The 1985-1994 Global Real Estate Cvcle. Page 9

# _2.5 Steep Domestic Asset Deflation in Japan, 1990-91_

The abrupt end of asset price inflation in Japan came in 1990 through the combination of two main factors: one domestic, the other external. In 1990, deflatioaarv and restructuring policies were implemented by Yasushi Mieno as neu Governor of the Bank of Japan in order to correct the 'bubble economy". Liquidity was cut back - particularly for real estate loans - and the discount rate was raised five times moving it from 2.5 percent to 6.0 percent by the end of 1990. These restrictive credit policies were already leading to an important stock market correction, but the stock market adjustment became really massive with the Gulf crisis. Externally, the August 1990 invasion of Kuwait and the Gulf War contributed to a shift in expectations and a sharp fall in the Nikkei index of 36.3 percent in just three months. See Ueda [1990].

Together with stock prices, Japanese real estate prices have declined sharply since 1990.9 Japanese banks now face an unprecedented increase in non-performing loans following five years of rapid growth in their real estate exposure from 7% to 17% of total loans between 1986 and 1990. Banking institutions have been hit with the double problem of falling real estate values and the sharp fall in security prices. This situation has forced banks to drastically curtail new lending with the joint effect of a severe credit crunch at home with an actual fall in domestic lending by city banks by 1% in 1993. This contraction of bank lending together with the overregulation of Japanese capital markets is leading to the migration of large corporate borrowers and financial services abroad.

At the end of this first global cycle which it contributed so much to creating, Japan's economy carries the dual burden of the decline in consumption linked to asset deflation and the credit crnmch linked to the weakened banldng system's inability to lend. Bad loans to all sectors are significantly concentrated in non-bank financial institutions -plus the seven housing loan companies _(usen)_ with an estimated '6 trillion ( $60 billion) of bad debt- which together had increased their loans four-fold since 1986. A 1991 suvey of the 300 largest non-bank financial institutions by the Ministry of Finance shows that 63 percent of their loans were secured by real estate, and 41 percent of total loans were to real estate and the construction industry. Long-term credit banks and trust banks were particularly affected by bad real estate loans. 10 9 Comparisons with transaction data collected by private Japanese finns suggest that there a significant amount of deliberate smoothing in the real estate price changes _(Koji Kakaku)_ reported by the National Land Agency. The expressed rational for such price smoothing being to reduce market volatility by not reporting extreme prices. During the boom, the magnitude of price gains was underreported. During the crash, price declines have been understated. It is generally agreed that the prices reported by the non-government Japan Real Estate Institute are closer to market conditions. (see Stone and Ziemba [19931, Natacha Dubach [1991], Renard and Bourdier [1989]. Officially, the Tokyo region housing prices are estimated to have fallen by more than 40% in nominal terms in less than four years since September 1990; land prices have declined by at least 50%. _[Etudes Fonci2res,_ Sept. 1994].

10 The true extent of the bad loan problem throughout the Japanese banking system has been obscured by the reporting and restructuring policies followed by Japanese authorities. Japanese regulators use rules that are opaque in comparison to common international accounting rules. Some foreign analysts estimate that instead of the reported Y 13.6 trillion (S 143 billion) the true size of all types of bank problem loans is Y 30.0 trillion (S315 billion) or 6 percent of the loan book, suggesting that the bad loan situation may take five years to clear. _(Financial 7imes,_ July 28, 1994). Govemor Mieno's decision on December 8, 1994 to close two credit unions with non-perforning loans df about Y100 billion (S I bn) may be marking a turn toward greater transparency away from the smoothing over of financial problems. (See _Financial Times,_ December 8, 1994, p.4)