increased the discount rate on March 31, 1989.^[3]

The table below demonstrates the monthly average of the U.S. dollar/Yen spot rate (Yen per USD) at 17:00 JST.^[8]

Timeline

Identification

Asset prices

The 1985-1991 asset price bubble affected the entire nation, though the differences in the impact depended on three main factors: the size of the city,^[11] the geographical distance from Tokyo metropolis and Osaka,^[11][12] and the historical importance of the city in the central government’s policy.^[6][11] Cities within prefectures closer to the Tokyo metropolis experienced far greater pressure in the asset prices compared to cities located in prefectures further from the Tokyo metropolis.

For definition purposes, Japan Real Estate Institute has classified Tokyo metropolis (including 23 special wards), Yokohama (Kanagawa), Nagoya (Aichi), Kyoto (Kyoto), Osaka (Osaka), and Kobe (Hyogo)^[13] as the six major cities most impacted by the price bubble. These six major cities experienced far greater asset price inflation compared to other urban land nationwide. By 1991, commercial land prices rose 302.9% compared to 1985, while residential land and industrial land price jumped 180.5% and 162.0%, respectively, compared to 1985.^[13] Nationwide, statistics showed that commercial land, residential land, and industrial land prices were up by 80.9%, 51.1%, and 51.7%, respectively.^[13]

By the early 1980s, Tokyo was an important commercial city due to a high concentration of international financial corporations and interests. The demand for office space continued to soar as more economic activities flooded Tokyo commercial districts, resulting in demand outstripping the supply.^[11] The government policies to solely concentrate its economic activities in Tokyo, and the lack of diversification of economic activities in other local cities, are also partly to blame for the bubble.^[11]

By 1985, lands within Tokyo commercial districts were unable to fulfill the market demand. As a result, land prices in Tokyo commercial districts increased sharply within a year. The average price per 1 sq. metre for land in Tokyo commercial districts in 1984 was 1,333,000¥ (U$5,600 assuming in 1984 that 1 U$=238¥).^[10] In just a year, the average price per 1 sq. metre for land in Tokyo commercial districts increased to 1,894,000¥ (U$7,958 assuming in 1985 average 1 U$=238¥).^[10] This roughly translates to an increase of 42%/sq. metre over just a year. By 1986, the average price per 1 sq. metre for land in Tokyo commercial districts had risen as high as 4,211,000¥ (U$25,065 assuming 1986 average 1 U$=168¥), a jump of 122% compared to 1985. Residential land jumped from an average 297,000¥/U$1,247 per 1 sq. metre (in 1985) to 431,000¥/U$2,565 per 1 sq. metre (in 1986), an increase of 45%.^[10]

Osaka also experienced a rapid growth in land prices, especially in commercial districts. Land prices in Osaka gained 35% to a price of 1,159,000¥/1 sq. metre (1986) from an average 855,000¥/1 sq. metre (1985).^[10] Since Osaka uniquely had historical importance as a commercial center in Japan;^[14] hence, land prices in Osaka tend to be higher than most other urban land in Japan.

By 1987, virtually all land within the Tokyo metropolis was unable to cope with demand. At this point, residential land in Tokyo increased to 890,000¥/1 sq. metre (U$6,180 based on the assumption 1U$ = 144¥) and commercial land 6,493,000¥/1 sq. metre (U$45,090).^[10] Consequently, investors flocked to prefectures surrounding the Tokyo metropolis, especially prefectures within the Greater Tokyo Area. Prefectures located in Southern Kanto were more favourable to investors compared to Northern Kanto. Hence, land in cities like Yokohama (Kanagawa prefecture), Saitama (Saitama prefecture), and Chiba (Chiba prefecture) tended to be more expensive than cities like Mito (Ibaraki prefecture), Utsunomiya (Tochigi prefecture) and Maebashi (Gunma prefecture). For instance, in 1987, commercial land prices in Yokohama (average 1 sq. metre) were 1,279,000¥, Saitama were 658,000¥ and Chiba were 1,230,000¥. On the other hand, commercial land prices in Mito (average 1 sq. metre) were 153,000¥, Utsunomiya were 179,000¥ and Maebashi were 135,000¥ in 1986.^[10]

Osaka continued to enjoy an increase in land prices especially in the commercial area, as the prices increased to 2,025,000¥/1 sq. metre in 1987.^[10] Kyoto (Kyoto prefecture) and Kobe (Hyogo prefecture) also enjoyed a sharp increase in land prices, especially in commercial areas which gained 31% and 23%, respectively.^[11] The effect of the bubble in Osaka spread as far as Nagoya (Aichi prefecture) which saw the commercial land prices gain as much as 28% compared to 1986.^[11]

The first sign of a possible bubble collapse appeared in 1988. By this time, non-prime land prices in Tokyo had reached their peak, though some areas in the Tokyo wards started to fall, albeit by a relatively small percentage.^[3] Prime land in Ginza district and areas in Central Tokyo continued to rise.^[3] Urban land in other cities at this point remained unaffected by the situation faced by the Tokyo metropolis. In Osaka, for instance, the commercial and residential land prices increased by 37% and 41% respectively.^[11]

By 1989, land prices in commercial districts in Tokyo began to stagnate, while land prices in residential areas in Tokyo actually dipped 4.2% compared to 1988.^[10] Land prices in prime areas in Tokyo also peaked around this time; Ginza district was the most expensive, peaking at 30,000,000¥/1 sq. metre ^[15] (U$218,978 based on assumption 1U$ = 137¥). Yokohama (Kanagawa prefecture) experienced a slowdown due to its location closer to Tokyo. Saitama (Saitama) and Chiba (Chiba) still chalked up healthy gain in land prices. All other urban cities in Japan had yet to see the impact of slowdown in Tokyo.^[10]

Between 1990 to mid-1991, most urban land had already reached the peak. The lag effect from the fall of Nikkei 225 pushed down the prices of urban land in most part of Japan by the end of 1991.^[2] The bubble collapse were officially declared in early 1992 – as land prices dropped the most in this period.^[2] Tokyo experienced the worst from the catastrophic in Japanese economic history. Land prices in residential area on average 1 sq/metre slid 19% while commercial land prices declined 13% compared to 1991.^[10] Overall land prices in residential area and commercial districts in Tokyo fell to the lowest level since 1987.^[10]

Stock Prices

In the 1980s, the direction of stock prices in Japan was largely determined by the asset market, particularly land prices, in Japan.^[11] Looking at the monthly performance of Nikkei 225 in 1984, the index largely moved within 9900-11,600 range.^[9] As land prices in Tokyo began to rise in 1985, the stock market also moved higher. Indeed, the Nikkei 225 managed to rise past 13,000 by December 2, 1985.^[9]

The major surge was obvious by 1986, as the Nikkei 225 gained close to 45% within a year.^[9] The trend continued throughout 1987, when it touched as high as 26,029 by early August ^[9] before being dragged down by the NYSE Black Monday. The strong rally throughout 1988 and 1989 helped the Nikkei 225 touch another new record high at 38,957.44 on December 29, 1989 before closing at 38,915.87.^[9] This translated to a gain of more than 224% since January 2, 1985.^[9] Some researchers concluded the unusual stock prices are likely due to the rise in land prices since the corporations’ net assets increases, hence pushing the stock prices upward.^[2][3] As long as the asset prices continued to strengthen, investors would more likely be attracted to speculate on stock prices. However, this also portrays the weaknesses of corporate governance in Japan.^[6]

On the downside, the tightening of monetary policy in 1989 seemed to affect stock prices. As lending costs increased drastically, coupled with a major slowdown in land prices in Tokyo, the stock market began to fall sharply in early 1990. The Nikkei 225 slid to 23,849 (December 2, 1990) from an opening of 37,189 (January 4, 1990),^[9] which resulted in a loss of more than 35% within a year. Stock prices had officially collapsed by 1990. The downward trend continued into 1991 as the Nikkei 225 slid to as low as 22,687 on November 1, 1991.^[9]

Money supply and credit

Initially, the growth of the money supply decelerated in 1986 (the lowest growth rate was 8.3 percent in October–December 1986), which marked the end of the brief “endaka recession”.^[5][16] The trend was gradually reversed as it accelerated afterwards and exceeded 10 percent in April–June 1987.^[16]

The growth of credit was more conspicuous than that of the money supply. During the bubble period, banks were increasing borrowing activity and at the same time, also financing from capital markets substantially increased against the backdrop of the progress of financial deregulation and the increase of stock prices.^[2] As a result, the funding of the corporate and household sectors rapidly increased from around 1988 and recorded a rate of growth close to 14 percent on a year-on-year basis in 1989.^[16] Money supply continued to increase even after the BOJ tightened its monetary policy and reached a peak in 1990, thereafter continuing to mark still double-digit growth until the fourth quarter.^[16] Money supply and credit dropped sharply by 1991, as bank lending began to drop due to a shift in bank lending attitude.^[2]

Causes

Monetary policy

The accelerating growth in terms of Japanese asset prices is closely associated with a significant drop in short-term interest rates, notably between 1986 and 1987. The BoJ had slashed the official discount rate from 5.00% (January 30, 1986) to 2.50% (February 23, 1987).^[3][17] The official discount rate remained unchanged until May 30, 1989.

BOJ official discount rates:^[6]

With the exception of the first discount rate cut, most of the discount cut was closely motivated by international policy to intervene in the foreign exchange market. Despite aggressive monetary easing by BOJ, the US dollar slid as much as 35% from ¥237/U$ (September 1985) to ¥153/U$ (February 1987).^[8] Consequently, the move by the BOJ was heavily criticized since such moves appeared to influence the outcome of the yen, a much neglected domestic factor. As a result of such move, money growth was out of control. In the 1985-1987 period, money growth had been lingering around 8% before being pushed up to more than 10% by the end of 1987.^[5][16] By early 1988, growth had reached about 12% per annum.^[5][16]

The Bank of Japan has also been criticized for its role in fueling the asset bubble. The movement of the BOJ to appreciate the Japanese yen rather than stabilizing the asset price inflation and overheating meant little could be done during the peak of the crisis. Despite the Bank of Japan stepping in to hike the interest rate by May 31, 1989, it seemed to have little effect on the asset inflation. Indeed, land prices continued to rise until the early 1990s.^[2]

Distortions in the tax system

Japan has one of the world's most complicated taxation systems, with its property tax provisions deserving specific mention. These provisions have been widely abused for speculation and have contributed to costlier land, especially within urban areas.^[3][17][18]

The inheritance tax is very high in Japan, reported to be 75% of the market price for over 500 million yen until 1988, and it is still 70% of the market price for over 2 billion yen.^[17] Yet the appraisal of land for tax purposes used to be about one-half of the market value and the debt was considered at face value during the bubble period.^[17][18] In order to evade inheritance tax, many wealthy individuals opt to borrow more money (since the interest rate was far lower), hence reducing exposure to inheritance tax.^[3]

Furthermore, given that capital gains on land are not taxed until the time of sale and interest rate payments can be deducted from taxable income for companies and individuals investing in assets (condominiums and offices), this has offered more incentive for wealthy individuals and company to speculate the asset price.^[17] The Japanese property tax stipulated that the statutory standard property tax stood at 1.4%.^[17] However, in terms of effective property tax, it is much lower than the published statutory property tax.^[17][18]

In the 1980s, local government imposed a tax on the market price land.^[17] Since the valuations did not rise in tandem with the actual rising market price, the effective property tax would regress over the time. As a result, the Greater Tokyo area dropped to 0.06% of the market price.^[17] As the land price escalated much quicker than the tax rate, most Japanese considered lands as asset rather than for production purposes. With strong expectations that the land prices were likely to escalate, coupled with minimum property taxes, it makes more sense to speculate the land price than to fully utilize the land for production purposes.^[18]

The land lease law

As provided under the Japan Civil Code, the rights of a lessee and tenant are protected under the Land Lease Law.^[17] This law can be traced back during the World War II, whereby most heads of household were conscripted for military duty, leaving their families in danger of being thrown out off their leased land.^[17] For this reason, land leasehold contracts automatically renew unless the landlord provides concrete reasoning to object.^[17]

In the event of a dispute between the lessee and tenant, courts may convene a hearing in order to ensure that the rent is “fair and reasonable”.^[17] If the rent is set by the court, tenants would pay according to the rent set by the court, which meant landlords could not raise the rent more than the actual market price. Hence, rents are actually kept “artificially low”^[17] and the market fails to respond according to the rental price set by the market. Due to this, many landlords refused to rent out their land for such steeply discount prices, but rather left the land deserted in order to reap huge capital gains should land prices increase sharply.^[17]

Changes in bank behaviour

Traditionally, Japanese are well known to be great deposit savers. However, the trend seemed to reverse by the late 1980s as more Japanese opted to shift funding from banks to the capital market – leaving banks in a tight squeeze as lending costs grew with the shrinking customer base.^[3]

In fact, bank behaviour has gradually become aggressive since 1983 (even before the monetary easing policy in Japan) after the ban on fund-raising in the securities market was lifted around 1980.^[2] However, major firms were not keen to utilize the bank as the source of funding. For this reason, banks were forced to aggressively promote loans to smaller firms backed by properties.^[2] Soon, especially around 1987-1988, banks were even more apt to lend to individuals backed by properties.^[3] Evidently, even an ordinary salaryman could easily borrow up to 100 million yen for any purpose, provided his house was used as collateral.^[3]

Consequently, this had an adverse impact on whole Japanese asset bubble. Firstly, cheap and easily available loans reduced the funding costs for the purpose of speculation.^[19] Second, stock rises, coupled by low interests rates, reduced the capital costs and aided financing the capital market (e.g. convertible bonds, bonds with warrants, etc.).^[19] Third, the combination of a rise in land and stock prices pushed up the value of assets held by corporations, which effectively increased their sources of funding since such these increased the collateral value of the assets.^[19]

Aftermath

Asset price

The asset price burst seemed to exert a strong impact on the overall Japanese economy. By 1992, urban land prices nationwide declined 1.7% from the peak.^[10] However, the impact was worse for land in the six major cities, as the average land prices (commercial, residential, and industrial) dropped 15.5% from its peak.^[10] Commercial, residential and industrial land prices dropped 15.2%, 17.9%, and 13.1%, respectively.^[10]

The entire asset price crisis was far worse, especially in the large business districts of Tokyo. By 2004, prime "A" property in Tokyo's financial districts had slumped to less than 1 percent of its peak, and Tokyo's residential homes were less than a tenth of their peak, but still managed to be listed as the most expensive in the world until being surpassed in the late 2000s by Moscow and other cities. However, since 2012, Tokyo is once again the world's most expensive city, followed by Osaka with Moscow as number 4. Tens of trillions of dollars of value was wiped out with the combined collapse of the Tokyo stock and real estate markets. Only in 2007 did property prices begin to rise; however, they began to fall in late 2008 due to the global financial crisis.^[19]

Household impact

The entire crisis also badly affected direct consumption and investment within Japan.^[20] As a result, from a prolonged decline in the asset prices, there was a sharp decline in consumption, which resulted in long term deflation in Japan.^[20] The asset price burst also badly affected consumer confidence since a sharp dip reduced household real income.^[19]

Corporate impact

At the same time, since the economy was driven by its high rate of reinvestment, the crash hit the stock market particularly hard. The Nikkei 225 at the Tokyo Stock Exchange plunged from a height of 38,915 at the end of December 1989 to 14,309 at the end of August 1992.^[20] By 11 March 2003, it plunged to the post-bubble low of 7,862 on March 11, 2003.^[20] As investments were increasingly directed out of the country, manufacturers were facing difficulties to uphold its competitive advantage since most manufacturing firms lost some degree of their technological edge.^[20] Consequently, Japanese products became less competitive overseas.

During the asset bubble period, most Japanese corporate balance sheets were backed by assets. Hence, the asset prices influenced the corporate balance sheet. Owing to a lack of corporate governance in Japanese companies,^[6] most Japanese corporations had an inclination to convince investors with their healthy balance sheet, since most investors believe that such prices are likely bullish.^[20] An important effect of the bubble collapse was the deterioration of balance sheets. Since asset prices tumbled, increasing liabilities on a long term basis projected a bad balance sheet to investors.^[20] Many Japanese corporations were facing huge difficulties to reduce the debt ratio – resulting reluctance from the private sector to increase investments.^[20]

Financial and banking sector

The easily obtainable credit that helped create and engorge the real estate bubble continued to be a problem for several years, and as late as 1997, banks were still making loans that had a low probability of being repaid.^[20]Loan officers and investment staff had a hard time finding anything to invest in prospects that would return a profit. They would sometimes resort to depositing their block of investment cash, as ordinary deposits, in a competing bank, which would bring complaints from that bank's loan officers and investment staff. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many so–called "zombie businesses".^[20] Eventually, a carry trade developed in which money was borrowed from Japan, invested for returns elsewhere, and then the Japanese were paid back, with a nice profit for the trader.^[20]

The post bubble crisis also claimed several victims such as Sanyo Securities Co., Hokkaido Takushoku Bank, and Yamaichi Securities Co. in November 1997.^[20] By October 1998, the failure of the Long-Term Credit Bank of Japan as well as Nippon Credit Bank in December the same year worsened the financial system unrest,^[20] drastically deteriorating consumer and business sentiment and dealing a heavy blow to the economy. To address the crisis, the government injected a total of 9.3 trillion yen in public funds into major banks in March 1998 and March 1999.^[20]

The lost decade

The decade beyond 1991 is known as the lost decade (失われた十年, ushinawareta jūnen, lit. "Lost Decade") in Japan, due to the gradual effect of the asset bubble collapse and effects.

Notes

Additional References

• Saxonhouse, Gary and Stern, Robert (Eds) (2004) Japan's Lost Decade: Origins, Consequences and Prospects for Recovery (World Economy Special Issues), Wiley-Blackwell, ISBN 978-1-4051-1917-7
• Wood, Christopher (2005) The Bubble Economy: Japan's Extraordinary Speculative Boom of the '80s and the Dramatic Bust of the '90s, Solstice Publishing, ISBN 978-979-3780-12-2
• Daniell, Thomas (2008) After the Crash: Architecture in Post-Bubble Japan, Princeton Architectural Press, ISBN 978-1-56898-776-7
• Klarman, Seth A. (1991) Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor, HarperCollins, ISBN 978-0-88730-510-8

External links

• Core Economics animated Real Estate Rollercoaster Ride
• Shigenori Shiratsuka: Asset Price Bubble in Japan in the 1980s: Lessons for Financial and Macroeconomic Stability PDF (263 KB) Bank of Japan Whitepaper (2003)
• Allan I. MENDELOWITZ: After the Bubble: Is Japan's Recent Past America's Future? RIETI speech summary, June 12, 2003
• Japan Ministry of Land, Infrastructure, Transport and Tourism Land Price Data
• Deloitte Report see page 10
• Status Ireland: Japan: Property crash example (Japan Urban Land Index 1964 - 2007)