System-Wide Meltdown versus Housing-Specific Decline
The Japanese real estate slide was merely part of an economy-wide meltdown and possibly not even a major part. From the 1960s through the 1980s, Japan had grown more rapidly than any other industrialized nation. Opposite that spurt, Japanese asset prices had soared for more than 20 years. Stock market multiples were in excess of 100. Real estate was so pricey that the Imperial Gardens in Tokyo were said to be worth more than all of California, with downtown Tokyo worth more than the whole United States.

Then, in mid-1991 the Japanese economy suddenly came to a screeching halt, and asset prices imploded. Japanese stock prices plunged sharply and protractedly and have never really recovered. Much the same was true for land and home prices. The country became mired in a prolonged deflation. Economic growth remained weak until early-1995, and even the 1995 rebound was short-lived.
This is a radically different milieu from what the U.S. has experienced in recent years. Rather than coming off a decades-long growth spurt, U.S. economic growth in this decade has been the slowest in postwar history. Rather than both stocks and real estate booming, as in Japan, the U.S. stock market has been relatively tranquil ever since its 1990s’ bubble burst in 2000. While U.S. equities have recently experienced a relatively mild, cyclical decline from non-spectacular valuation levels, this does not compare with the bubble-bursting implosion seen in Japan.

Homebuilding in Japan and the U.S.
More importantly, whereas Japan’s housing decline was incidental to its broader economic slowdown, the current U.S. malaise has been virtually all about housing. As detailed in a companion white paper, outside of housing, it is not clear that the U.S. economy has slowed at all in the last two years.² The plunge in U.S. homebuilding since early 2006 is primarily a reversal of the overbuilding that occurred over 2002-2006, possibly exacerbated by swings in mortgage credit availability. In Japan, however, there does not appear to have been any overbuilding prior to the 1990s’ declines in home prices, else why would homebuilding there have continued to rise through the four years of economic implosion?

When Japanese homebuilding did begin a protracted decline in 1996, it dropped by only a third from its highs and over a period of only two years. In the U.S., again, falling homebuilding activity precipitated the economic slowdown rather than lagging it by four years. Furthermore, we have already seen a 60% drop in building activity from early-2006 highs over a period of more than two years. So, U.S. homebuilding has already dropped sooner, more sharply, and over a longer period of time than what Japan experienced in the 1990s. There is nothing in the Japanese experience to suggest that U.S. homebuilding should continue to diminish or to contradict recent signs of a U.S. homebuilding bottom.

Home Prices in Japan and the U.S.
As for home prices, again, the Japanese declines after 1991 were part of a system-wide pullback from speculative excesses built up over as much as twenty-five years. Prices started weakening even while homebuilding activity was rising and alongside even sharper declines in stock prices. This indicated that the home price declines were merely part of a bursting price bubble across asset markets and not due to overbuilding. In contrast, in the U.S., homebuilding activity and home prices began to fall in tandem in early 2006, with no follow-through in other assets or in the rest of the economy until financial system dysfunction set in eighteen months later. Also, rather than decades of speculative build up, the bubble in U.S. home prices “expanded” over only a five-year period, from 2002-2006.

While it is staggering to think that Japanese real estate prices fell for 15 years, it took that long merely to unravel the “parabolic” component of a decades-long speculative build-up. Even now, at the bottom of the slide, Japanese land prices in real terms are barely back to the levels of 1986, less than four years prior to the peak. In contrast, in terms of the real, nationwide S&P/Case-Shiller Index, U.S. home prices are already back to 2002 levels, which is when overbuilding and parabolic price gains set in.

Furthermore, deflation in Japan in the 1990s meant that nominal real estate prices there had to fall more sharply to match the real levels in place prior to the late stages of the boom. No such deflation is currently in place to aggravate declines in U.S. home prices.

Institutional Factors
In addition to the economic factors discussed above, it is common to attribute the protracted decline in Japanese asset prices to various institutional rigidities that prolonged both the preceding boom and the bust. There is no doubt such factors are important in understanding the Japanese experience. However, in order for these factors to be germane to our story, one would have to assert not only that very similar institutional rigidities are in place in the U.S. as befell Japan, but also that these institutional similarities are so thorough and powerful that they more than offset the economic differences listed above. Such an assertion would be more than a stretch.

Conclusion
Japan’s 1990s’ malaise was prolonged, but the preceding boom was also much longer, more pervasive, and more intense than anything the U.S. experienced in this decade. Just as the Japanese boom was widespread, so too was the bust, with both equity real estate prices dropping dramatically and protractedly from speculative bubble levels. In the U.S., both the early-2000s’ expansion and the post-2005 slowdown have been all about housing. Even so, the U.S. has already seen sharper and longer declines in housing construction than those experienced by Japan, and U.S. home prices have already unwound in three years as much of the preceding run-up as Japanese land prices did over a 15-year period.

The differences between the Japanese and U.S. experiences indicate that it could be misleading to believe that U.S. adjustments will have to be as intense as in Japan. At the same time, however, there is reason to believe that the U.S. has already seen as much adjustment in homebuilding activity and home prices as did Japan. On either grounds, it is dubious to assert that the U.S. housing slide is not over merely because it hasn’t stretched over as long a period as that of Japan.

Footnotes

1. See “No Bust, No Boom In Store For U.S. Economy,” Western Asset, August 2008, available on our website.
2. Ibid.