BFP Management Blog

Archive: September 2010

Is the US Following in Japan’s Footsteps?

Japan’s “Lost Decade” (1991-2000) began with the asset bubble collapse. The bubble was caused by a massive wave of speculation on assets in Japan then worldwide including stocks and real estate (remember the Japanese purchase of Rockefeller Center in New York City and the Pebble Beach Golf Club in California) fueled by cheap and easy credit. The Japanese government then realized that their entire financial system had become a house of cards leveraged against assets that if priced at “market” value would cause most banks to collapse.

Despite the advice from the United States government to cleanse their bad debts and confront their problems, the Japanese Central Bank in effect categorized their banks as “too big to fail,” poured money into them and allowed them to carry their bad debts undeclared on their balance sheets. As a result, the Japanese began the lost decade and I would argue is still in it. The Nikkei 225 peaked at almost 39,000 in December of 1989 and today sets below 10,000, ¼ of its value from over 20 years ago. The Japanese decision to not “take the pain” and cleanse the system led to this prolonged period of deflation and economic stagnation.

Sound familiar? While the United States did the exact opposite in the late 1980’s – early 1990’s and confronted its problems by creating the Resolution Trust Corporation to dispose of the “toxic assets” on the balance sheets of banks that had failed, the decision was far different this time. They instead chose the path taken by the Japanese.

Have real estate values bottomed? In Chart 1, we see California residential properties for sale on the MLS (Multiple Listing Service) while the shadow inventory of distressed real estate remains gargantuan.

Chart 1

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Source: MLS, MBA and compiled by Dr. Housing Bubble

Let’s remember that the US economy is sputtering at barely positive GDP growth even though the government is borrowing massively to pump money into it. The latest forecast by the White House Budget Office shows the deficit rising to $1.47 Trillion this year, forcing the government to borrow 41 cents of every dollar it spends. It is reasonable to believe that at some point the government will raise taxes and adopt austerity measures (see Greece, Ireland, Spain and Great Britain) to close this gap. Both solutions will cause the US economy to shrink.

In California where the state can’t technically run a deficit, legislators are confronted by a $19 Billion dollar budget hole. In response Governor Schwarzenegger ordered state workers to take 3 unpaid days off per month like he did during the budget stalemate last year. In 2009, it equated to a 14% pay cut for state workers and a reduction of services (i.e. prolonged eviction times due to closed courthouses) for the citizenry.

In chart 2 we see California’s unemployment rate is still above 12%.

Chart 2

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Source: California EDD

The Federal Reserve is keeping interest rates at near zero which punishes savers, because it wants people to instead use their money to buy assets and accept lower rates of return than they would otherwise demand. The Fed’s ultimate goal is to keep asset prices from falling further by prodding savers to invest. I see the results when my friends and clients tell me that they “need to make some money because they are earning nothing in the bank.” They then want me “to buy or find them something that will generate a decent rate of return.” The definition of decent is relative.

The headwinds in the national and most state economies will drag down NOI’s and thusly more price deflation is ahead. I believe a very good opportunity to purchase properties is in our future but like Japan, we may be in for an extended period of deflation before we get there.




Kyle Kazan


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