Is our bubble any different?

The graph showing Residential Urban Land Price Index shows a real estate "bubble." If you grew up during the era of the 1980's and your mind wasn't destroyed by listening to the Bee Gees, then you probably heard that the Japanese were going to buy up America. As it turned out, the Japanese were merely in the midst of a real estate bubble, and the effects of that bubble are shown in the graphic above. Note that the six largest cities had a huge bubble while Japan as a whole did not.

Why does this matter? Well, let's take a look at the American real estate "bubble" and see how its affects have been distributed.

What do you notice as similar between the two graphics? You might notice that the cities in Japan had a tremendous increase in land prices, and the values have continued to slide for about 14 years. Japan's central bank has been very active during this period. It has cut interest rates to nothing. Still, Japan has not escaped economic chaos. Like Japan, much of America's rise in real estate wealth was concentrated in major urban areas.

Home prices and land prices tend to follow each other rather closely. The concentration near urban centers is due to wealth created around financial centers. New York, Los Angeles, Boston, and San Francisco all experienced huge increases in home prices during the recent bubble. People flocked to where the money was. What happened in the heartland? Well, if you go to a town in the Rust Belt like Youngstown, Ohio, you can pick up a fine house for about what is charged by a contractor to remodel a kitchen in California.

Japan had a huge trade imbalance in the late 70's and early 80's as the manufacturing sector outperformed every country in the world. However, as Japan's prices increased, it became easier to transfer manufacturing jobs to other countries.

Why did Japan end up going down the tubes? The government created subsidized risk-taking so that restraint wasn't used for business decisions. The American equivalent of this was the transfer of debt via securitization to the market (at large). In both cases, investments or loans were made that were dubious in quality. When financial institutions do not have to be responsible for their actions, they move in the direction of profit.

When there was a decline of asset prices in the Japanese market, bank balance sheets were weakened. There was a general reluctance to extend credit due to increased risk.

The Japanese regulators were unwilling to close down the weakened financial institutions and this prolonged the affect of the recession.

The Japanese introduced fiscal stimulus packages that did little to affect the economy since they were merely pork-barrel projects. The government's spending led to an unprecedented amount of debt. Eventually, the Japanese economy experienced deflation. America has supported banks by giving them public money and now has passed a huge stimulus package that will amount to pork barrel spending.

In 2007, in terms of GDP, at 170% Japan had the third highest public debt of any nation in the world. The public debt of the United States in 2007 was at 61% of GDP. The President and Congress recently approved a 780 billion package. At $13.2 trillion in 2007, the United States' GDP is quite large. Even with the 3 trillion that the Treasury Department is talking about putting into the economy, we won't be in Japan's pitiful condition... or will we?

We're throwing money at the problem, but do we understand the problem? Having listened to the "experts" in Washington and from Wall Street, I would conclude that we do not.

Japan is still having economic problems 14 years after the bubble. What exactly is supposed to make the United States improve the economy? Why will policies that repeated failed to stimulate the Japanese economy be successful in the United States?