Red-hot housing may cool economy

Article published Sep 28, 2005

Mediocrity is the best Californians can hope for on the economic horizon, according to today's third-quarter report from the UCLA Anderson Forecast.

The worst scenario -- a real estate-led recession -- could bring about weak growth for the next two years. And it all revolves around the red-hot housing market and its cousins -- construction and finance -- the dominant force in the state's economy for many years running, Anderson Forecast senior economist Christopher Thornberg said.

The recovery mode the state finds itself in has not been seen before, according to Thornberg, author of the Anderson Forecast's California Report.

"It's being driven by consumer spending that is itself being driven ever higher by the fabulous sense of wealth homeowners are feeling," according to the report.

"In the meantime, sectors core to California's long-run economic health -- information, manufacturing, professional services -- continue to languish," Thornberg wrote.

Jobs, especially in manufacturing, are at risk, and growth in what Thornberg called "real workplace earnings" is expected to slow down more that it has already.

In a telephone interview from his Los Angeles office, Thornberg said that when homeowners realize their sense of wealth -- "completely unjustified based on fundamentals" -- diminishes, it will come fast, and that will cause problems.

"People need to be saving, and they are not saving," he said.

"The primary drivers of job growth are in retail, construction and finance. When those three drivers go away, it's going to be ugly. You have a lot of people getting over their head thinking that appreciation will bail them out, but that wealth is going to go away," he said.

Thornberg expects a big decline in housing-market activity, primarily in resale homes.
"When this real estate boom does come to an end, as it inevitably must, the economy is going to feel the impact directly and indirectly in almost every sector of the economy. In many ways, the forecast for California is dominated by one question: When is the party going to end?" the report asked.

University of the Pacific economist Sean Snaith, director of the Business Forecasting Center at the Eberhardt School of Business, believes 2005 will be looked upon as the peak of the housing market in terms of new-home starts and appreciation in value.

Earlier this month, he predicted in his U.S. economic forecast that the "housing market soufflé" should peak this year and begin to cool off during the next three years.

"Our region is one of the stronger performers in California, and Stockton in particular stands out, being driven by population growth," said Snaith, who issues a quarterly business outlook focusing on San Joaquin County.

Right now, according to the Anderson Forecast, the housing market is at a crossroads. Keeping an eye on sales and inventory is the key. In the past six months, housing inventories have doubled while overall market activity has been flat statewide, despite a high pace.

Some of the most expensive markets in the country, such as San Diego and the Bay Area, are still seeing appreciation in home prices but total sales falling off.

The quarterly Anderson Forecast also looked at the national economy, predicting a "soft landing" for the housing sector when the bubble bursts.

UCLA senior economist Michael Bazdarich, writing on U.S. conditions, said the bottom line for the nation calls for an improvement in our trade deficit due to slower consumer spending, followed next year by a decline in housing activity. He expects economic growth over the next two years to be in the mid-2 percent range.

The report touched briefly on the effects of Hurricane Katrina, which should amount to little economic impact in California or the nation in the long run.

"Katrina will work to slow U.S. growth in late 2005 and boost it in 2006 and 2007," the report said.

A lot will depend on how long gasoline prices remain high. At $3 a gallon, the price has finally hit the inflation-adjusted price of the early '80s.

"As long as Americans have the time to adjust to the new realities, we don't expect much secondary effects. After all, remember that Europe and Japan have been paying much higher prices than Americans for years," the authors said.