First Into Recession, California Shows Possible Future for U.S.
By CONOR DOUGHERTY, RHONDA L. RUNDLE and JUSTIN LAHART
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Economy »
Here's the latest trend that started in California and is spreading to the rest of the country: recession.
It's all but certain the U.S. economy is in a recession, as falling home prices and Wall Street turmoil have put the brakes on consumer spending and stoked unemployment. But California got there first. Now, the state provides a template of how a broad U.S. downturn could look.
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Getty ImagesCalifornia's current problems started with the housing bubble, which hit places like Moreno Valley, above, particularly hard.
With its export businesses, manufacturing sector, professional services and big retail employers, California looks like many other U.S. states, only more so. California's $1.8 trillion economy -- twice the size of India's and accounting for about 15% of the U.S. gross domestic product -- is powerful enough to have ripple effects nationally. It is home to Hollywood, five of 30 Major League Baseball franchises and the largest farming sector in the nation.
California was also at the leading edge of the nation's recent housing bubble, which is where its current problems started. Home prices in California rose higher and faster than in most of the U.S., and started weakening earlier, in 2005. Some mortgage-holders defaulted. Others struggle along under a mountain of debt. The problems spread to the state's financial sector, which was heavily exposed to local real estate. As Californians cut their spending, job losses spread from the housing sector to retail stores and auto dealers. Now the state's unemployment rate is 7.7%, among the highest in the nation.
Along with Sunbelt states such as Florida and Nevada, California is a big source of the shocks now working through the world's banks, corporations and stock markets. The financial crisis has frozen credit markets, cutting into companies' ability to engage in even the day-to-day borrowing they need to run their businesses.
But even before the most recent blows to the national economy, Californians were feeling the downward drag of a consumer-led recession -- in which shrinking home values caused people to rein in their spending, fueling unemployment and, in turn, sparking further spending cuts and joblessness.
John Luc has seen how housing problems bleed into the broader economy. Mr. Luc is the 36-year-old manager of Homestore Furniture in Ontario, a middle-class community 40 miles east of Los Angeles and one of the centers of the housing bust. Since last year, retail sales have fallen, while unemployment and office vacancies have soared. Eighteen months ago, he watched a nearby Levitz furniture store close down in a bankruptcy sale. Since then, he said, the few buyers who've visited his store ask for discounts. "Everybody negotiates," he says.
The other day, Mr. Luc was presiding over the store's going-out-of-business sale. Although the father of two young children expects to get a job at another Homestore outlet, he and his wife have checked their spending. He says he saves $50 or more each week by packing a lunch each day, and he makes coffee at home instead of stopping at Starbucks during his long commute. "I haven't gone into a steakhouse like a Black Angus for dinner in six to eight months," he says.
Consumer spending accounts for about 70% of U.S. economic activity, so as people like Mr. Luc cut back, job losses and other economic woes follow. In the third quarter of 2007, California's taxable sales declined 1.82% from the year-earlier period, the first annual decline since 2002. Taxable sales have fallen every quarter since. Now in addition to construction workers and mortgage brokers, people like retail clerks, accountants and information-technology consultants are losing their jobs.
A similar dynamic is playing out nationally. Retail sales recently started declining, after peaking in June. Rising job losses appear likely to cut into future sales. In September, the U.S. economy shed 159,000 workers from its payrolls. The unemployment rate was 6.1%, compared with 4.7% a year earlier.
There's no universal definition of recession, and little agreement of what constitutes one in a state economy. But by most measures economists use -- rising job losses, shrinking consumer sales -- California fits the bill. "There is no question that this area is in a recession," says John Husing, an economist in Redlands, Calif., who tracks the Inland Empire region east of Los Angeles. "We're the canary in the mine shaft."
It's unclear whether the state, as one of the first to enter an economic slowdown, will be among the first to emerge. Problems in the broader economy could also hit California in a second wave. Stephen Levy, director of the Center for Continuing Study of the California Economy, expects the state's economy to get worse before it gets better. He expects job loss to continue through 2009, as consumers continue to pull back. While the housing sector probably won't fall much further, Mr. Levy said, many consumers aren't able to tap the equity in their homes for purchases. Falling stock prices and expensive gasoline and food will continue to eat into spending, he says.
Not Always a Bellwether
California isn't always a bellwether for the nation's economy. In fact, in the past two national recessions, the state was stung by sharp job losses in important industries -- aerospace and defense in the early 1990s, and technology in the early 2000s -- but was among the last group of states to succumb to recession.
But this time around, after years of double-digit price rises, median home prices stood far above what a household with a median income could afford. Permits for new homes began dropping sharply in fall 2005, something that didn't happen for the nation as a whole until spring 2006. Home prices in the state's largest real-estate markets fell earlier and further than those countrywide. Prices in San Francisco, Los Angeles and San Diego are currently down an average of 28% from their 2006 levels, compared with 19% for the S&P/Case-Shiller 20-City Composite Home Price index nationally.
The mortgage-lending frenzy was at its hottest in California, and the state's financial firms were at the forefront of extending untraditional mortgages that were then folded into complex securities. Those firms were also among the first to face disaster when the value of those securities collapsed.