Will Redevelopment Be Demolished?

JUNE 23, 2011

By WAYNE LUSVARDI

As California politicians are deciding whether to have a clean break from the state’s addiction to redevelopment, or to substitute some other methadone-like economic policy drug to replace it, the global economy is subtly changing. Like a drug addiction, redevelopment will be for the losers who want to make a career out of living in perpetual “rehab.”  The winners will be those who can quit cold turkey and change.

It now is clearer that the economic doldrums California is continuing to experience are more structural than cyclical.

The Federal Reserve Board’s Quantitative Easing 2 (QE2) program to dilute the value of the U.S. dollar and pump up monetary inflation is coming to an end. While the general policy of inflating our way out of debt will continue, the persistent trend is deflation driven by an excess supply of goods and labor over demand.  Nonetheless, commodity price inflation in food, energy and oil will continue, some of it intentional, as seen in California’s Green Power Law and Cap and Trade program poised to launch early in 2012 because of AB 32, the Global Warming Solutions Act of 2006.

It remains to be seen how the U.S. and California economies will perform without the steroid drugs provided by the federal stimulus program and QE2.  Foreign banks have significantly cut down the amount of U.S debt that they were buying, most notably China. This means that U.S. private money markets will have to buy this debt, but will want an interest rate premium to do so. This will result in less capital available for commodity and stock markets and for things like redevelopment.  This is especially so in a California real estate market that remains overbuilt.

The California economic data for May 2011 was abysmal, despite Gov. Jerry Brown’s report in April that tax receipts were up and the economy was showing signs of recovery. The mirage of a recovery in April seems to have been a one-shot deal based on payment of capital gains taxes.

California Isn’t Investing, It’s Gambling

If the United States and California do not want to live within their means, another crisis is likely to force the issue.  A run on the value of the U.S. dollar in 2012 or 2013 may be reality therapy.  Another $100 billion drop in CalPERS and CalSTRS pension funds might also be a realization that recovery may not be right around the corner.

California is desperately gambling in the money markets to try to make up what it lost in 2008-09 in pensions funds.  CalPERS reported more than a 12.5 percent annual return on its investments in a money market that is paying about 3 percent on 10-year Treasury Bills and the CPI is trending at 3.6 percent. CalPERS is gambling on rates of return about four times that of the safe rate on 10-year government securities.

If California ever gets its act together and realizes that Green Power and Cap and Trade are ineffective therapies, they may understand that many companies that had abandoned California for other countries might be interested in returning, given that stagflation may make production in the U.S. more competitive because of declining labor costs here. But if California wants to spike energy prices, these industries will move from offshore to onshore, but not to California. Try Texas.  Back in 2006, when AB 32 was devised, policy makers could not have foreseen a bursting of the U.S. economic bubble and the possibility of reindustrialization.

Reverse Globalization

As reverse globalization unfolds, industries will no longer be compelled to put manufacturing offshore. Not only will there be a narrowing of the cost differential to produce goods, but land availability and price, the cost of electricity and taxes will be crucial.  Here, California state politicians and small-minded local bureaucrats’ persistent desire to press the restart button on redevelopment will be misplaced.  Even worse, it could be disastrous to the state’s general fund tax base.

Social change is slow, even if economic meltdowns seem sudden and unforeseeable.  Some foresee the possibility of U.S. manufacturing again becoming Number One in the world again in a decade.

California, with its postmodern political culture’s aversion to hard industries and embrace of Green Energy polices that will inflate the price of water and power, will unfortunately put the state in a non-competitive position should the reindustrialization lamp be lit again.  The choice of Jerry Brown as governor, a countermodern politician whose track record in his first governorship was to stop building freeways, conventional power plants and dams, may end up unfortunate.

To take advantage of the coming opportunities presented by de-globalization, California will need to switch from using redevelopment to artificially create local real estate bubbles for upscale malls and industrial parks for overpriced goods and services that are no longer affordable.

Redevelopment is Obsolete

In the last few decades, perpetually ridding California’s cities of older, obsolescent housing and commercial building stock by redevelopment to puff up the property tax base in one city at the expense of another became a statewide horse race. But redevelopment is not a value-added activity. It merely shifts real estate development around from one jurisdiction or neighborhood to another. It overheats local real estate markets by creating bubbles.

Redevelopment also redefines “affordable housing” as luxury housing, complete with pools, spas, gyms in upscale mixed-use projects next to light rail stations.  On the contrary, true affordable housing is old, obsolescent and further from commercial centers and public transit.

“Blight” is Good for You

Tomorrow it may be older shopping centers, Mom and Pop retail stores and restaurants, and older housing that provide a price advantage to consumers with lower incomes. It may be older industrial centers with infrastructure in place that provides landing pads for relocating offshore industries. Obsolescence may again mean affordability, not “blight.”

Instead, California will need an industrial development policy that doesn’t rely merely on more tax-exempt redevelopment conduit bonds as a “drug fix” to stimulate growth.  Rather, it will need to rely on cheap land, water and energy, a competitive labor force and flexible government coordination. Giant sub prime easy money loans to business and industry are not a way to build an economy, even though government thinks it is.  Easy money makes businesses think they can achieve super profits, just as a drug gives you an artificial “high.”

Slow Growth and Deflation, Not Redevelopment

As economist Gary Schilling points out in his book, The Age of Deleveraging, there will be a decade of slow growth and deflation as:

1. Consumers shift from borrowing and spending binges to a saving spree.

2.  Financial deleveraging will reverse the artificial spurt of growth in recent years. (Leveraging means borrowing capital with no or little of one’s own money in the game, like being given free chips at a poker table. Deleveraging means having to pay cash.)

3.  Increased government regulation and involvement in major economies will stifle innovation and reduce efficiency.

4.  Low commodity prices will limit spending by commodity producing countries (that trade with California).

5.  Developed countries are moving toward fiscal restraint.

6.  The housing market will be weak due to excess inventories and loss of investment appeal.

7.  Deflation will curtail spending as buyers anticipate lower prices.

8.  State and local governments will contract (page 182).

In such a slow-growth economy, redevelopment and affordable housing will be obsolete.  The mission of redevelopment to eliminate blight and real estate obsolescence has paradoxically become obsolete itself.

The current public discussion in Sacramento on whether redevelopment should be shut down or be reformed is passé.  The discussion California needs is not how it is going to cope without redevelopment.  Rather, it should be about how it is going to manage in a slow-growth and deflationary economy and be ready should reverse globalization bring about reindustrialization in the U.S.