CalCoast News

Downturn takes a toll on Golden State fortunes

Any recession likely to hit harder here

By Dale Kasler
Sacramento Bee
February 17, 2008

If recent economic history is any guide, California is in for a nasty tumble.

The world's eighth-largest economy is prone to severe peaks and valleys. It soars higher when the financial climate is good – and falls more spectacularly when the nation struggles. Already the real estate meltdown is causing more damage in California than practically anywhere else.

"I think you can safely say if the nation goes into a recession, we're going to have a rougher time," said Howard Roth, chief economist at the state Department of Finance. "The job growth is slowing faster here. We're taking a bigger beating in the housing slump."

Boom and bust have been part of California since the Gold Rush. The state's entrepreneurial streak is legendary and manifests itself in phenomena like the dot-com craze that swept Silicon Valley.

This culture of creativity can lead to excesses that produce wild swings in economic fortunes, said Steve Cochrane, senior managing director of national consulting firm Moody's Economy.com. According to a "volatility index" his firm created, California's job market fluctuates more dramatically than most other states.

"You develop bubbles," said Cochrane, a graduate of the University of California, Davis. "As different industrial trends pass through, for some reason or another they seem to get magnified in California. The strength of the defense spending in the early '90s, the strength of the tech boom in the late '90s, the strength of the housing market – everything seems to get magnified in California."

The state absorbed the worst of the last two national recessions. The vast aerospace industry that transformed Southern California after World War II was devastated by the collapse of the Cold War. The technology bubble that inflated Silicon Valley burst, erasing 20 percent of the valley's jobs, and left the state with a fiscal and political crisis.

The pattern is repeating itself in real estate. The surging housing market – fueled in part by a subprime mortgage industry headquartered in Orange County – became the state's leading economic driver. The collapse could be harder on Californians than the two previous recessions because the troubles in real estate are so pervasive, Cochrane said.

"It's spread pretty broadly across the whole state, in a way worse than 1990 or 2000," he said.

More than most states, California's economy fattened up on real estate when the market was healthy. Housing accounted for one-third of the state's new jobs. Average home prices doubled in five years, which prompted a flood of subprime mortgages to serve moderate-income Californians.

Statistics from the federal Home Mortgage Disclosure Act show about 24 percent of all the subprime mortgage dollars loaned in the United States in 2006 were in California, setting the stage for an epidemic of foreclosures.

The run-up in home prices warped California's economy in another big way. To a degree not seen in most other states, California homeowners tapped their home equity to remodel their kitchens, buy sport-utility vehicles and make other purchases.

Thelma Pugh of North Highlands came to rely on home equity as a cushion. She and her husband took out a $25,000 line of credit a year and a half ago from Countrywide Financial Corp. They've used about $9,000, mostly to pay for home repairs and – when her husband was hospitalized recently – to pay some bills.

"It was like a lifeline," she said. "If I couldn't make ends meet, I had this."

That lifeline was just cut off. The Pughs were among 122,000 Countrywide customers recently notified that, because of vanishing equity, they no longer can tap into their lines of credit.

In the fourth quarter of 2006, so-called equity extractions – from refinancing, home-equity loans or outright sales – accounted for about 17 percent of Californians' disposable income, according to statistics compiled by Scott Hoyt, the director of consumer economics at Economy.com. That was about twice the U.S. average. Only in Arizona and Nevada did homeowners depend more on home equity for cash.

Now significant slowdowns in consumer spending are occurring in states like California where the real estate boom was the loudest.

"It's the reverse piggy bank effect," said Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School. "These are the markets where consumption was driven up by equity. These are the markets where consumption is under negative pressure, where consumption is declining."

Rich Lawrence, a long-standing Sacramento hardware and home-furnishings merchant, is getting an unwanted taste of the downturn in consumer spending.

"This real estate market has just set it off," said Lawrence, president of Emigh Hardware and its sister store, Emigh's Casual Living, on El Camino Avenue. "I've been in this for 40 years, 39 years. I don't remember any time … that it's affected us like it has now."

The last two recessions were more pronounced in California than in the nation. The early 1990s layoffs in aerospace and defense drove statewide unemployment as high as 9.9 percent. National unemployment never topped 7.8 percent.

The dot-com recession wasn't much worse in California as measured by unemployment. But incomes fell further in California than almost every other state. That reflected the wipeout in Silicon Valley, where thousands of high-wage jobs vanished.

That recession spotlighted the perverse nature of California's income tax structure, which relies heavily on relatively few wealthy taxpayers – the people whose incomes fluctuate the most. The end of the tech boom dried up income from capital gains and stock options, triggering a $30 billion state budget deficit. That led to the recall election that ousted Gov. Gray Davis.

Now another big downturn is bringing budget woes to Sacramento. The state, facing a deficit of more than $14 billion, recently scrapped a $400 million office project planned near the Capitol, and the Legislature and Gov. Arnold Schwarzenegger developed a plan for emergency spending cuts last week. Further cuts are almost a certainty for the fiscal year that begins July 1.

"For whatever reason, we've been right at the center of two bubbles," said Roth, the state's chief economist. "I would like to hope we could get some nice steady growth here, so it's not all ups and downs."

Dale Kasler - dkasler@sacbee.com