Following is from “Take It From Japan: Bubbles Hurt” in the New York times back in December 2005, still a year and a half from the bubble peak in the US real-estate market. The history of events as they looked during the bubble, and what they look like afterward are critical to understand.
To be sure, there are several major differences between Japan in the 1980’s and the United States today. One is the fact that property prices rose much faster and more steeply in Japan, partly because speculators used paper profits from a booming stock market to invest in property, insupportably leveraging the prices of both higher and higher.
Another difference is that the biggest speculators in Japan’s frenzy were deep-pocketed corporations, and they pumped up the commercial property market at the same time that home prices were inflating.
The current Chinese real-estate bubble is also fueled by hot money and savings, though leverage on inflated real estate is accelerating the pace of expansion.
JAPAN suffered one of the biggest property market collapses in modern history. At the market’s peak in 1991, all the land in Japan, a country the size of California, was worth about $18 trillion, or almost four times the value of all property in the United States at the time.
I haven’t seen these numbers nation wide, but Shanghai and Los Angeles seem to be priced at similar levels.
Then came the crashes in both stocks and property, after the Japanese central bank moved too aggressively to raise interest rates. Both markets spiraled downward as investors sold stocks to cover losses in the land market, and vice versa, plunging prices into a 14-year trough, from which they are only now starting to recover.
This is exactly what China needs to worry about – when the debt is unwound, what will keep the brakes on the descent.
Now the land in Japan is worth less than half its 1991 peak, while property in the United States has more than tripled in value, to about $17 trillion.
Homeowners were among the biggest victims of the Japanese real estate bubble. In Japan’s six largest cities, residential prices dropped 64 percent from 1991 to last year. By most estimates, millions of homebuyers took substantial losses on the largest purchase of their lives.
Victims in China will be the same. See “Wo Ju”.
Their experiences contain many warnings. One is to shun the sort of temptations that appear in red-hot real estate markets, particularly the use of risky or exotic loans to borrow beyond one’s means. Another is to avoid property that may be hard to unload when the market cools.
Most of all, economists say, Japan’s experience teaches the need to be skeptical of that fundamental myth behind all asset bubbles: that prices will keep rising forever. Like their United States counterparts today, too many Japanese homebuyers overextended their debt, buying property that cost more than they could rationally afford because they assumed that values would only rise. When prices dropped, many buyers were financially battered or even wiped out.
“The biggest lesson from Japan is not to fall into the same state of denial that existed here,” said Yukio Noguchi, a finance professor at Waseda University in Tokyo who is perhaps the leading authority on the Japanese bubble.
“During a bubble, people don’t believe that prices will fall,” he said. “This has been proven wrong so many times in the past. But there’s something in human nature that makes us unable to learn from history.”
Bubbles. Purchases are based on expectations about future prices being even higher. Basically, average folks purchase out of fear.
Since 1991, Japan has spent 11 years sliding in and out of recession. It is only now showing meaningful signs of recovering, with the World Bank forecasting that Japan’s economy will grow by a solid 2.2 percent this year
“It was déjà vu,” Professor Noguchi said. “People were in a rush to buy, and at extraordinary prices. I saw this same haste psychology in Japan” in the 1980’s. “The classic definition of a bubble,” he added, “is people buying on false expectations about future prices, and buying with the hope of selling in the future.”
A similar pattern is found today in the United States, where the methods include interest-only mortgages, which allow homebuyers to repay no principal for a few years. Japan had its own versions of these loans, including the so-called three-generation loan, a 90- or even 100-year mortgage that permitted buyers to spread payments out over their lifetimes and those of their children and grandchildren.
When you hear about exotic new loan types being created to enable buyers to pay higher prices, you should be aware you’re in a bubble. Most economics are not a zero-sum-game, the economic pie can get bigger. However, real-estate is a zero-sum-game.
Even many of those who avoided financial collapse found themselves marooned in homes that they never intended as lifelong residences. For many Japanese homebuyers in the 1980’s, land prices had risen so high that the only places they could afford were far from central Tokyo. Many went deep into debt to buy tiny or shoddily built homes that were two hours away from their offices.
Mr. Nakajima said he had barely missed being stuck out there himself. In 1991, he was looking at a 100-square-meter apartment (1,080 square feet) for about $600,000 about two hours outside Tokyo. He said his wife stopped him. Six years later, he spent the same amount to buy a more spacious house in a downtown neighborhood.
For years after the real estate bubble burst, the Japanese government tried to resuscitate the market and other parts of the economy with expensive public works projects, but they were so poorly planned that they succeeded only in inflating the national debt.
The 2009 “Expand Domestic Consumption” (扩大内需) policy of China has been a newspaper success around the world, however, I’m inclined to think the result will be exactly what was experienced in Japan: “succeeded only in inflating the national debt”.
NOT until the late 1990’s did the government try a new tack: deregulation. To kick-start the economy, Tokyo started loosening restrictions on the financial industry. While most of this effort was aimed at reviving the banking industry, it also allowed investors to create real estate investment trusts, essentially mutual funds that invest in commercial property. A few years later, the government also eased building codes, such as height limits, and cut approval times for building permits.
There’s a strong bias in this one though – not sure bank de-regulation is the best answer if we’re going to bail them out. There’s a classic case of public risk, private reward in 21st century finance.
“Japan shows the importance of avoiding a hard landing,” Professor Makabe said. “Avoid big shocks. That is the biggest lesson of Japan’s bubble.”
Nobody wants a hard landing, but remember when the “experts” were talking about the “Goldilocks Economy“? It’s never different.