The Japanese Asset Price Bubble

Japan's asset bubble of the late 1980s inflated real estate and stocks at the same time. Banks lent against land, companies used that land and their rising stock as collateral to borrow more and buy more of both, and when the Bank of Japan tightened policy starting in 1989, land and stock prices fell together starting in 1990.

The same collateral chain that inflated both unwound both, and Japan spent the following decade working through the wreckage, a period that came to be called the "lost decade." At the peak, the land under the Imperial Palace in Tokyo was said, by one widely repeated estimate, to be worth more than all the real estate in the state of California. That kind of number happens when the pricing mechanism has stopped being about what the land produces and started being about what it can be borrowed against. A bank holding land as collateral for a loan, and a company holding stock as collateral for another loan, are both exposed to the same underlying asset even though they look like separate balance sheets.

why both fell at once

Shared collateral links markets that look unrelated on the surface. When land prices fell, the collateral backing corporate borrowing shrank, which forced deleveraging, which pressured stock prices, which shrank the collateral value of the shares companies also held, which pressured lending further. Two asset classes, one chain, and pulling on one end pulled the other down with it.

the balance-sheet recession

The economist Richard Koo later described what followed as a "balance-sheet recession": companies whose asset values had collapsed while their debts stayed the same size spent the next years paying down debt instead of investing or expanding, even at very low interest rates. That's a different animal from an ordinary recession caused by weak demand. It's a hole in the balance sheet that has to be filled before normal decision-making can resume, and filling that hole took the better part of a decade.