Financial bubbles become so large because they have the potential to self-perpetuate. When expectations for future prices are based on a recent trend, the best performing investments in the near future will usually be the same as those which have performed well thus far. If encouraged by greater publicity, credit availability, loose regulation, or an absence of compelling alternatives, these bubbles can transform the functioning of an economy or financial market beyond recognition, with reasonable concerns smothered by a feeling that this is simply how the future was meant to look.
Already between 1956 and 1986, land prices in Japan had increased 5,000%; for comparison, consumer prices had only doubled in the same period. Yet, the pace of appreciation actually accelerated in the mid-to-late 1980s. An accelerating increase in land values began in the business districts in the center of Tokyo but spread to the city’s outskirts and other parts of Japan from there.
In August 1985, the sale of a previously public-owned site in the Chiyoda ward of Tokyo achieved a price roughly three times greater than the prevailing average market price of land in central Tokyo. By 1990-91, the average price of a home in Tokyo had reached fifteen times the average annual income in the city, and even small condominiums would sell for ten times average annual incomes.
Tokyo land values rose 10.4% in 1986, 57.5% in 1987, and 22.6% in 1988; this amounted to well over a doubling in just three years. Some areas of central Tokyo saw values rise 400%. Wild statistics were tabulated to summarize the state of the market. In 1988, the entire land value of Japan supposedly exceeded that of the United States four times over. The land value of Chiyoda alone exceeded that of all of Canada. The grounds of the Imperial Palace in Tokyo were estimated to be worth more than the entire real estate value of the state of California.
Speaking of other countries, the speculation was not limited to the home market; Japanese investment in foreign property also surged. Mitsui Corporation purchased the Exxon Building in New York for $610 million in 1986 and Mitsubishi Estate paid $846 million for 51% of American real estate firm Rockefeller Group in 1989. Japanese investment in the United States property market rose from $1.9 billion in 1986 to $7.5 billion in 1987 and $16.5 billion in 1988. The United Kingdom was another common destination for Japanese outbound investment in real estate.
The land bubble coincided with a stock market boom. This was partly because firms unrelated to real estate were increasingly valued according to their real estate holdings, which were rapidly appreciating. The cumulative capital gains in Japan, including from both land and stocks, exceeded $3.4 trillion in 1987, or more than 40% of gross national product.
The reasons for the boom were several. First, the Japanese economy began to slow in the late 1970s. Profits remained high but firms became less eager to invest in plant and equipment, especially after a strengthening yen in the mid-1980s made Japanese exports less competitive. The high profits and limited investment opportunities meant Japanese firms stopped borrowing and reduced investment in their respective industries.
To the extent they needed to raise any capital at all, they did so by issuing stock amidst a buoyant stock market. Large firms went from being net borrowers, or users of credit, to net suppliers of funds to the banking system. The banks were in need of a new area in which to deploy all this money and they turned to real estate.
Money became even easier to come by when the Bank of Japan cut interest rates from 5.0% in 1985 to 2.5% by February 1987. Thereafter, the money supply increased faster than average. The interest rate cuts coincided with a Japanese yen appreciating against the U.S. dollar, helping trigger Japanese investment in the United Stated and thus the exportation of its property boom to foreign markets. Falling oil prices and cheaper imports, a result of the strong yen, meant the interest rate moves were not inflationary, except in financial and real estate assets.
With cheaper funds in hand and in need of new opportunities, domestic banks were keen to lend against land which had seemed like it could only appreciate. Japanese banks also held common stock in nonfinancial companies, meaning they had benefited from the stock market boom which they had perpetuated by their lending. The banks appeared well capitalized and profitable, encouraging more aggression in their real estate activities.
Further, nonbank lenders also expanded into property finance. Their property loans increased from ¥22 trillion in 1985 to ¥80 trillion at the end of 1989. Towards the end of the boom, when loans to the real-property industry by actual banks made up 11.5% of all loans made by banks, the non-bank lending sector’s exposure to real property was a much higher 35.7% of its total loan portfolio.
As it was easy to use land as collateral for borrowing, loans to property development firms acquiring land increased quickly. There was more speculative buying of land by property companies responding to record sales. Especially in the central wards of Tokyo, the portion of land owned by corporations rose while that by individuals fell in the late 1980s. Ownership also became more concentrated in larger firms; less than 10% of corporations owned over 80% of company-owned land in Tokyo. Corporations even began to provide housing to employees and offered mortgage financing as a fringe benefit, as individual home ownership looked further out of reach.
The real estate holdings of Japanese corporations were estimated to have increased by more than $2 trillion in the three years between 1985 and 1988. This was an amount equal to half of the combined value of all the companies listed on Tokyo Stock Exchange.
Government policy also encouraged a land boom. The large increase in land values was partially driven by high capital gains taxes which discouraged selling, limiting the number of properties on the market.
Also, Japan had already had a lax regulatory environment on real estate development with less rigid land use policy than was common in other developed countries. Still, urban development by private companies was further promoted by the government, most notably after 1983, including through deregulation, subsidies, tax breaks, financing, and ceding control of public-owned land. This was intended to drive economic growth as Japan was coming under pressure from international trade partners related to its trade practices and industrial growth slipped. The government wanted to stimulate the economy while minimizing the need for more public sector resources.
Nonetheless, after a recession in the mid-1980s, the government began to dedicate more public money into urban development to stimulate the economy. The focus was on Tokyo especially since the faster growth of finance and services compared to Japanese industry favored the capital city. In any case, loose zoning restrictions meant flexibility in land use. Thus, land values increased more or less in tandem rather than depending on the existing land use, in which case the surge in prices might have been limited to commercial properties.
Land prices peaked in stages; first was central Tokyo in 1986 and by 1987-88 they had peaked in the outskirts of the city. The boom continued a bit longer for other Japanese cities and the satellite towns around Tokyo. The bust would not start until the very end of the decade. The Bank of Japan began to raise interest rates in 1989, eventually taking its rate up to 6.0% by August 1990. The Ministry of Finance also increased regulation on lending to property companies.
As the end of 1989 approached, stock prices had already risen 27% as the Nikkei stock index neared 40,000. It would fall below 20,000 by the following September. A sharp fall in stock prices and land values took place in 1990. People and firms felt poorer as unrealized capital gains on their landholdings evaporated.
The potential impact did not go ‘unrealized’ though. The bust saw increased bankruptcies of property firms and bad debt reduced the profitability of the banks. The deflating bubble suppressed consumption and economic activity generally. A 1992 economic stimulus program featured an initiative to purchase land, including that obtained by banks as a consequence of loan defaults, using public funds. The early 1990s were generally characterized by official attempts to halt the fall, usually unsuccessful.
When an economy slows, it may be wishful thinking to believe more credit will bring about a turn of fortune. If pessimism about the worth of productive investment continues, any new credit may be put to poor use. In Japan, a lack of good productive investment opportunities combined with an excessive amount of credit availability led to land speculation. Efforts to stimulate the economy can rarely control the destination of investment and the unintended results may be less desirable than the conditions that prompted the intervention to begin with.
More from the Tontine Coffee-House
1. Chancellor, Edward. “Chapter 9: Kamikaze Capitalism: The Japanese Bubble Economy of the 1980s.” Devil Take the Hindmost: A History of Financial Speculation, Farrar, Straus and Giroux, New York, 1999, pp. 283–327.
2. Cutts, Robert L. “Power from the Ground Up: Japan’s Land Bubble.” Harvard Business Review, May-June 1990.
3. Oizumi, E. “Property Finance in Japan: Expansion and Collapse of the Bubble Economy.” Environment and Planning A: Economy and Space, vol. 26, no. 2, 1994, pp. 199–213.