(March 24, 2008) California has been underperforming the rest of the United States by most economic indicators, largely due to fallout from housing-mortgage problems, according to the latest quarterly report of the California Chamber of Commerce Economic Advisory Council (EAC).
The economic statistics seemed to deteriorate along with the headlines and the financial markets over the past three months.
Since midyear, weakness has spread from residential construction to manufacturers and distributors of housing-related products (doors, windows, shingles, furnaces, etc.) to the financial sector -- first, to mortgage finance and then more broadly to Wall Street and beyond. Employment growth has slowed in other industries as well, reflecting an abundance of employer caution. The nation’s unemployment rate, meanwhile, moved up from 4.6 percent in June to 5 percent in December before edging down to 4.9 percent in January.
Concerns about a possible recession have increased as the data worsened. Virtually all economic forecasters recently reduced their economic forecasts for 2008, with some now expecting a shallow downturn (in GDP terms) early in the year.
Read the full report.
Interest Rates
The Federal Open Market Committee (FOMC) dropped its fed funds target rate in several steps from 5.25 percent in August 2007 to 3 percent at its January 2008 meeting, a swift decline not seen since the 2001 recession. The Fed was motivated by two concerns: an upsurge of extreme instability in global financial markets and fears that the volatility could spread to the real economy, bringing on a recession.
To calm things down, the Federal Reserve and other central banks flooded their respective capital markets with funds and made special lending facilities available to institutions that needed cash to build reserves. But things haven’t calmed down yet; credit markets still get “the jitters” periodically, especially when new data are released about declining home sales or rising loan delinquencies, or when financial institutions announce they have to take large write-offs to reflect the lower value of their mortgage or mortgage-backed portfolios.
Once some degree of normality returns to credit markets and to the real economy, the Fed is likely to raise the target fed funds rate back toward neutrality to avert an upsurge of inflation.
California
Much of the California slowdown in employment growth during 2007 came in the construction, real estate, mortgage-related financial and manufacturing sectors, all of which reduced head counts during 2007.
Exports of goods made in California are providing much-needed strength to the state’s economy. Total state exports grew by 5 percent during 2007, a solid performance, though not as strong as in 2006.
Regional economic performance is mixed, depending in part on the importance of the residential -mortgage-related industries to the local economy and in part on how the rest of the economy is doing.
The San Francisco Bay area continues to outperform other regions of the state. In addition, the biotech sector continues to develop, and tourism-related activities are doing well.
In Southern California, the motion picture industry might return to normal now that the writers’ strike has ended. In Los Angeles, the strongest industries are tourism, technology, and professional business services.
Agriculture and Resources
California’s agriculture sector is holding up well. Prices are high for most products and exports are growing nicely. However, costs also are rising, especially feed grains for livestock and energy of all types.
Water supply will be an important concern in 2008. The weather has been cooperative early in the year, with precipitation at or above normal across most of the state and the areas that feed the Colorado River. Because recent years were relatively dry, however, the water actually in storage is well below average.
Real Estate
The downturn in housing has worsened over the last three months along with conditions in the primary and secondary mortgage credit markets.
The declines in home sales and prices are exacerbated by the scarcity of jumbo mortgages. Because they can be sold readily in the secondary market, most primary mortgage lenders are dealing only in so-called conforming mortgages, which top out at $417,000.
Residential construction also has plunged. Construction of new homes is dropping and effective prices are falling, as they must before the unsold inventories can be cleared and the bottom of the cycle reached.
In contrast to the residential situation, most of California’s commercial real estate markets held up fairly well in 2007. Office markets are mixed, reflecting the mixed trends expected for employment growth in office-based industries.
Risks
Risks are mostly to the downside in this environment. Troubles in the state’s housing markets could worsen further, especially if prices continue to decline.
More volatility in global capital markets might reduce the willingness of financial institutions to take on mortgage-related debt and also to engage in ordinary business and consumer lending, worsening the current credit crunch and slowing business and household spending.
Rising energy prices continue to be an important risk factor. Higher prices of gasoline and other energy-intensive products actually shrink the amount of consumers’ income available for other types of purchases.
Read the full report.
Staff Contact: Dave Kilby