Is California's Economy Sending a Warning Signal?

There is no question that this area is in a recession. We are the canary in the mine shaft.

- John Husing, California Economist.

We are all living in the shadow of a gigantic question mark. What is happening to the global economy? Are we slipping into a recession? How bad will it be? Millions of Americans are asking these questions: Will we lose our homes, our dignity, or our ability to feed our children?

The fact is nobody knows what is going to happen. In fact, most people aren’t really sure what is happening. All they know is that all of the charts are pointing down.

Last week, I talked to a London-based investment banker who is convinced that many senior bank officials do not understand their own “financial instruments.” Not just why they failed, by how they worked in the first place.

When the big picture is so cloudy, financial pundits look for smaller pictures to bring into focus. One popular obsession is trying to “call the bottom.” In other words trying to predict when stocks - as a group – will reverse their descent and begin going up (and yes this will eventually happen).

“The bottom” will come when we get the first signal that better economic times are ahead. Some financial analysts think we are there now. Others think we’ll get there in Q3, 2009. As I said, no one knows.

As it turns out, California may be the key to predicting the bottom.

I spent five days in Los Angeles on my way back from a research trip to South America. I arrived at LAX at 7 a.m. It was already so hot I felt like eating ice cream. I chatted to the bus driver on way to Union Station. She’d lost her home. She told me times were tough. Three of her friends had recently left Los Angeles to live with their parents “down south.”

California’s $1.8 trillion economy is one and half times the size of Russia’s and generates 16% of the U.S. GDP. Over the last few years, California has been a bellwether of America’s economic health. House prices in California rose faster than the rest of the United States. In addition, they began to decline earlier (in 2005), and when they fell, they fell harder.

House prices in San Francisco, Los Angeles and San Diego have plummeted 28% in the last two years compared with 18% for the S&P 20-City Composite Home Price Index.

As the equity drained out of Californians’ homes, they reduced spending. Consumers stopped renovating their houses and buying news cars. That caused a devastating ripple effect with 70% of the economy based on domestic consumer spending. Now the state’s unemployment rate is 7.6%, the highest in the nation. California’s taxable sales have declined for the last three quarters. The state’s home foreclosure rate is one of the highest in the nation.

Palo Alto economist Steve Levy says:

California is moving from a housing-driven slowdown to a consumer-driven recession.

In Los Angeles, I stayed in the Hollywood Hills, in a house that’s lost $600,000 in value in the last 24 months.

I expected that California’s deepest financial wounds would be invisible at this relatively high altitude. But that wasn’t the case. Going for an evening stroll with my friend’s children, I saw four houses for sale that had been repossessed by banks.

Clearly the former tenants are not”Joe-the-Plumber” property owners who got tricked into re-mortgaging their houses with “teaser rates.” The downturn in California has been so severe that it has created a new class of victims.

If you live in a $2,000,000 mansion, typically you are cushioned from the worst type of financial devastation. However, the “cushion” is likely the equity in your home and stocks. When these both lose 50% of their value and you’re in debt up to your eyeballs – a few missed payments –suddenly the bank owns your house.

This matters because – just as California led the way into our current mess, they will likely lead the way out of it. They are a massive diversified, technology-heavy economy.

The first to fall down is usually the first to get back up. Housing prices will likely begin rising in California, before they do in the rest of the United States. Eventually California will rebound.

At Q1 Publishing, we believe in using hard data to predict trends and indentify buying opportunities. “The bottom” is a phantom event. Historically, there are proven conservative buying strategies that will allow you to benefit, no matter which way the market goes. Meanwhile, we’ll be keeping an eye on the economic data coming out of California for an early warning that the economy is starting to turn.

 

Comments

[carey_jim:]

I'm not sure if admitting that we don't understand something is better than thinking, Mr. Magoo-like, that we do understand and that we know perfectly well what we are doing and how the economic world operates.

The virtue of classical economics is that it assures us that it can explain everything even though it is nothing more than a set of ingenious tautologies based on axioms about human nature that are not true. Oddly enough, it gives people confidence to invest in and trust a rosy future.

When we finally start poking around again in the ideas of Keynesian economics, the German historical school and institutional economics, not to mention socialism, we will get closer to the economic truth but further away from our former confidence in the American Way.

Will it be:

"Ye shall know the truth and the truth shall make you free."

or,

"Ignorance is bliss."

2008 Oct 22 12:13 PM

[The Retired...:]

My truth is what i see in working people and that means educated people and working hands on folks.
Too many have lived beyound their means and used the money offered to them by bonus greedy banking .mortgage Co's and bankers that get a yearly bonus
based on the projected profit by the numbers of mortgages they write. then they fudge the applicatioins just enough to screee freddy mac and fannie mae to buy the mortgage and screw the tax payers for a bail out. Then B ear Sterns and lehgman Bros and citi and chase sell this crap to England and scottland rating the C.M.O. "AAA" When it was half full of the fudged application and mortages that were sold to American agency's that were trusting banking to do things by crtedible banking standards.
Lost when we had our bank examiners fired in 1980's
so the big boys could play with our savings.
That's right it started rtight after the S&L blow out set up by the Go0od old boys from 1980 to 1992.
Now 8 more years of rule by the son of the monster thieves .
Desert Storm and now Iraq.
Now they want you to look at joblessness and the stock market see the trees from the forrest.
THINK it's time for a change????
I hope so.

2008 Oct 22 04:01 PM