The day the Nikkei average ended the year at 38,915 yen

After the Plaza Accord of September 1985, the official discount rate was lowered to 2.5% in February 1987 and remained there for two years and three months. Stocks peaked at 38,915 yen at the end of 1989, and land prices peaked in 1990. The increase in stock and land values from 1986 to 1989 reached 452% of nominal GDP. Following interest rate hikes from May 1989 and lending restrictions in March 1990, stocks, land, and the economy collapsed in that order. The cumulative disposal losses on banks' non-performing loans reached 107 trillion yen by the fiscal year ending March 2020.

The original question Why did "land prices never fall" sound rational?

On September 22, 1985, the finance ministers and central bank governors of five countries issued a statement in New York. It called the U.S. current account deficit and the Japanese and German current account surpluses an imbalance that threatened to destabilize the economy, and stated that exchange rates should play a role in correcting this, and that a further orderly appreciation of the main non-dollar currencies was desirable. In an annexed document, Japan pledged a "flexible monetary policy that gives full consideration to the yen exchange rate" and to stimulate domestic demand by expanding the consumer credit and home loan markets. To cope with the recession caused by the rapid appreciation of the yen, the Bank of Japan lowered the official discount rate five times between January 30, 1986, and February 23, 1987, for a total of 2.5 percentage points. From 5.0% to 4.5%, 4.0%, 3.5%, 3.0%, and then 2.5%. Of the five times, only the first was a unilateral decision by the Bank of Japan. The second and third cuts were coordinated with rate cuts in the U.S. and Germany, the fourth coincided with the Miyazawa-Baker joint statement, and the fifth was on the same day as the Louvre Accord. The 2.5% rate lasted for two years and three months, until May 31, 1989.

Land prices began to move in Tokyo. According to a table from the Ministry of Land, Infrastructure, Transport and Tourism, as of July 1, 1987, land prices for all uses in the Tokyo metropolitan area were up 57.5% year-on-year, and commercial land was up 76.1% (from July 1 of the previous year). The following year, 1988, this spread to the Osaka and Nagoya metropolitan areas, and in 1990, the Osaka area saw a 45.7% increase, with a 13.7% increase nationwide. The economy bottomed out in November 1986 and began to recover, continuing a 51-month expansion until February 1991. The year-on-year money supply (M2+CD) bottomed out at 8.3% in the October-December quarter of 1986 and exceeded 10% in the April-June quarter of 1987.

Stock prices began to accelerate their rise from 1986. After a temporary dip on Black Monday, October 19, 1987, they reached a closing price of 38,915 yen on the last trading day of the year, December 29, 1989. This was 3.1 times the 12,598 yen at the time of the Plaza Accord, with a 29% increase in 1989 alone. The Bank of Japan, concerned about excessive monetary easing since the summer of 1986, guided short-term market interest rates higher at the end of August 1987, but this was interrupted by Black Monday. Consumer prices, at an annual rate of 0.7% in 1988, did not provide a compelling reason for an interest rate hike.

Interest rate hikes began on May 31, 1989. They were raised to 3.25%, then to 3.75% on October 11, 4.25% on December 25, 5.25% on March 20, 1990, and 6.0% on August 30. At the same time, through "window guidance," the Bank of Japan called for "disciplined lending in terms of both quantity and quality." On March 27, 1990, the Banking Bureau of the Ministry of Finance issued a notice titled "On the Control of Land-Related Financing." It had three main points: the basic stance that it was desirable for land-related financing to be at a balanced level relative to total financing; for the time being, the growth of loans to the real estate industry (excluding those to public housing development agencies) should be kept below the growth of total loans; and the status of loans to the real estate, construction, and non-bank sectors should be reported quarterly. This was implemented from April and was referred to in the Diet as "total volume regulation."

The order of collapse differed for each asset. Stocks peaked at the end of 1989 and fell to half their peak value about one month after the interest rate hike of August 1990. The Urban Land Price Index for the six major cities peaked in September 1990 at about four times its September 1985 level. The same land price table showed a 3.2% year-on-year decline for the three major metropolitan areas as of July 1, 1991, and a 14.2% decline as of July 1, 1992. Going back to April 1990, the Bank of Japan's Monthly Research Report wrote that economic agents were implicitly assuming the "land myth"—that land prices would continue to rise, or at least not fall. The Guidelines for Comprehensive Land Policy Promotion, decided by the Cabinet on January 25, 1991, listed the "debunking of the land myth" as the primary goal of land policy.

The total volume regulation was lifted at the end of 1991. The decision was based on the significant decline in land prices, mainly in the three major metropolitan areas, as shown in the July land price survey and a special survey published on December 20; trends in lending by financial institutions; and hindrances to the supply of residential land. Simultaneously with the lifting, a "trigger mechanism" was introduced, which would reactivate the regulation if land prices rose again. The official discount rate began to fall from 5.5% on July 1, 1991, reaching 0.5% on September 8, 1995. The economic peak was in February 1991, and the trough was in October 1993.

The repercussions lasted for a long time. The disposal losses of non-performing loans for all banks, which began to be tallied in the fiscal year ending March 1993 at 1.6398 trillion yen, reached 13.3692 trillion yen in the fiscal year ending March 1996, and exceeded 13 trillion yen in both the fiscal years ending March 1998 and 1999. The Financial Reconstruction Law of October 1998 set a public fund framework of 60 trillion yen, or 12% of nominal GDP. The outstanding balance of risk-monitored loans peaked in the table at 42.028 trillion yen in the fiscal year ending March 2002, and the cumulative disposal losses since fiscal 1992 reached 107.2204 trillion yen by the fiscal year ending March 2020.

What moved were land prices and the credit collateralized by land. Capital gains from stocks and land reached 452% of nominal GDP in the four years from 1986 to 1989, while losses from 1990 to 1993 were 159%. During the 1972–73 "Plan for Remodeling the Japanese Archipelago," this figure was 193%. Gross national assets increased from 4,377 trillion yen at the end of 1985 to 7,937 trillion yen at the end of 1990, rising from 12.88 to 17.18 times the nominal GDP. Within this, the proportion of land and other assets rose from 24.3% to 31.2%. It was not the area of land that increased, but its price, and this price, used as collateral, fueled the expansion of lending.

Who were the borrowers? At the end of December 1989, loans from all banks to the real estate industry amounted to 46.9 trillion yen, and to the construction industry, about 20 trillion yen. The Director-General of the Banking Bureau stated in the Diet that lending to these three sectors, including non-banks, accounted for about 30% of total lending. Corporate and household financing grew by nearly 14% year-on-year in 1989, not only through borrowing but also through a combination of public stock offerings at market price, convertible bonds, and warrant bonds. On the banking side, as deposit interest rates were liberalized starting in 1985 and large corporations began to raise funds in the capital markets, banks shifted towards lending to small and medium-sized enterprises collateralized by real estate and other real estate-related loans. Seven second-tier regional banks that later failed had low profitability from the early 1980s and had been expanding their real estate-related lending since the mid-1980s.

Okina, Shirakawa, and Shiratsuka identify three channels through which monetary easing pushed up asset prices. First, the cost of financing for speculation decreased. Second, high stock prices made it easier to raise funds in the capital markets. And third, the rise in land and stock prices increased the value of collateral, expanding borrowing capacity. This third channel created a feedback loop between land prices and credit: as land prices rose, collateral value increased, leading to more lending, and that money flowed back into land, pushing prices up further. In the fourth quarter of 1989, Japanese banks' share of international lending peaked at 41%. The equity capital of city banks, long-term credit banks, and trust banks increased from 35 trillion yen at the end of September 1988 to 46 trillion yen a year later, due to unrealized gains on stock holdings and capital increases.

Why did the idea that "land prices never fall" sound rational? One reason lay in the system. Taxes on holding land were light, while taxes on selling it were heavy, making it more profitable to hold on to land when prices were expected to rise. The expectation that farmland would be converted to residential land also suppressed supply. From the owner's perspective, rising land prices represented the present value of the benefits created by the system, and this expectation pushed prices up even further. A heavy tax on resales of land held for two years or less was introduced in 1987, and a land value tax was implemented in January 1992, but this was after land prices had already begun to fall. Another reason was experience. According to Okina et al., the rise in land prices at this time was the largest since statistics began in the mid-1950s, both in terms of the real rate of increase and its duration. The system that encouraged rising prices was built on the memory of continuous increases. Words questioning this did not appear in official documents until the Bank of Japan explicitly referred to the "land myth" in April 1990.

The flow reversed after the collapse. Okina, Shirakawa, and Shiratsuka explain the long stagnation through three channels. First, the correction of bullish expectations. Second, the decline in the economic value of capital investment made during the bubble period. And third, the fall in land prices, which eroded the capital of lenders and borrowers, leading to balance sheet adjustments that contracted credit; this third channel was the most significant. Loans where the value of collateral and the borrower's income move in the same direction are, in their words, effectively unsecured. If you ask who ultimately paid the price, it was the borrowers who lost their collateral, the banks that booked disposal losses, and the government, which prepared a framework of 60 trillion yen in 1998. The actual amount injected cannot be confirmed from the sources cited here. The cumulative 107 trillion yen in disposal losses is the trace of land prices that remained on the lenders' books.

'The land inside the Yamanote Line was worth enough to buy the entire United States.' It is not known who first said this. What can be confirmed from the National Accounts is that at the end of 1990, land and other assets accounted for 31.2% of the 7,937 trillion yen in gross national assets. However, there are no materials among the sources cited here that compare this with the total value of land in the United States. The phrase conveys the magnitude of the event, but I have not yet found a record indicating who made this calculation and when.

'Everyone was flipping land.' What can be confirmed from documents is that from 1987, heavy taxes were imposed on resales of land held for two years or less; that loans to the real estate, construction, and non-bank sectors reached about 30% of all loans from national banks; and that the National Land Agency attributed the cause of the price surge to demand for commercial land in central Tokyo, replacement purchases of residential land in surrounding areas, and speculative transactions in anticipation of these trends. There are no records among the sources cited here that quantify the extent to which households and individuals participated.

'The quantitative restrictions burst the bubble.' Looking at the sequence of events, the directive was issued on March 27, 1990, three months after the stock market peak and one week after the official discount rate was raised to 5.25%. Okina et al. write that 'the introduction of quantitative restrictions was almost simultaneous with the collapse of the bubble,' and assess that such restrictions create loopholes when expectations of land price appreciation are strong. In the 1992 Diet, it was noted that a 1990 issue of 'The Economist' had commented that 'implementing it now is far too lenient,' and the swiftness of its repeal was questioned. The Ministry of Finance acknowledged its effectiveness, stating that 'the growth of land-related lending was generally brought under control.' While it was a contributing factor, the documents do not support it as the sole cause.

"Land prices will not fall." This phrase itself was specifically mentioned by the Bank of Japan in April 1990, and in January 1991, the government set its debunking as a goal. Land prices for all uses in the three major metropolitan areas fell for 15 consecutive years from 1991 to 2005 on a year-on-year basis as of July 1, and the Urban Land Price Index for the six major cities was about 80% lower than its peak in 1999. The myth collapsed after it was identified as a myth in official documents.

'It happened because the Japanese were euphoric.' This explanation does not align with the series of causes identified by research. The factors cited by Okina et al. are the behavior of financial institutions, interest rates, the tax system, disciplinary mechanisms, and the policy issues of the era. Psychology appears as a result of the interplay of these factors. The authors themselves point to counter-evidence, such as the fact that similar monetary easing in past phases did not create a bubble, and that asset prices also rose in other countries, such as in Scandinavia, in the late 1980s.

What remains from this event today is not the prices, but the structure. The cycle where rising collateral values increase lending, and lending pushes up collateral values. The observation that when the value of collateral and the borrower's income move in the same direction, the collateral fails to function as such. And the pathway where, after prices fall, the capital of both lenders and borrowers is simultaneously eroded, causing credit to contract. These three points are covered in the page on recurring structures and in the "When Collateral Values Fall" section of the modern money course.

One other point remains: the sequencing of policy tools. Interest rate hikes, window guidance, quantitative restrictions on lending, and the land tax system were all implemented in succession around the time land prices peaked. Opinions are still divided on whether they were effective, too late, or had loopholes. Here, we make no predictions about current Japanese stock or land prices.

It can be compared to the U.S. housing and credit crisis from 2007 in that real estate prices and bank lending were linked, and the fall in prices damaged banks' balance sheets. The difference lies in the location of the mechanism. In Japan, it was centered on bank lending and land collateral, whereas securitization, repo markets, and MMFs were not the main players. The speed of the collapse also differed by an order of magnitude, taking years versus weeks. We do not equate "Japan's Lost Decade" with the post-2008 United States.

We do not draw parallels with Tulip Mania or the Panic of 1907. Land is an asset whose supply can expand, whereas tulip bulbs are unique items; the quality of price records also differs, and the panic had a different time scale. A more instructive comparison, as made by Okina et al., would be to measure the post-World War I land price rise and subsequent losses within the same country using the same yardstick.