Chapman CA Forecast Warns Legislature

JUNE 16, 2011

By JOHN SEILER

This morning, Gov. Jerry Brown vetoed the budget passed yesterday by the Democratic-run California Legislature. Even as he was doing so, Chapman University was revealing a sobering economic forecast that should make the Legislature think twice before raising taxes. I attended the presentation before more than 800 Southern California business and community leaders.

The upshot is that there is going to be no booming economic recovery, as after the 1991-92 and 2001 recessions, with zooming new revenues.

Instead, the modest economic ongoing recovery will continue nationally, with about 2.7 percent growth in 2011 and 3.6 percent in 2012. Chapman last December forecast that the First Quarter of 2011 would enjoy a robust 4.6 percent annual growth rate; but the rate instead was a disappointing 1.8 percent.

Chapman University President James Doti explained that the disappointing First Quarter numbers stemmed from higher gas prices dampening consumer spending, the Japanese Earthquake, frozen Defense spending outlays and the European debt crisis. He forecast that all these will change for the better as the year progresses.

He also said that housing prices nationally would drop 4.3 percent in 2011. This will cause a “negative wealth effect,” in which people, because they have lower home equity, spend less in other areas. “If there is any risk to this weak recovery, the most serious threat is a worsening drop in housing prices,” he warned.

However, he added, the number of households is beginning to expand. People who “doubled up” — such as living with parents — to ride out the hardest times, now are looking for rentals. Eventually, that could turn into increased demand for purchasing homes.

This is reflected in the national number of excess vacant apartment units dropping from 1,008,000 units in the First Quarter of 2011 to 714,000 units in the First Quarter of 2011. Currently, the vacancy rate for apartments is 9.5 percent. That’s getting close to the 8.5 vacancy rate of normal times.

“There’s a lot of pent-up demand to live somewhere,” Doti said. “People are beginning to rent units, while seeing what’s going to happen.”

He added that, over the course of the past century, housing prices have averaged three times personal income. Currently, the ratio is 2.6 times personal income, meaning, “Housing rarely has been as affordable as today.”

The national housing affordability index is 70 percent of people being able to buy a home, “the highest since 1999.” However, he expects foreclosures to exert “36 more months of downward pressures on prices.” He noted that, during the Great Recession, housing prices have dropped faster than during the Great Depression; and there have been twice as many foreclosures.

California’s Forecast

California’s jobs were hit much harder than national jobs, Esmael Adibi told the audience; he’s Director of the A. Gary Anderson Center for Economic Research at Chapman University, which prepares the forecast.

He said that the peak California unemployment rate during the 1990-91 recession was 9.9 percent; during the 2001 recession, 7 percent; and during the 2007-09 recession, 12.5 percent. So we were hit harder this time.

Moreover, the time from the peak unemployment level to the time unemployment dropped to a normal level was 30 months in the 1990-91 recession and 21 months in the 2001 recession. But the number of months from peak unemployment during the 2007-09 recession is 38 — and counting.

California, with its heavy load of taxation and regulation, is just having a tough time dragging itself out of the recessionary bog.

Green Shoots

On the positive side, hiring finally is rising. Payroll jobs growth crashed 6 percent in 2009 and another 1.3 percent in 2010. But Adibi forecast payroll jobs would rise by 1.6 percent in 2011 and another 2.1 percent in 2012. That will create 216,000 payroll jobs in 2011 and 290,000 in 2012.

He also expects that, although state and local governments have been cutting jobs during the recession, they will start hiring again. This will be because the improving economy will generate more tax revenue; and some of the tax increases being proposed will be enacted.

I asked Adibi how the tax increases in the budget passed by the Legislature, but vetoed by Gov. Brown today, would affect the economy. Adibi said he would have to wait to see a final product before offering an analysis.

However, in talking with him many times over the years, including on Monday, he always has warned that higher taxes reduce private-sector economic activity.

Other positive signs for California growth are an improving trend in merchandise exports. From a low of $27.6 billion exported in the First Quarter of 2009, exports rose sharply to $38.7 billion in the Fourth Quarter of 2010. However, they dropped a bit, to $37.5 billion in the First Quarter of 2010, because of the Japanese Earthquake-Tsunami-nuclear crisis.

Chapman’s survey of purchasing managers also has risen. Anything over 50 on this composite index indicates growth. From a low of 41.2 in the First Quarter of 2009, indicating contraction, the index has risen to 62.2 in the Second Quarter of 2011, indicating a continued expansion.

Construction spending also has risen for the first time this year, although it is expected to rise at only about a 5 percent annual rate throughout 2012. That’s still much better than the 36 percent drop in 2010.

California’s housing prices essentially will reflect the stagnant national market. In California, prices rose 10.1 percent in 2010. But for 2011, prices are expected to drop by 4.4 percent; and drop by 0.7 percent in 2012. Adibi said, “There will be no significant increase in housing prices until we get significant job creation. Home prices will stay flat the next two years, waiting for incomes to rise. But prices won’t be declining.”

As I keep warning, the main economic focus of the governor and Legislature should be on jobs creation.

State Budget

Adibi forecast that, if the economy continues to increase, the state will reap higher revenues. However, he criticized Gov. Brown for spending half the unexpected $6 billion in revenues taken in this year because of higher capital gains taxes from the improving stock market. And he noted that the stock market has been declining in recent weeks.

He also warned that the state continues to be foolish in spending increased revenues during recoveries; that the state must even out the boom in revenues in good times, with the trough in revenues during bad times. “Without changes, we will have problems again,” he cautioned.

That was a clear warning to the Legislature to reform its high-spending ways, while restructuring the tax and budget system to prevent future crises. Unfortunately, the insular Legislature is living in a world of its own.