(December 18, 2007) By most indicators, California continues to underperform the U.S. economy, largely due to fallout in the housing sector, according to the latest quarterly report of the California Chamber of Commerce Economic Advisory Council (EAC).
There have been several negative developments since the EAC’s August report, including intensification of the housing slowdown, further deterioration in the credit markets, and soaring oil prices. Nevertheless, the economy has maintained moderate growth.
Consumer spending increased at a 3 percent annual rate and business spending on equipment and software accelerated to a 5.9 percent annual rate of growth. Net exports, which have been contributing strongly to growth throughout 2007, remained very healthy.
Employment growth, which slowed during the summer, picked up steam in October. Job cuts have continued in the housing and financial sector, and in manufacturing. But other sectors are faring better, indicating limited contagion from the housing fallout.
Despite the good economic data, concern about a possible recession has increased. Indeed there is evidence the economy will grow more slowly in the fourth quarter. Consumer sentiment has weakened substantially and retailers are reporting disappointing sales as we approach the holiday season.
Read the full report.
Interest Rates
The Federal Open Market Committee (FOMC) dropped its fed funds target from 5.25 percent to 4.50 percent at its September and October policy meetings. To a large extent, the Fed’s decision was intended to stabilize deteriorating credit markets.
FOMC members also expressed concern about the intensification of the housing market decline and its impact on consumers going forward. But the Fed also maintained warnings about inflation. The EAC believes that credit market developments will determine whether additional Fed rate cuts are likely in the short term.
Problems in the mortgage securities market also continue. Prime mortgage securities that are insured by government-sponsored enterprises -- Fannie Mae and Freddie Mac -- are trading normally. But secondary market trading in subprime mortgage securities remains negligible. The jumbo mortgage loan market (very important to California) froze up in August and has resumed trading since, but at below normal activity levels.
California
California’s non-farm employment increased 71,300 during the first nine months of 2007, accounting for only 6.6 percent of the 1.09 million jobs created in the United States during that period. This compares to California’s 11.5 percent share of U.S. job gains in 2006 and its 12.9 percent share in 2005.
The state’s unemployment rate has increased from 4.8 percent to 5.6 percent since December, while the national unemployment rate has seen a milder increase from 4.5 percent to 4.7 percent.
While the Southern California economy has seen a housing-induced slowdown, particularly sharp in San Diego and Riverside-San Bernardino, the region continues to benefit from its diversity, with solid performances in international trade, technology, aerospace, and tourism.
Industry Highlights
Real Estate
Regional growth differentials within California largely reflect significant differences in housing market performance. Generally, the interior regions of the state, including the Central Valley, High Desert, and Inland Empire regions, are suffering the deepest housing downturns.
Although housing markets are also softening in the coastal areas, home inventories are lower in these regions and price declines (except for San Diego) have been more contained. The San Francisco Bay Area has continued to outperform other California regions. There has been moderate job growth in Silicon Valley, although employment levels remain below peaks of the dot-com era.
Tourism
Tourism remains very strong throughout the country, but there is a risk of decline -- and a consequent decrease in hotel occupancy -- if there is a global economic slowdown.
Banking
The U.S. housing downturn has intensified in recent months. This is in part due to tightening credit conditions related to the near collapse of secondary mortgage markets. California has suffered disproportionately from these problems in part due to the high concentration of subprime loans -- the state accounted for 17 percent of national subprime adjustable rate mortgages and 19 percent of subprime foreclosures in the second quarter, according to the Mortgage Bankers Association.
Agriculture and Resources
California’s agriculture sector is holding up well considering persistent cost pressures derived from several sources. The run-up in corn and other grain prices -- tied largely to rising ethanol demand -- has pushed up animal feed costs. Energy cost increases have also intensified. And farmers face substantial water supply cutbacks during the coming year due to drought and likely reductions in water allocations related to preserving the Delta smelt.
Risks
Risks are mostly to the downside in the current environment. The first risk derives from the decline in home valuations. Another risk derives from the ongoing turbulence in the credit markets. Rising energy prices also remain an important risk factor. The EAC believes that barring a recession, inflated energy prices will play a role in keeping economic growth below its potential during the coming year.
Read full report.
Staff Contact: Dave Kilby