COLUMN LEFT : The Ruinous Folly of Rising Land Values : In the Bush-Reagan years, the assumption has been that what goes up won’t come down.
It is in the nature of all booms that people delude themselves that the laws of economic gravity have been permanently suspended. Today, despite ominous cracks in the masonry, a measure of such optimism still prevails. The crash of BCCI, disclosing regulatory oversight and theft on a staggering scale, is treated as aberrant from normal banking practices. The news that major Japanese securities firms have been faking the value of their portfolios is not treated with the extreme alarm that it deserves.
The scandal can be stated simply enough. Securities firms like Nomura guaranteed that big corporate clients buying into their portfolios would be indemnified against any drop in the price of the stock. In other words, it was a straight scam, in which the price of a stock had absolutely no relationship to its true value.
Japanese assets--shares and, most important of all, land--have long been wildly overpriced. In 1987 the price/earnings ratio of Japanese stocks peaked at 73. This implies a dizzying faith in the future, since if the price remained stable it would take 73 years for the stock to earn in dividends the price put down by the investor. Today the P/E value of Japanese stocks averages out at 45, still highly inflated. In the United States, the equivalent peak in the P/E ratio for Standard & Poor’s 500 was around 22 in 1987; today it hovers just under 20.
Value in Japan ultimately rests on land. Land price inflation far exceeds growth rates in the “real” economy, while at the same time it drives such rates upward. Throughout the 1970s, Japan’s gross national product increased by five times, but its land assets grew by double that amount. The disproportion has been widening.
Land constitutes 65% of Japan’s national wealth, against comparable figures of 33 for the United States and a mere 2.5 for the United Kingdom. There is no parallel in the history of the world for the land inflation in Japan.
As with all inflations, everything is fine if the graphs go up. But last year the Japanese government, urged on by the international banking regulators, began to attempt a measured return toward some sort of congruence between prices and real values. There was a political imperative, too. Social stability and political loyalty in Japan rest to some extent on the hope of young couples that, even if they could never actually afford to buy a home, they might at least dream of doing so.
So the Ministry of Finance instituted a credit crunch. The cap rate on a typical Japanese real estate deal is 2%, meaning that if the purchaser puts cash down for his property, his rate of return is no more than 2%. But if the cost of borrowing is, let us say, 8%, then the purchaser’s hope must be that the underlying asset value will shoot up fast enough to make up the 6% difference. But lately land values have plunged, taking down with them the ability of Japanese companies to raise money on the security of wildly overvalued land--and to finance exports and acquisitions in the United States.
Anyone who thinks that such eruptions are confined to Japan should study the crash of commercial property in the United States. New Jersey regulators recently took over Mutual Benefit Life, the fourth-oldest and 18th-largest life insurance company in the nation. Mutual had come to this disaster through its real estate investments. Moody’s has just downgraded its ratings of the cream of the U.S. insurance industry--among them John Hancock, New England Mutual and Travelers.
The reasons are laid out in detail by Maggie Mahar in “The Great Collapse” in this week’s issue of Barron’s. Mahar paints a desolating picture of overbuilding, overvaluation, back-of-envelope financing and regulatory laxity which now threaten to put the nation’s banking and insurance industries in the same trough as the S&Ls.;
Barron’s saved its final paragraphs for the situation in Los Angeles, where the now-stricken Japanese until recently owned 40% of all downtown office buildings. Vacancies on the West Side have risen from 13% to 15% a year ago to 18% today, and to 20% downtown. The real estate recession has rolled from Texas to New York to Boston, and now to L.A.
What goes up won’t in the end come down has been the assumption of the Reagan-Bush years. In the real world, that is folly. Now and for a long time to come, the consequences will be spelled out in falling rents, bankruptcies and kindred impedimenta of ruin.
