The most important case for understanding what happens after a leveraged asset bubble bursts, and the direct template for policymakers' fears in 2008. Displacement: the Plaza Accord (1985) drove the yen sharply higher; to cushion the export blow, the Bank of Japan eased aggressively, unleashing a credit boom into an economy already euphoric about Japan's world-beating industrial rise.
How did the bubble build and burst?
Boom & euphoria, where the numbers are almost unbelievable: the Nikkei ran to 38,957 (December 29, 1989); Tokyo real estate reached valuations so absurd that the land under the Imperial Palace was said to be worth more than all of California, and the grounds of Japan more than the entire United States. The mechanism was a land-collateral loop: banks lent against land, rising land prices increased collateral values, which supported more lending against land. That is pure credit cycle reflexivity, all of it resting on the cultural "land myth" that Japanese land could never fall. Cross-shareholdings (keiretsu) hid leverage and propped valuations.
Trigger/Minsky moment: the BoJ, alarmed, hiked rates sharply (1989–90) and capped property lending. The loop reversed. The crash: the Nikkei fell roughly 80% (to about 7,600 in April 2003 and about 7,050 in March 2009, and it did not reclaim the 1989 high until early 2024, a 34-year round trip); urban land fell ~70%+.
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What is a balance-sheet recession?
The distinctive aftermath, Richard Koo's balance-sheet recession: here is the insight that makes Japan essential. After the crash, Japanese corporations found themselves technically insolvent, because the asset side of their balance sheets (land, stocks bought at the peak) had collapsed while the liabilities (the debt used to buy them) remained at full nominal value. Firms that were still profitable on a cash-flow basis nonetheless shifted their entire objective from maximizing profit to minimizing debt: they used every yen of cash flow to pay down debt and repair their balance sheets, refusing to borrow or invest no matter how low interest rates went. The BoJ cut rates to zero and invented QE; it did almost nothing, because the problem was not the price of credit but that no one wanted to borrow, which is "pushing on a string." With the entire corporate sector saving (deleveraging) at once, private demand collapsed, and the only thing that kept Japan out of a 1930s-style depression was sustained government fiscal deficits filling the demand hole (which is why Japan's government debt ballooned toward 200%+ of GDP). Compounding it: forbearance. Banks and regulators kept insolvent "zombie" firms and banks alive rather than forcing losses, which prevented the cleansing and prolonged the stagnation into the "lost decades" of deflation.
Lesson: after a leveraged asset bubble bursts, you get a balance-sheet recession in which the private sector deleverages regardless of how cheap money is, monetary policy is nearly impotent (pushing on a string), only fiscal policy can fill the gap, and denial and forbearance (zombies) prolong the pain. This is the exact nightmare 2008's policymakers were trying to avoid: a Japan-style lost decade, which is why they moved so fast to recapitalize banks and force loss recognition rather than let zombies fester.