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Monday, Oct. 22, 2007

JAPANESE PERSPECTIVES

Japan should study U.S. housing crisis, end land price stagnation


On Sept. 19, just as global financial markets were getting jittery about the U.S. subprime mortgage loan problem, the Land, Infrastructure and Transport Ministry released its survey of Japanese land prices.

The annual survey listed the market prices for land as of July 1 at 25,346 points selected by prefectural governments. This year's news was that commercial land prices had risen 1 percent on average from a year ago. The first such increase in 16 years made headlines as a good sign that Japan's deflationary woes were coming to an end.

But many Japanese may have asked themselves: "What is the point of looking at musty two-month-old pricing data if housing prices in the United States are falling so sharply?"

In the first place, Japan has so many varieties of government land data — including street prices used to calculate inheritance and fixed-asset taxes and other data used to guide government calculations for buying land for public works projects — that people are often left wondering where they can get the most accurate, real-time data on Japanese land prices.

This is because Japan lacks a mature system for setting land and housing prices according to market-based mechanisms.

One major problem with subprime mortgages, which were essentially loans made to people with poor credit, is the fact that asset-backed securities were being divided into small parcels, some of which were repackaged as collateralized debt obligations and sold on the market.

This process blurred the link between the properties, which were serving as the collateral, and the securities themselves, thereby preventing fluctuations in property prices from being reflected in the securities they were backing.

If subprime loans had been kept in their original form as "indirect financing," lenders would have watched over the prices of the properties because drops would amplify the risk of the loans becoming uncollectible.

Behind the banking industry's move to securitize subprime loans was the so-called Basel agreement, which governs their capital-to-asset ratios. Financial institutions that worried their ratios would drop because of an increase in lending opted to sell their housing loans to securities houses to collect their funds.

Meanwhile, the primary objective of the securities firms that bought subprime loans to turn them into asset-backed securities for sale was to earn commissions.

Once they sold the securities, they didn't care whether the value of the properties rose or fell, because that was now the purchasers' problem.

This is where the risk of "direct financing" lies. It is the job of rating agencies to let investors know about risk. When it came to subprime mortgages, however, the rating agencies failed to properly assess the the reality of the properties involved and gave property-backed securities higher ratings than they deserved. Hence the huge investor losses.

Lawsuits against rating agencies are expected to multiply. The subprime mortgage crisis is a clear example of the securitization process going too far.

The problem in Japan, on the other hand, is that the market for land- and housing-related securitization is so underdeveloped. A mechanism for trading land and housing in a single package with loans backed by these properties — an activity so common in the West — has not yet been established in Japan.

Such a mechanism would substantially boost real estate transactions in Japan and create a market-based system for setting prices, thereby saving people the trouble of wading through the government's bewildering swamp of land price data.

If an active relationship between interest rates and housing prices/rents can be established, monetary policy will become more effective as it will affect prices not only in the flow economy, but the stock economy as well.

Given the rapidly aging population and the continuing increase in nuclear families, the Japanese people will need to move more frequently than ever to houses that fit their changing family structures. Japan should learn from America's housing woes and make efforts to increase liquidity in land and housing by establishing a mechanism that sets market-based prices for these properties.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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