[Pen-l] First Into Recession, California Shows Possible Future for U.S.

["Charles Brown" <charlesb@xxxxxxxxxxxxxxxxxxxxx>]

First Into Recession, California Shows Possible Future for U.S. 
By _CONOR DOUGHERTY_ 
(http://online.wsj.com/search/search_center.html?KEYWORDS=CONOR+DOUGHERTY&ARTICLESEARCHQUERY_PARSER=bylineAND) , _RHONDA L. RUNDLE_ 
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ESEARCHQUERY_PARSER=bylineAND)  and _JUSTIN LAHART_ 
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Here's the latest trend that started in California and is spreading to the  
rest of the country: recession. 
It's all but certain the U.S. economy is in a recession, as falling home  
prices and Wall Street turmoil have put the brakes on consumer spending and  
stoked unemployment. But California got there first. Now, the state provides a  
template of how a broad U.S. downturn could look. 
 
 
 
 
 
 
View Full Image


Getty Images  
California's current problems started with the housing  bubble, which hit 
places like Moreno Valley, above, particularly hard.
 
 





With its export businesses, manufacturing sector, professional services and  
big retail employers, California looks like many other U.S. states, only more  
so. California's $1.8 trillion economy -- twice the size of India's and  
accounting for about 15% of the U.S. gross domestic product -- is powerful  enough 
to have ripple effects nationally. It is home to Hollywood, five of 30  Major 
League Baseball franchises and the largest farming sector in the  nation. 
California was also at the leading edge of the nation's recent housing  
bubble, which is where its current problems started. Home prices in California  
rose higher and faster than in most of the U.S., and started weakening earlier,  
in 2005. Some mortgage-holders defaulted. Others struggle along under a 
mountain  of debt. The problems spread to the state's financial sector, which was 
heavily  exposed to local real estate. As Californians cut their spending, job 
losses  spread from the housing sector to retail stores and auto dealers. Now 
the  state's unemployment rate is 7.7%, among the highest in the nation. 
Along with Sunbelt states such as Florida and Nevada, California is a big  
source of the shocks now working through the world's banks, corporations and  
stock markets. The financial crisis has frozen credit markets, cutting into  
companies' ability to engage in even the day-to-day borrowing they need to run  
their businesses. 
But even before the most recent blows to the national economy, Californians  
were feeling the downward drag of a consumer-led recession -- in which 
shrinking  home values caused people to rein in their spending, fueling unemployment 
and,  in turn, sparking further spending cuts and joblessness. 
 
 



John Luc has seen how housing problems bleed into the broader economy. Mr.  
Luc is the 36-year-old manager of Homestore Furniture in Ontario, a 
middle-class  community 40 miles east of Los Angeles and one of the centers of the 
housing  bust. Since last year, retail sales have fallen, while unemployment and 
office  vacancies have soared. Eighteen months ago, he watched a nearby Levitz 
furniture  store close down in a bankruptcy sale. Since then, he said, the few 
buyers  who've visited his store ask for discounts. "Everybody negotiates," he 
says. 
The other day, Mr. Luc was presiding over the store's going-out-of-business  
sale. Although the father of two young children expects to get a job at 
another  Homestore outlet, he and his wife have checked their spending. He says he 
saves  $50 or more each week by packing a lunch each day, and he makes coffee 
at home  instead of stopping at Starbucks during his long commute. "I haven't 
gone into a  steakhouse like a Black Angus for dinner in six to eight months," 
he says. 
Consumer spending accounts for about 70% of U.S. economic activity, so as  
people like Mr. Luc cut back, job losses and other economic woes follow. In the  
third quarter of 2007, California's taxable sales declined 1.82% from the  
year-earlier period, the first annual decline since 2002. Taxable sales have  
fallen every quarter since. Now in addition to construction workers and mortgage 
 brokers, people like retail clerks, accountants and information-technology  
consultants are losing their jobs. 
A similar dynamic is playing out nationally. Retail sales recently started  
declining, after peaking in June. Rising job losses appear likely to cut into  
future sales. In September, the U.S. economy shed 159,000 workers from its  
payrolls. The unemployment rate was 6.1%, compared with 4.7% a year earlier. 
There's no universal definition of recession, and little agreement of what  
constitutes one in a state economy. But by most measures economists use --  
rising job losses, shrinking consumer sales -- California fits the bill. "There  
is no question that this area is in a recession," says John Husing, an 
economist  in Redlands, Calif., who tracks the Inland Empire region east of Los 
Angeles.  "We're the canary in the mine shaft." 
It's unclear whether the state, as one of the first to enter an economic  
slowdown, will be among the first to emerge. Problems in the broader economy  
could also hit California in a second wave. Stephen Levy, director of the Center  
for Continuing Study of the California Economy, expects the state's economy 
to  get worse before it gets better. He expects job loss to continue through 
2009,  as consumers continue to pull back. While the housing sector probably 
won't fall  much further, Mr. Levy said, many consumers aren't able to tap the 
equity in  their homes for purchases. Falling stock prices and expensive 
gasoline and food  will continue to eat into spending, he says. 
Not Always a Bellwether
California isn't always a bellwether for the nation's economy. In fact, in  
the past two national recessions, the state was stung by sharp job losses in  
important industries -- aerospace and defense in the early 1990s, and 
technology  in the early 2000s -- but was among the last group of states to succumb to  
recession. 
But this time around, after years of double-digit price rises, median home  
prices stood far above what a household with a median income could afford.  
Permits for new homes began dropping sharply in fall 2005, something that didn't  
happen for the nation as a whole until spring 2006. Home prices in the 
state's  largest real-estate markets fell earlier and further than those 
countrywide.  Prices in San Francisco, Los Angeles and San Diego are currently down an 
average  of 28% from their 2006 levels, compared with 19% for the 
S&P/Case-Shiller  20-City Composite Home Price index nationally. 
The mortgage-lending frenzy was at its hottest in California, and the state's 
 financial firms were at the forefront of extending untraditional mortgages 
that  were then folded into complex securities. Those firms were also among the 
first  to face disaster when the value of those securities collapsed. 
 
 



In April of last year, New Century Financial Corp., a subprime lender in  
Irvine, filed for bankruptcy protection. Four months later, Calabasas-based  
Countrywide Financial Corp. was at the center of the credit-market convulsions.  
The fallout continued into this year: When federal regulators seized  
Pasadena-based IndyMac Bancorp Inc. in July, it was the third-biggest U.S. bank  
failure to date. 
California's losses prefigured the later fallout on Wall Street. Through  
August, California had seen finance-related jobs fall 6.8% over the past two  
years, compared with 1.5% nationally. 
California's consumers are among the country's most indebted. For every  
dollar they take home, Californians spend about 19 cents on mortgages, cars,  
credit cards and other debt payment, compared with about 15 cents nationally,  
according to Equifax and Moody's Economy.com. As consumers pay down that debt,  
there will be less left over for purchases, which is better in the long run for 
 the economy's health but hard on retailers now. 
Pool and Pet Toys
With banks tightening the flow of credit, even companies with rising consumer 
 demand are having a hard time expanding. For the past decade, CoopSport in 
Vista  has sold its beach, pool and pet toys mostly in specialty retailers. But 
last  month, it received orders for the first time from mass merchants Target 
Corp.,  Wal-Mart Stores Inc. and Toy "R" Us Inc. 
In the past, says owner Scott Cooper, CoopSport was able to get credit from  
its Chinese factories at an annual interest rate of about 10%. But as the 
credit  crisis spreads globally, Chinese factory owners won't provide him the 
usual  financing. He also can't get the credit he needs from the U.S. banks he has 
 contacted. So he has stitched together loans from a series of nontraditional 
 lenders, which charge as much as 18% annual interest. 
Mr. Cooper says he has sold a 7.5% equity stake to raise additional capital  
to fund the expansion. Far from adding staff as he gets ready to expand,  
CoopSport eliminated eight warehouse workers and two office staff. The company  
further cut costs by switching to a cheaper box manufacturer and a cheaper truck 
 company. "It's all the things you do when you go into survival mode in this  
economy," he said. 
California's big technology sector could also get hit hard by slowing  
overseas growth and the troubled financial sector. Santa Clara-based  
semiconductor-equipment manufacturer Applied Materials Inc., for example,  fetches more than 
80% of its revenue from overseas sales. And financial firms  are among the 
technology sector's biggest customers. 
Of course, even in recession California has its strengths. With its  
universities producing new technologies and entrepreneurial talent, the state  has a 
disproportionate share of well-paying jobs in sectors like  telecommunications, 
biotechnology and energy-efficient technology. Its  health-care sector, like 
that of the rest of the U.S., has continued to add  jobs. 
Exports also have been a bright spot as a weak U.S. dollar has made goods  
cheaper abroad. The ports of Long Beach and Los Angeles are the nation's two  
largest, and have seen a rising stream of goods headed overseas. Through August  
this year, 22% more full containers were shipped out of the ports combined,  
compared with the first eight months of last year. With the world economy  
slowing, exports are expected to slow locally and across the country. 
Some economists also believe the state's housing market may hit bottom before 
 the rest of the nation's, and could start an upward tick earlier as well. 
The  loss of construction and finance jobs has slowed. In San Diego, one of the 
first  housing markets to falter, home prices are roughly in line with the 
city's  incomes and rental rates. "Housing is becoming affordable again," said 
Steve  Cochrane, an economist at Moody's Economy.com. 
Trouble in Stockton
The pain of the housing bust has been harder on inland areas than it has been 
 in coastal cities such as San Francisco and Los Angeles, which generally 
have  more high-paying jobs. 
Stockton, a bedroom community to the Bay Area known for its asparagus  
festival, saw a boom in home-building and subprime loans this decade. Now,  median 
home values are down nearly 50% from the market's peak, according to  
real-estate information service Zillow.com. Stockton's unemployment rate has  risen 2.8 
percentage points, to 10.3% over the past two years. In San Francisco,  which 
has a greater concentration of jobs in areas like technology and  
professional services, the unemployment rate has risen 1.1 percentage point, to  5.1% 
over the same period. 
In the Bay Area, the creep of economic weakness unfolds in an hour's drive  
from the San Francisco exurbs. Cities like Antioch and Brentwood, past the last 
 stop on the BART commuter rail line, are among the hardest hit by the 
housing  bust. Closer to the coast are Concord and Walnut Creek, two San Francisco  
suburbs that have previously thrived with light industrial and office 
buildings  that are a lower-cost alternative to downtown San Francisco and the Silicon 
 Valley. 
Now, downtown Walnut Creek's commercial vacancy rate for Class A space has  
risen to 14.7% from 9.9% last year. Concord's commercial vacancy rate has 
jumped  to 21% from 9.5% in 2007. 
Ed Del Beccaro, an office broker and senior managing partner at Colliers  
International in Walnut Creek, says his office's income is down about 20% this  
year. Mr. Del Beccaro cut four of his 38 brokers in January. Others, he says,  
have left for "real jobs" because their commissions were so low. 
Car Sales Down
As East Bay consumers have struggled, so has Darren Anderson, whose family  
owns Lehmer's Buick Pontiac GMC in Concord. Mr. Anderson says Buick Pontiac GMC 
 dealers in Northern California sold about 1,000 cars in August, compared 
with  around 1,900 last year. In the past few months, Lehmer's has cut 10 of its  
roughly 50 employees. 
As sales fall, so have the taxes collected by California governments, whose  
spending can offer a buffer during times of economic weakness. Through the 
first  three quarters of this year, California's sales tax revenue is down about 
5%  compared with the first three quarters of 2007. Ongoing budget troubles 
resulted  in a $15 billion deficit this year for California. 
Budget troubles are dÃjà vu for many Californians. In the aftermath of the  
dot-com bust, falling incomes and stock-market losses created a $38 billion  
budget deficit, and the ensuing furor sparked a recall election that brought  
current Gov. Arnold Schwarzenegger to power. 
Today's budget troubles are potentially even worse than in the late 1990s:  
Falling home prices have reduced property taxes on which local governments  
depend, at a time when the state is cutting aid to municipalities. Also, the  
credit crunch has made it harder to sell bonds to fund longer-term capital  
projects such as roads and  schools.



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