Bay Area Economic Forecast 2008-2009

0 0 Bay Area Economic Forecast 2008–2009 0 A Report by Beacon Economics and the Bay Area Council Economic Institute November 2008 This forecast was developed by Beacon Economics in partnership with the Bay Area Council Economic Institute as part of their 2008 Bay Area Economic Forecast conference series. This annual event provides original, incisive analysis on the economic outlook for the Bay Area and its key subregional economies in the year ahead. Beacon Economics www.BeaconEcon.com Christopher Thornberg Founding Principal 2478 Roscomare Road Los Angeles, CA 90077 (310) 739-3286 Chris@BeaconEcon.com Jon Haveman Founding Principal 1299 Fourth Street, Suite 400 San Rafael, CA 94901 (415) 457-6006 Jon@BeaconEcon.com Bay Area Council Economic Institute www.bayareaeconomy.org R. Sean Randolph President & CEO 201 California Street, Suite 1450 San Francisco, CA 94104 (415) 981-7117 gerrie@bayareacouncil.org §1 Bay Area Outlook W hat is the San Francisco Bay Area? The region’s 7.5 million inhabitants are divided across five Metropolitan Statistical Areas. These MSAs comprise 10 counties, 103 cities, and numerous unincorporated areas. But realistically, the whole area functions as a single integrated economy. And what an economy it is, making up one of the most diverse economic regions in the United States. Heavy manufacturing, information technology, finance, high end agriculture, and logistics all share space around the San Francisco Bay. The region has one of the most educated workforces in the world and—with almost one-quarter of the population base born outside of the United States—one of the most diverse. Add two of the best research institutions in the world, a location on the booming Pacific Rim, a premiere port, and an amazing climate, and you have something akin to an urban planner’s pipedream. Given all this, it is clear that the idea that economic diversity and a skilled workforce automatically equal economic stability is simply not true. Instead, the Bay Area has been through a difficult series of booms and busts over the past decade—first with information technology and now with real estate. In many ways the cycles in this region are a magnification of the turmoil the overall U.S. economy has experienced. Yet while the cycles have been large, the underlying strengths of the region have not been undermined—the Bay Area will continue to prosper for the foreseeable future once the imbalances in the local economy are worked through. In short, economic diversity and a skilled workforce don’t promise stability, but they do promise resiliency. Resiliency will be the watchword for the region as the state and nation continue to move through the current financial meltdown and economic recession. The last U.S. recession occurred in the wake of the collapse of the IT bubble in the late 1990s. The hype of this period seems almost comical in hindsight—that information technology was going to create a new economy where old models (such as profit being important) didn’t apply. There would be no more business cycles, growth would run five percent per year, and let’s not forget Dow Jones 33,000. The net result of this hype and resultant surge in the stock markets brought a deluge of investment money into the region. Venture capital was one major source of funding. The PWC Moneytree Survey has been keeping track of venture capital investments for the past 13 years. According to its figures the amount of cash entering Silicon Valley alone grew over five-fold between 1998 and 2000, from $6 billion per year to $33 billion. Add in direct investment and IPO money, and the region began to resemble what the Bay Area looked like during the last great speculative frenzy over gold more than a century before. Amazingly, per capita personal income in San Jose increased by nearly 50 percent between 1997 and 2000. Unemployment across the region dropped to unsustainably low levels even as rents and property prices rose to unsustainable levels. 1 Bay Area Economic Forecast, 2008–2009 Venture Capital Funding Silicon Valley, Q1–1996 to Q2–2008 0 2 Trillions 4 6 8 10 Q1-96 Q1-98 Q1-00 Q1-02 Q1-04 Q1-06 Q1-08 Source: Moneytree Survey Per Capita Personal Income, 1995–2006 Index (1995 = 100), Nominal 120 140 160 180 200 100 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Year San Francisco (MD) United States Source: Bureau of Economic Analysis Of course reality never matched the hype and the crash was realistically just a function of time. When the cash left as fast as it had arrived, the region had to go through a painful period 2 Bay Area Outlook of readjustment. Among regional downturns seen in the United States over the past 30 years, San Jose and San Francisco rank near the top in terms of overall job losses. San Jose lost almost 17 percent of all payroll jobs between 2000 and 2003, and San Francisco lost over 12 percent. Only New Orleans post-Katrina saw a greater loss of jobs in a shorter period of time than San Jose. Worst 3-Year Regional Declines in Payroll Employment MSAs with Greater than 100,000 Jobs New Orleans, LA 2003 to 2006 San Jose, CA 2000 to 2003 Flint, MI 1979 to 1982 Hickory, NC 2000 to 2003 San Francisco, CA MD 2000 to 2003 Gulfport, MS 2003 to 2006 Los Angeles, CA MD 1990 to 1993 Baltimore City, MD 1990 to 1993 Percent -21.3 -16.7 -14.0 -12.2 -12.1 -10.8 -10.4 -10.3 Source: Bureau of Labor Statistics For most of these economies, the damage stayed with the region for an extended period of time; unemployment remained high for five to ten years. But the two economies in the Bay Area saw their unemployment rates drop back to normal levels in three years. In 2005, San Jose ranked number one in terms of median household income among MSAs in the nation, San Francisco was number five, Napa number six, and Vallejo number 11. Investment money continues to flow at a growing pace, and many venture capitalists are now looking to renewable energy and clean technologies as the next big opportunity for the region’s high tech barons. Median Household Income, 2005 Ranking by Household Income MSA San Jose, CA Washington, DC-VA-MD-WV Bridgeport, CT Ventura, CA San Francisco-Oakland, CA Napa, CA Trenton-Ewing, NJ Torrington, CT Lexington Park, MD Poughkeepsie, NY Vallejo-Fairfield, CA Income ($) 76,478 74,708 71,633 66,859 65,382 65,260 64,657 64,544 62,939 62,433 62,213 Rank 1 2 3 4 5 6 7 8 9 10 11 Source: U.S. Census Bureau The reason these areas maintained their high income rankings is that the drop in economic activity was not due to the critical loss of some central industry (e.g., aerospace in Los Angeles in the early nineties) or to some permanent collapse in the population base (e.g., New Orleans this decade) but rather was due to economic activity returning to a “normal” level after being 3 Bay Area Economic Forecast, 2008–2009 overheated for a number of years. The fundamental strengths remained in the local economy despite the boogeyman of outsourcing, high business costs, and infrastructure collapse. Certainly some industries saw a rapid contraction, but none disappeared or even dropped to a point below where they had been in 1997 when the boom began. Hence, a relatively fast recovery was ensured. The greatest legacy of the entire episode may be the fortunes gained and then lost by the region’s many entrepreneurs, leading to the now common bumper sticker seen on many cars reading “Please God—just one more bubble!” While San Jose and San Francisco felt the brunt of the job losses in the 2001 downturn, the East Bay and the North Bay escaped the worst of the downturn. The reasons are numerous. One was that these parts of the Bay Area simply did not have the same degree of up, thus were spared much of the down. But more substantively, as we now can identify with hindsight, these regions had their economies buoyed by another source of aggregate demand— housing and consumer spending. The 2001 downturn was unusual because it was generated primarily by a pullback in business spending. A typical recession has three primary sources of reduced aggregate demand—business spending, consumer spending (particularly on durable goods) and housing. The North Bay and East Bay rely more heavily on consumer spending to fuel economic growth than San Francisco and the South Bay, and as such, the recession simply didn’t hit their economies as hard. Now the U.S. economy has entered into another recession, this time starting with housing and consumer spending. The last of the imbalances that existed in the system in the 2001 downturn are now starting to work their way out of the system. What does it mean for the Bay Area? Many pundits in the region have largely dismissed the national issues as not being local, in large part due to the fact that home prices in the area did not rise by as much at the start of the decade relative to other locations in the state, such as the Inland Empire or Sacramento. Combined with the heavy technology presence and the strength of export growth, many feel that the Bay Area might miss the downturn entirely. But housing is a red herring. The bubble in real estate prices in the Bay Area was reflected not in the rise but the lack of fall—prices had already risen substantially in late 1990s during the IT rush, and they should have fallen in the bust—but they didn’t. Home prices in the area are as disproportionate today as anywhere in the state relative to incomes. Consider the following table where the affordability of homes in the area is calculated by considering how much the median home-owning family would have to spend of their annual income in order to buy the median house with 15 percent down, including taxes and insurance. In 2007, this ratio ran from a high of 72 percent in Marin to a low of 43 percent in Solano. Affordable implies a maximum ratio of 30 to 32 percent. Prices will fall across the Bay Area over the next few months. The pain started in the East Bay and North Bay but is already creeping west and south. Given this, the same issues of falling prices affecting consumer spending that are occurring across the nation and the state are also starting to occur in the Bay Area, and the impact is being felt. 4 Bay Area Outlook Bay Area Home Price Affordability County Alameda Contra Costa Marin Napa Santa Clara San Francisco San Mateo Solano Sonoma Median Price ($) 618,167 584,833 943,167 576,833 738,000 799,000 792,167 436,167 540,667 Median Income ($) 94,228 93,160 107,269 80,089 101,558 102,243 108,924 84,374 78,768 Annual Costs ($) 51,055 48,302 77,897 47,641 60,952 65,990 65,426 36,023 44,654 Share (%) 54.2 51.8 72.6 59.5 60.0 64.5 60.1 42.7 56.7 Notes: Median price is for existing single family home in Q1 2007 Median Income is for home owners in 2007 Annual costs based on 30-year fixed rate mortgage at 6.5% after 15% put down Source: DataQuick Unemployment is up already across the region. The East Bay, not surprisingly is feeling the greatest pinch, but San Jose and San Francisco have also experienced a gradual creeping up of unemployment. Bay Area Unemployment Forecast Q1–1990 to Q4–2012 3 Unempoyment Rate (%), SA 4 5 6 7 Actual Forecast Q1-90 Q3-92 Q1-95 Q3-97 Q1-00 Q3-02 Q1-05 Q3-07 Q1-10 Q3-12 Source: Calculations by Beacon Economics The Bay Area is going to continue to feel the effect as the economy continues to slide into a downturn. This time, it will be a much different experience, but the net result will be that the overall unemployment rate in the region will rise from the 4 percent level it hit in 2006 to over 7 percent, on par with the peak hit in 2003 and 1992. The overall increase is smaller than 5 Bay Area Economic Forecast, 2008–2009 in the 2001 downturn—but this is largely due to the fact that the area’s economy is not dramatically overheated at the moment. In other words, this is a more traditional type recession hitting the region. Other differences include: The greatest impact will shift to the home-centered areas of the North and East Bay, but the overall impact will be spread across regions, since consumer spending is an important driver of growth everywhere. San Jose will be helped by exports, but will be hurt by a decline in domestic business spending. San Francisco will be helped by foreign tourism, but hurt by the financial turmoil. The Bay Area will do better than the state as a whole, in large part due to the quality of its workforce—highly educated workers have more options available to them in a period of economic weakness. This downturn will be seen more in unemployment and less in payroll employment than in the 2001 downturn. This is due to the peculiar nature of the 2001 downturn, in which payrolls were artificially inflated by workers carrying multiple jobs. The losses in jobs will be much broader-based across sectors. The good news is that in 2010, the economy that emerges from the downturn will be much more competitive. The general drop in land prices will take much of the strain off local businesses that compete in the global marketplace, not only from an overall cost perspective, but also in their ability to attract the best workers from around the world. The Bay Area continues to have one of the brightest futures of any economy in the United States. 6 §2 San Francisco Forecast he San Francisco metropolitan area, defined here as San Francisco, San Mateo, and Marin Counties, is the historic core of the vibrant Bay Area economy. It also represents the strongest economy in the state of California at the moment. This is a far cry from the situation seven years ago when the area saw the second-largest increase in unemployment in the state in the wake of the collapsing dot-com bubble and, from an employment and income perspective, suffered one of the worst regional downturns in the United States since the Second World War. The reason for the difference is clear. The downturn that hit the nation in 2001 was driven by a rapid decline in business spending, which both the South Bay and San Francisco areas rely on heavily as a driver of growth. The area had been largely overheated, and much of the decline experienced was due less to a true economic slide than to a simple return to rationality. This time around, the weakness in the economy started with housing, not a primary driver of growth for the already densely populated San Francisco metropolitan area. Indeed, for a while, the area started to think of itself as largely immune to a decline in home prices, much less a decline in overall economic activity. Unfortunately, the troubles that started in the inland areas have indeed begun to infect coastal areas, not just in the Bay Area but across the state. Unemployment has risen in the San Francisco metropolitan area by 1.3 percentage points over the past six months. Payroll employment growth in the region has also started to tip into negative territory after growing at a solid pace through 2006 and 2007. T Forecast of Non-Farm Employment and Unemployment San Francisco Metropolitan Area, Q1–2003 to Q4–2010 Number of Employees (Thousands, SA) 1000 7 Non-Farm Payrolls Q2-04 Q3-05 Actual Forecast Q4-06 Q1-08 Q2-09 Q3-10 940 Q1-03 Source: Calculations by Beacon Economics 3 4 5 6 Unemployment Rate (%) Unemployment Rate 960 980 7 Bay Area Economic Forecast, 2008–2009 A good way of assessing how the labor markets are shifting is to consider the change “offtrend.” How does employment growth over this year compare to the previous two years? The San Francisco metropolitan area was adding approximately 25,000 payroll jobs per year until January 2008. Growth so far this year adds up to a negative 2,000 jobs per year—implying that the region is 27,000 jobs off-trend. From this perspective, the generality of the slowdown can be seen. Every sector of the San Francisco area economy has slowed, with the exception of transport—where the off-trend gain is due to a slowing of job losses in the sector. In absolute terms, the three sectors that have fallen farthest off-trend are professional services, leisure, and retail—sectors critical to this tourist- and office-dependent market. Employment by Industry in the San Francisco Metropolitan Area Year-to-Date Employment Change (Jan.–Sept.) Transport and Utilities Information Wholesale Trade Financial Activities Manufacturing Government Retail Trade Education and Health Services Total NonFarm Construction Other Services Professional and Business Leisure and Hospitality 2007 2008 -4 -2 0 2 4 Change from December (%AR) 6 Source: California Employment Development Department There are other signs of a slowing economy. Taxable sales growth has fallen. Office vacancy rates, still in double digits after the 2001 downturn, have stopped falling, and rents have ominously leveled off. Anecdotally, the once-hot commercial investment market has cooled sharply, and cap rates are already starting to rise. Construction permits have also fallen off. In all cases, the numbers remain stronger than in other regions, but down nonetheless. Housing has also taken a turn for the worse. Home prices—even in central San Francisco County— have started to fall, down 10 percent over the past 12 months according to numbers from DataQuick. Foreclosures are also on the rise. Although still low, the number of foreclosed units has grown by a factor of 3.5 since last year, and notices of default (a pre-step before foreclosure proceedings) are also on the rise. 8 San Francisco Forecast Forecasts of Taxable Sales Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 110 120 130 140 100 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Marin County San Mateo County San Francisco County California Source: Calculations by Beacon Economics Forecast of Building Permits San Francisco Metropolitan Area, Q1–2003 to Q4–2010 Non-Residential Building Permits Millions of Dollars, SA .2 .4 .6 .8 Q1-03 Q2-04 Q3-05 Q4-06 Q1-08 Q2-09 Q3-10 Non-Residential Permits Residential Permits Source: Calculations by Beacon Economics .1 Actual Forecast .2 .3 .4 Residential Building Permits Thousands of Units, SA 9 Bay Area Economic Forecast, 2008–2009 Forecasts of Home Prices Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 100 120 140 160 180 80 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Marin County San Mateo County San Francisco County California Source: Calculations by Beacon Economics The San Francisco metropolitan area is definitely not at the center of the current crisis, but our forecast calls nonetheless for the economic stress in the area to intensify in the coming months. The sources of economic weakness are various, but include the following: While the San Francisco area did not see the same overuse of alternative mortgage products, prices are seriously out of alignment relative to local incomes. The drop in local prices will have an impact on construction and consumer spending. The city center has a large financial industry presence. While much of the pain currently being experienced is hitting Wall Street more directly, as banks continue to consolidate and cut back on costs, the resultant loss of jobs will be substantial. The Bay Area has an integrated economy, and the deeper troubles in the East Bay will have some impact within the San Francisco area. The commercial markets are nearly as out of whack as the real estate markets in terms of price, and the dramatic oversupply that formed from the building boom in the late 1990s remains in place. Despite these downsides, the economy will remain one of the stronger regional economies in the state. The reasons include: Technology will fare well in this downturn as demand from Asia will continue. 10 San Francisco Forecast Home prices will fall less in the area than elsewhere, given the lack of substantive construction in the immediate area. Nevertheless, expect to see them fall 25 percent to 30 percent in the region overall. Educated workers tend to have more options available to them. Because the San Francisco metropolitan area has high educational attainment levels, the region will see less unemployment in times of economic decline. This will maintain the aggregate demand in the area. Tourism will continue to do well with the weak dollar. The highlights of our forecast include: Unemployment in the San Francisco metropolitan area will rise to 6.3 percent by the end of 2009. Payrolls will fall by 2.5 percent over the course of the next two years. Taxable sales will drop by 10 percent across the area. Home prices will fall roughly 25 percent peak to trough. Population growth will flatten over the next two years, but will resurge strongly as lower home prices draw families back to the state. Forecasts of Population Year-Over-Year Change, Q1–2003 to Q4–2010 0 Percentage Change .5 1 1.5 2 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Marin County San Mateo County San Francisco County California Source: Calculations by Beacon Economics 11 Bay Area Economic Forecast, 2008–2009 San Francisco Metropolitan Area Forecasts San Francisco Metropolitan Area Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) Marin County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) San Francisco County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) San Mateo County Population (000s) Net Migration (000s) Home Prices ($,SA) Taxable Sales ($Mil, SA) Actual Forecasts Q1–08 Q2–08 Q3–08 Q4–08 Q1–09 999 1,000 1,000 999 996 4.2 4.7 4.9 5.2 5.5 266 272 275 276 276 220 223 226 227 229 166 116 129 143 153 9 15 12 14 13 569 454 497 434 427 Q1–08 Q2–08 Q3–08 Q4–08 Q1–09 258 258 259 259 259 0.35 0.26 0.19 0.10 0.04 900,801 971,573 919,432 877,993 839,140 1,106 1,106 1,101 1,081 1,069 Q1–08 Q2–08 Q3–08 Q4–08 Q1–09 827 831 834 837 839 2.82 2.83 2.74 2.62 2.52 837,323 798,096 801,223 794,683 785,275 3,794 3,759 3,760 3,706 3,638 Q1–08 Q2–08 Q3–08 Q4–08 Q1–09 741 744 745 746 746 1.08 0.63 0.10 -0.55 -1.06 773,610 718,090 711,999 699,730 682,337 3,323 3,364 3,368 3,305 3,240 Forecasts Q1–10 Q2–10 987 984 6.3 6.1 271 271 232 233 174 185 16 16 347 339 Q1–10 Q2–10 260 261 0.10 0.12 730,828 716,875 1,034 1,040 Q1–10 Q2–10 850 852 2.32 2.23 739,255 727,307 3,381 3,364 Q1–10 Q2–10 746 746 -1.01 -0.67 618,307 607,769 3,117 3,132 Q2–09 994 5.8 274 230 157 14 387 Q2–09 259 0.03 804,543 1,056 Q2–09 842 2.44 773,578 3,554 Q2–09 746 -1.35 662,928 3,187 San Francisco Metropolitan Area Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) Marin County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) San Francisco County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) San Mateo County Population (000s) Net Migration (000s) Home Prices ($,SA) Taxable Sales ($Mil, SA) Q3–09 992 6.1 273 231 158 15 368 Q3–09 260 0.04 774,051 1,040 Q3–09 845 2.39 762,199 3,482 Q3–09 746 -1.43 645,805 3,143 Q4–09 989 6.3 272 232 165 15 349 Q4–09 260 0.07 749,838 1,042 Q4–09 847 2.36 751,463 3,421 Q4–09 746 -1.29 631,147 3,119 Q3–10 980 5.9 272 233 198 17 343 Q3–10 261 0.12 709,773 1,051 Q3–10 855 2.09 718,834 3,375 Q3–10 746 -0.36 602,222 3,180 Q4–10 978 5.7 274 234 211 18 350 Q4–10 261 0.11 705,929 1,061 Q4–10 857 1.90 711,629 3,411 Q4–10 748 -0.14 600,308 3,246 Source: Calculations by Beacon Economics 12 §3 East Bay Forecast arlier this decade, the San Francisco Bay Area, suffering the effects of the bursting dotcom bubble, experienced a significant recession. The San Francisco and San Jose regions led the way, with employment declines of 16 percent and 20 percent, respectively. In the East Bay, Alameda and Contra Costa Counties were relatively insulated from the declines, with a loss of less than 5 percent of their employment base. In the current economic downturn, however, the story is reversed: the East Bay will bear the brunt of the downturn, while San Francisco and San Jose will be less affected. It will be a while before economists can pinpoint the official beginning of this recession. With overall U.S. employment continuing to grow through the beginning of this year, the onset of the recession will likely be considered to have occurred in early to mid 2008. What is clear, however, is that for some regions in California, the recession started significantly earlier. In particular, the East Bay and Orange County began shedding jobs much sooner than other regions. These two areas have one thing in common: they both experienced a dramatic increase in employment in the finance and insurance segment of the economy, which includes mortgage originators. As the East Bay more fully benefited from the run-up in mortgage activity than did other parts of the Bay Area, it is no surprise to find it on the leading edge of the recession. The recession in the East Bay will therefore be both deeper and longer than much of the rest of the region and state. Recovery will come, however, and the East Bay has much to gain from the bursting of the housing bubble. Home prices in the East Bay increased right along with prices in other Bay Area regions. As did these other regions, Alameda County and Contra Costa County experienced a significant erosion of affordability. The high cost of housing has pushed middle-class workers to outlying areas of the region. As housing prices come back into line with affordability, the workers who fuel the East Bay economy will return. Over the longer term, the future remains bright for the region. With a world-class university, world-class infrastructure in the airport and seaport, affordable and plentiful office space, a skilled labor force, and significant cultural diversity, the East Bay has been identified as a region with significant economic potential. This is evidenced by the flood of venture capital related to alternative energy flowing into the region—perhaps making the East Bay the region’s Green Corridor—and by the significant quantity of foreign direct investment. E 13 Bay Area Economic Forecast, 2008–2009 In the meantime, however, the East Bay will see continued declines in employment and personal incomes through 2010. Of additional importance, declining home prices will exert downward pressure on the region’s taxable sales and revenue from the housing sector, challenging local government budgets for several years to come. The East Bay essentially stopped adding jobs in August of 2006. Since then, non-farm payroll employment has fallen by nearly 20,000. The region’s unemployment rate started ticking upward a couple of months later, and now stands at 6.6 percent after bottoming out at 4.4 percent, also in August of 2006. Forecast of Non-Farm Employment and Unemployment East Bay Metropolitan Division* Q1–2003 to Q4–2010 Number of Employees (Millions, SA) 1 1.01 1.02 1.03 1.04 1.05 Q1-03 Q2-04 Q3-05 Q4-06 Q1-08 Q2-09 Q3-10 Non-Farm Payrolls Unemployment Rate * The statistical area that comprises the East Bay encompasses Alameda and Contra Costa Counties and is otherwise known as the Oakland–Fremont–Hayward, CA Metropolitan Division (MD). Source: Calculations by Beacon Economics Endowed with strong fundamentals, the East Bay is likely to recover and resume a solid growth path in the near future, but correcting for some of the overgrowth of the housing bubble may be painful in the short run. Employment is forecast to decline by 27,000 by the middle of 2010, at which point it will resume its positive trajectory. The region’s unemployment rate, which never made it above 7 percent during the last recession, is likely to flirt with 8 percent this time around. The declines in employment began in the financial activities sector. This is one of a small number of sectors in the region’s economy, along with information services and manufacturing, to have experienced a decline through the first eight months of 2007. 14 4 Actual Forecast 5 6 7 Unemployment Rate (%) 8 East Bay Forecast However, through early 2008, the declines in employment have become increasingly broadbased. The only major sector to have experienced positive employment growth through August of this year is education and health services. The construction sector, especially residential activities, has been leading the charge downhill through much of this year. Employment by Industry in the East Bay Year-to-Date Employment Change (Jan.–Aug.) Financial Activities Information Manufacturing Wholesale Trade Total NonFarm Professional and Business Transport and Utilities Construction Leisure and Hospitality Other Services Retail Trade Education and Health Services Government 2007 2008 -15 -10 -5 0 5 Change from December (%AR) Source: California Employment Development Department Construction Employment, Jan. 2006–Aug. 2008 Index (Smoothed, Jan 96 = 100) 90 95 100 Jan-06 Jun-06 Nov-06 Bay Area Apr-07 Sep-07 Feb-08 Jul-08 East Bay (MD) Source: California Employment Development Department 15 Bay Area Economic Forecast, 2008–2009 Alameda and Contra Costa Counties have experienced more significant declines in construction and financial sector employment than any other Bay Area counties except Napa. Both declines are closely related to the bursting of the bubble in housing markets. The relationship between construction and housing is clear. With housing starts nationwide having reached a 17-year low in August of this year, it is no wonder that construction employment is down more than 10 percent from its peak in the East Bay. That the housing market should take down employment in the financial sector is less obvious. Granted, part of the financial sector is devoted to real estate services, and these services are in lower demand when fewer houses change hands. This element has contributed significantly to the decline in financial employment in the region. However, playing an even larger role, on both a percentage basis and in absolute terms, is the finance and insurance sector, reflecting significant reductions in the demand for mortgage loan services. Both of these sectors have been falling significantly faster than elsewhere in the Bay Area, and we expect this trend to continue over the near term. Financial Activities Employment, Jan. 2006–Aug. 2008 Index (Smoothed, Jan 96 = 100) 80 85 90 95 100 Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Bay Area East Bay (MD) Source: California Employment Development Department While many of the jobs associated with mortgage loan origination have already been shed, construction employees are continuing to work on those residential projects already started. When these are finished, there will be precious little residential construction to absorb these workers. 16 East Bay Forecast Forecast of Building Permits East Bay (MD), Q1–2003 to Q4–2010 Non-Residential Building Permits Millions of Dollars, SA .1 .3 .4 .2 Q1-03 Q2-04 Q3-05 Q4-06 Q1-08 Q2-09 Q3-10 Non-Residential Permits Residential Permits Source: Calculations by Beacon Economics The housing bubble is largely a phenomenon of the post-dot-com era. Between 2000 and 2006, the average price of a home in the East Bay metropolitan division increased by 114 percent. Having peaked in the first quarter of 2006, prices had fallen by 39 percent by the end of the first quarter of this year. This decline in housing prices has been accompanied by a staggering increase in foreclosures in Alameda and Contra Costa Counties. At over 3 percent in Contra Costa and just over 2 percent in Alameda, foreclosure rates are at historic highs and appear to be headed higher. (Our data only go back as far as 1994, making the current figures at a minimum 14 year highs.) Because of the easy availability of credit and the ever-growing variety of mortgage products, many in the East Bay have found themselves locked into mortgages that they can no longer afford, on houses that are now worth less than the original mortgage. Of the common subprime loans, the East Bay has roughly 32,000 outstanding. Many of these loans have yet to reach their first reset date, having originated in 2006 or 2007. Recent history suggests that these loans will go into foreclosure at staggering rates. In the last five months, for every one of these loans that paid off, six went into foreclosure. This does not bode well for the foreclosure rates in the East Bay. Home prices have declined significantly from their peak. We expect these declines to continue through the middle of 2012. The majority of the decline will be experienced by the end of 2010, at which point median home prices in Alameda and Contra Costa Counties are likely to be on the order of $320,000 and $284,000, respectively. .2 Actual Forecast .4 .6 .8 1 Residential Building Permits Thousands of Units, SA 17 Bay Area Economic Forecast, 2008–2009 Forecasts of Home Prices, Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 100 120 140 160 180 80 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Alameda County California Contra Costa County Source: Calculations by Beacon Economics This recession, more than most, will strain the budgets of local municipalities. In particular, they will suffer the twin burdens of declining taxable sales revenues and rapidly declining property tax and transfer tax revenues. Although the latter tend to decline in a typical recession, the declines that will be experienced this time around will play a much larger role. Forecasts of Taxable Sales, Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 120 110 130 100 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Alameda County California Contra Costa County Source: Calculations by Beacon Economics Taxable sales in the East Bay started their decline in early 2007. As of the second quarter of 2008, taxable sales were below their peak in both counties, though more significantly so in 18 East Bay Forecast Alameda County than in Contra Costa County. These declines are driven not only by declines in employment but also by the perception of reduced wealth among the region’s residents due to the decline in their housing values. We anticipate a decline in taxable sales in both counties through early 2010. These declines will not be as severe as those in much of the rest of the state, but will cramp the style of many local governments. Along with the double-edged sword of both a falling base for property taxes and a rapidly diminishing number of housing transactions, residential property–related receipts will also decline for the next several years. Home Sales, East Bay (MD), Q1–2003 to Q4–2010 Index (Q1-2003 = 100), SA 60 80 100 120 140 40 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 New Home Sales Existing Home Sales Source: DataQuick The years 2007 and 2008 have been difficult years for the East Bay. Our forecast is that 2009 and 2010 will be equally difficult, with an earnest recovery beginning in 2011. Nonfarm payroll employment will likely decline by another 29,000 jobs, or 3 percent of the current level. The unemployment rate will flirt with 8 percent by the middle of 2010. The biggest fiscal effect on the East Bay economy will come from continued declines in home prices. Throughout the East Bay, home prices will experience an additional 25 percent to 30 percent decline by the end of 2010, with small lingering corrections to remain thereafter. Taxable sales will decline by 6 percent from the current level, bottoming out in the first quarter of 2010, before beginning a slow march upward. 19 Bay Area Economic Forecast, 2008–2009 East Bay Forecasts East Bay (MD) Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) Alameda County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Contra Costa County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Actual Q1–08 Q2–08 1,043 1,036 5.2 5.8 265 271 220 223 256 203 12 6 328 354 Q1–08 Q2–08 1,543 1,548 1.3 1.0 535,475 488,124 6,166 6,271 Q1–08 Q2–08 1,054 1,058 2.4 2.6 437,973 363,394 3,453 3,539 Q3–08 1,034 6.0 272 225 264 6 335 Q3–08 1,551 0.8 469,604 6,274 Q3–08 1,061 2.7 353,426 3,516 Forecasts Q4–08 Q1–09 1,030 1,025 6.2 6.5 271 270 227 228 325 305 8 7 326 311 Q4–08 Q1–09 1,554 1,555 0.3 -0.2 452,624 433,475 6,189 6,126 Q4–08 Q1–09 1,065 1,068 2.6 2.5 348,317 340,921 3,471 3,444 Q2–09 1,019 7.0 267 229 263 8 294 Q2–09 1,557 -0.7 413,348 6,050 Q2–09 1,072 2.4 330,832 3,425 East Bay (MD) Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) Alameda County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Contra Costa County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Q3–09 1,015 7.5 265 230 269 8 273 Q3–09 1,559 -1.2 394,230 5,966 Q3–09 1,075 2.2 320,523 3,387 Q4–09 1,009 7.8 263 230 322 9 254 Q4–09 1,559 -1.7 377,105 5,947 Q4–09 1,078 2.0 311,388 3,389 Forecasts Q1–10 Q2–10 1,007 1,005 8.0 8.1 262 261 230 230 406 507 12 15 241 232 Q1–10 Q2–10 1,560 1,559 -2.3 -2.8 360,401 344,483 5,909 5,925 Q1–10 Q2–10 1,081 1,084 1.8 1.6 302,355 294,048 3,366 3,372 Q3–10 1,006 8.1 261 230 601 18 229 Q3–10 1,559 -3.2 331,366 5,979 Q3–10 1,087 1.4 288,048 3,396 Q4–10 1,007 8.0 262 230 683 22 229 Q4–10 1,558 -3.6 319,975 6,048 Q4–10 1,089 1.3 284,107 3,417 Source: Calculations by Beacon Economics 20 §4 South Bay Forecast W ith employment falling nationwide in each of the last nine months, and statewide for most of the last year, the San Jose Metropolitan Statistical Area (Santa Clara and San Benito Counties) has held up reasonably well. Though it has been experiencing employment declines in recent months, these declines did not begin until April or May of this year. A late bloomer in this recession, this region is also likely to get off relatively easy. Unemployment in the region bottomed out at 4.4 percent in September of 2006, increased slowly through much of 2007, and took off in earnest in 2008, increasing from just 5.1 percent in January to its current level of 6.6 percent. San Jose and the East Bay currently share the honor of the highest unemployment rates in the Bay Area. Forecast of Non-Farm Employment and Unemployment San Jose Metropolitan Statistical Area, Q1–2003 to Q4–2010 Number of Employees (Thousands, SA) 860 880 900 920 Q1-03 Q2-04 Q3-05 Q4-06 Q1-08 Q2-09 Q3-10 Non-Farm Payrolls Unemployment Rate Source: Calculations by Beacon Economics Endowed with strong fundamentals, the South Bay will recover and resume a solid growth path in the near future, but correcting for some of the overgrowth of the housing bubble will lead to some job loss in the short run. South Bay employment is forecast to decline by 11,000 4 Actual Forecast 5 6 7 8 Unemployment Rate (%) 9 21 Bay Area Economic Forecast, 2008–2009 by early 2011. Employment growth will then return, with the region recovering its current employment levels by late 2012. This is a much faster recovery than that experienced earlier this decade. The region’s unemployment rate is forecast to peak at 7 percent in late 2009. With relatively small employment declines and unemployment levels well below their post dot-com peak in late 2000, this recession, though uncomfortable, will be much shallower than the last. Year-to-date employment for the region has turned negative. Having grown at a 1.6 percent annual rate in the first 8 months of 2007, employment has declined at a -0.3 percent annual rate during the same period in 2008. In 2007, contracting employment was experienced by a handful of sectors, led by construction, finance and insurance. These are the sectors most heavily influenced by the housing bubble—finance and insurance through the dramatic increase in mortgage loan originations, and construction through the building of ever more homes. Leisure and hospitality and federal government employment also declined in 2007. Employment by Industry in the San Jose MSA Year-to-Date Employment Change (Jan.–Aug.) Leisure and Hospitality Construction Financial Activities Government Retail Trade Professional and Business Wholesale Trade Total NonFarm Other Services Education and Health Services Transport and Utilities Manufacturing Information 2007 2008 -5 0 5 Change from December (%AR) 10 Source: California Employment Development Department Employment declines were experienced much more broadly in 2008 as information services, professional and business services, and education and health were the only major sectors to see growth during this period. Employment declines in finance have accelerated in 2008, but remain low by Bay Area standards. Led by the East Bay, this sector has experienced dramatic Bay Area-wide declines. Since its peak in roughly January of 2006, employment in financial activities has fallen by more than 6 percent. 22 South Bay Forecast Financial Activities Employment, Jan. 2006–Aug. 2008 Index (Smoothed, Jan 96 = 100) 100 102 94 96 98 Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Bay Area San Jose MSA Source: California Employment Development Department Construction in the South Bay peaked much later, but has fallen more rapidly than in the rest of the region. As was true of much of the region, the decline was moderate until early 2008, when it accelerated sharply. There are signs of a bottoming out, but it is too soon to tell. Construction Employment, Jan. 2006–Aug. 2008 Index (Smoothed, Jan 96 = 100) 94 96 98 100 102 Jan-06 Jun-06 Nov-06 Bay Area Apr-07 Sep-07 Feb-08 Jul-08 San Jose MSA Source: California Employment Development Department 23 Bay Area Economic Forecast, 2008–2009 The housing bubble is largely a phenomenon of the post dot-com era. Between 2000 and early 2006, the average price of a home in the South Bay increased by 70 percent. Having peaked in the first quarter of 2007, prices had fallen by 12.7 percent by the end of the first quarter of 2008. This decline in housing prices has been accompanied by a dramatic increase in foreclosures in Santa Clara County. The number of homes in foreclosure in Santa Clara County has increased by 518 percent since the end of 2006—from 301 to 1,863. As is true following most housing bubbles, the rate of sales of private residences was the first to begin to decline. Peaking in early 2004, the volume of home sales is now less than half of what it was at its peak. This declining sales volume and the significant mortgage interest rate resets on variable rate loans were together likely responsible for the increase in foreclosures. The increase in foreclosures began in early 2006, has continued through today, and will likely continue for the foreseeable future. Santa Clara County Housing Market, Q1–2003 to Q2–2008 120 130 140 150 160 170 Case Shiller Index (Q1-2000 = 100) Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Foreclosures All Home Sales Case Shiller Index: San Jose MSA Sources: S&P and DataQuick Because of the easy availability of credit and the ever-growing variety of mortgage products, many in the South Bay have found themselves locked into mortgages that they can no longer afford, on houses that are now worth less than the original mortgage. Of the common subprime loans, the South Bay has roughly 12,000 outstanding. More than half of these loans have yet to reach their first reset date, having originated in 2006 or 2007. Recent history suggests that these loans will go into foreclosure at staggering rates. In the last five months, for every one of these loans that paid off, six went into foreclosure. This does not bode well for the foreclosure rates in the South Bay. Home prices play a significant role in generating foreclosure activity. Having fallen by 15 percent from their peak, home prices are forecast to decline by another 13 percent from 24 Foreclosures and All Home Sales Thousands of Units 0 2 8 4 6 Q1-03 South Bay Forecast current levels. Declines in the region are forecast to be much less than across much of the state; Santa Clara County simply did not experience the astronomical appreciation that occurred elsewhere in California. Forecasts of Home Prices, Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 100 120 140 160 180 80 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 Santa Clara County California Source: Calculations by Beacon Economics Though the price declines will be relatively small, more and more homeowners in Santa Clara County will find themselves with the principal on their mortgage exceeding the value of their home (a situation commonly referred to as being underwater on your mortgage). In this position, homeowners may be inclined to simply walk away from a mortgage. This is not only true of homeowners in the South Bay, but of homeowners all across the state and much of the nation. This recession, more than most, will strain the budgets of local municipalities. In particular, they will suffer the twin burdens of declining taxable sales revenues and rapidly declining property tax and transfer tax revenues. Although the latter tend to decline in a typical recession, the declines that will be experienced this time around will play a much larger role. Taxable sales in California started their decline in early 2007. As of the second quarter of 2008, taxable sales in Santa Clara County had not declined significantly, though they were off slightly from their peak in the first quarter of 2008. Taxable sales in San Benito County are much more volatile, and we have not yet detected significant declines, nor do we anticipate a major decline in San Benito taxable sales. The declines in taxable sales in Santa Clara County are driven not only by declines in employment but also by the perception of reduced wealth among the region’s residents. We anticipate a decline in taxable sales in the county through early 2010. These declines will not be as severe as those in much of the rest of the state, but will nonetheless cramp the style of local governments. 25 Bay Area Economic Forecast, 2008–2009 Forecasts of Taxable Sales, Q1–2003 to Q4–2010 Index (Q1 2003 = 100) 110 120 130 100 Actual Forecast Q1-03 Q4-03 Q3-04 Q2-05 Q1-06 Q4-06 Q3-07 Q2-08 Q1-09 Q4-09 Q3-10 San Benito County California Santa Clara County Source: Calculations by Beacon Economics Santa Clara County Home Sales, Q1–2003 to Q2–2008 Index (Q1-2003 = 100), SA 100 200 300 400 0 Q1-03 Q1-04 Q1-05 Q1-06 Q1-07 Q1-08 New Home Sales Existing Home Sales Source: DataQuick 26 South Bay Forecast The year 2008 has seen the onset of economic difficulties for the South Bay. Our forecast is that these difficulties will carry on into 2009 and early 2010. At that point, recovery will begin in earnest and the region will experience rapid growth. Nonfarm employment will decline by only 12,000 jobs throughout the recession, or just over 1 percent of the current level. The unemployment rate will flirt with 7 percent, well below its 2001 levels. A significant fiscal effect on the South Bay economy will come from continued declines in home prices. Throughout the South Bay, home prices will decline by approximately 13 percent from their current levels. This decline will persist through early 2011, at which point home prices will experience respectable and long-term sustainable growth. Taxable sales will decline by just over three percent, exerting relatively little influence on local government revenues. Transfer taxes and reduced growth in property tax revenues will likely exert a more significant force on local revenues. Because of relatively small declines in home prices and the presence of strong fundamentals, the recession in this region will be relatively mild, by Bay Area standards. 27 Bay Area Economic Forecast, 2008–2009 South Bay Forecasts San Jose MSA Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) San Benito County Population (000s) Net Migration (000s) Taxable Sales ($Mil, SA) Santa Clara County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Actual Q1–08 Q2–08 913 913 5.1 5.8 110 113 220 223 291 461 12 4 604 448 Q1–08 Q2–08 57.9 58.1 46 48 134 139 Q1–08 Q2–08 1,840 1,848 2,368 1,633 710,293 675,357 8,635 8,561 Q3–08 913 6.0 115 226 439 7 539 Q3–08 58.1 71 140 Q3–08 1,856 935 675,409 8,625 Forecasts Q4–08 Q1–09 912 911 6.2 6.4 116 116 228 229 437 435 6 6 512 523 Q4–08 Q1–09 58.3 58.4 79 73 140 140 Q4–08 Q1–09 1,862 1,868 204 -354 665,249 652,244 8,559 8,470 Q2–09 911 6.7 116 230 440 6 514 Q2–09 58.5 63 140 Q2–09 1,873 -622 637,880 8,360 San Jose MSA Nonfarm Payrolls (000s, SA) Unemployment Rate (%, SA) Personal Income ($ Bil, SAAR) Inflation (CPI) Single-family Permits (Units) Multifamily Permits (Units) Nonresidential Permits ($ Mil, SAAR) San Benito County Population (000s) Net Migration (000s) Taxable Sales ($Mil, SA) Santa Clara County Population (000s) Net Migration (000s) Home Prices ($, SA) Taxable Sales ($Mil, SA) Q3–09 910 6.9 116 231 439 6 511 Q3–09 58.8 52 140 Q3–09 1,879 -633 625,157 8,311 Q4–09 908 6.9 117 233 454 6 502 Q4–09 59.0 42 140 Q4–09 1,884 -426 614,735 8,293 Forecasts Q1–10 Q2–10 907 906 6.8 6.7 117 118 234 235 467 485 5 5 494 487 Q1–10 Q2–10 59.3 59.5 37 41 141 141 Q1–10 Q2–10 1,889 1,895 -64 358 604,136 594,840 8,313 8,367 Q3–10 904 6.5 119 236 508 5 482 Q3–10 59.7 55 143 Q3–10 1,901 755 590,045 8,451 Q4–10 903 6.2 121 237 526 5 483 Q4–10 59.9 78 144 Q4–10 1,907 1,059 586,848 8,559 Source: Calculations by Beacon Economics 28 Data Sources State and Local Public Finance California Department of Finance California State Legislative Analyst's Office California State Franchise Tax Board California State Board of Equalization www.CalTax.org California State Controller Quality of Life NOAA National Weather Service California Department of Justice California Department of Finance Texas Transportation Institute Fatality Analysis Reporting System California Air Resource Board California Department of Education Research and Development (RAND) National Science Foundation Employment and Income California Employment Development Department U.S. Census Bureau, American Community Survey U.S. Department of Labor, Bureau of Labor Statistics Real Estate Altos Research DataQuick Information Systems Hanley Wood Market Intelligence Property & Portfolio Research RealFacts Construction Industry Research Board California Association of Realtors Mortgage Bankers Association S&P Case-Shiller Demographics California Department of Finance U.S. Census Bureau Business Activity California Board of Equalization U.S. Bureau of Economic Analysis California New Car Dealers Association WISERTrade.org Bureau of Transportation Statistics Research and Innovative Technology Administration 29 Beacon Economics is home to some of California’s leading economic researchers and consultants. Founded in 1996 by two PhD economists, Beacon has offices in both Northern and Southern California and provides independent and rigorously researched analysis on a wide range of business, economic, and public policy issues. Our expertise spans national, state, and regional forecasting; real estate and business market analysis; local and state economic development strategies; and the economics of international trade. Services Regional Economic Forcasting Public Speaking Research Expert Testimony and Litigation Support The Bay Area Council Economic Institute is a public-private partnership of civic leaders that works to support the economic vitality and competitiveness of California and the Bay Area. Its work builds on the twenty-year record of fact-based economic analysis and policy leadership of the Bay Area Economic Forum, which merged with the Bay Area Council in January 2008. The Bay Area Council and the Association of Bay Area Governments (ABAG) are its leading institutional partners. Through its economic and policy research and partnerships, the Economic Institute addresses major issues impacting the competitiveness, economic development and quality of life of the region and the state, including infrastructure, globalization, science and innovation, and governance. Its Board of Trustees, which oversees its products and initiatives, is composed of leaders representing business, labor, government, higher education, science and technology, philanthropy and the community. 30 0 Bay Area Council Economic Institute 201 California Street, Suite 1450 San Francisco, CA 94111 (415) 981-7117 (415) 981-6408 Fax gerrie@bayareacouncil.org www.bayareaeconomy.org