Japan's Home Prices, Post-Bank Crisis

The US seems to be adopting the "Japan approach" to its current banking and housing crises - a slow, patch the holes as they appear strategy.  In 1990, Japan's banking crisis began in earnest. The Nikkei plunged and so did property values, as you can see, left.  Nominal home price changes have been negative each year since. The housing index chart (below, left) shows that home prices rose over 40% between 1985 and 1990 but, on an inflation adjusted basis, they are now close to 1980 levels.  Will US housing follow?  Looking back, most experts agree the cause of Japan's crisis was excessive risk taking by banks that filtered through the economy.  A combination of declining profit margins, deregulation, and weak regulation of banks led to: aggressive expansion, credit liberalization and inflated asset values.  Sound familiar?  Hopefully the US housing market will not go sideways, or gradually downward, for 20 years like Japan's.

Japan's financial crisis took an entire decade to play out as follows:

1989-90:The stock market peaked in 1989, then collapsed in 1990, dropping an incredible 43% (the Dow is currently down 38% from its peak).  Japan's banks were allowed to hold equities as part of their capital base.  Over the next three years the market experienced high volatility, with a general downward trend.

1992: Land and home prices begin a steep decline and defaults rise on consumer loans.

1993: Problem real estate loans are makelife difficult for banks and they establish the CCPC, Cooperative Credit Purchasing Program.  It is funded by banks to take bad loans off their balance sheets.  The loan balance less appraised value is deductible from taxes on bad loans transferred to this "bad bank." 

1994: Some banks still try restructuring "problem loans" by lowering interest rates and extending maturities in an attempt to delay the inevitable.

1995: Residential and commercial property values continue to decline and take down a major residential mortgage lender.  I found one study which reported that real estate prices for commercial land dropped 80% from 1991 to 1998, although other data seems to indicate a lower number. 

1997: Many banks are experiencing negative return on equity, and some keep paying dividends even though they need capital.  Making matters worse, the government has yet to intervene in a meaningful way, expecting the problem to self-correct.  In April, Nissan Life goes bankrupt; later Sanyo Securities defaults and two major banks suspend operations.

1998: The crisis peaks.  The government finally steps in and authorizes "almost unlimited" public funds to shore up capital.  An initial $17 billion bank bailout is made, but a credit crunch ensues anyway as banks try to preserve capital.  Later that year, Long Term Credit Bank of Japan is nationalized. 

Resolving the Crisis: Part One- In 1997 the government creates a stress test for banks.  They must revalue their assets realistically and the valuations can be audited.  Capital ratio thresholds are specified at which the government can reduce dividends or scale back operations.  Part Two: By 1999, banks need significant significant capital injections.  Japan's Deposit Insurance Corporation will grant these through the purchase of preferred shares or subordinated debt, and each bank must submit a restructuring plan.  If unsatisfied with the progress made by a bank, the government could convert these obligations to common voting stock, to have control over management.  During audits the government found that many banks were still valuing assets at unrealistic levels.  The Resolution and Collection Corporation is formed to buy bad loans from banks.

The resolution process results in a wave of bank mergers (think WaMu-JPM and Wachovia-WFC), and eventually the bailout funds reach $399 billion of which nearly $200 billion has been recovered.

Post Crisis:  Consumers must reduce consumption significantly, as there is less credit available.  Unemployment increases and GDP growth slows.  From "start to finish" the problems in the financial sector took over 13 years to play out, but housing has yet to recover. 

The situation seems to have many similarities to that underway in the US.  To date, the domestic financial crisis is not as bad as Japan's and not yet as bad as the S&L Crisis of the late 80's.  Between 1989 and 1991, it has been reported that 1,187 banks and S&L’s failed, consisting of more than $454 billion in assets.  This was according to the Federal Deposit Insurance Corporation.  So far in 2008 and 2009, there have been 62 bank failures per the FDIC failed bank list .   It is my opinion, however, that the crisis is still in its early stages and that the US government has acted more swiftly, taking a cue from Japan's crisis.  But I think it will be years, until the US problems play out to their conclusion.  And that will mean less consumption by consumers and a resetting of asset values, as the US learns to live within its means.  Meanwhile the Nikkei has yet to return to its 1989 peak - it is currently 7,994.  Home prices have not rebounded either.

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