Thursday, December 31, 2009

Celebrate the New Year now - 2010 will be worse in California

Get tipsy on California sparkling wine (aka erroneously as champagne which is produced exclusively within the Champagne region of France) and wish California a Happy New Year with glowing optimism.

When you sober up you'll be entering a sobering new year, 2010. It will be the Year of the Tiger in the Chinese Calendar, but in the California Calendar it appears it is going to be symbolized as the Year of the Missing Sea Lions.

The Missing Sea Lions are a good symbol of 2010 in California. They symbolize the 2+ million missing jobs that will plague California for the next decade.1

The signs indicate the next dip in the double-dip is approaching. The fallout from the commercial real estate market collapse is about to be felt in the financial sector, particularly in California. Daily Finance summarized the situation:
Reports that commercial real estate (CRE) is suffering from a double whammy of soaring vacancies and declining valuations have been making news recently with sobering regularity. DailyFinance addressed the risks that CRE meltdowns pose to banks in early December. And in a stunning confirmation, just weeks later Morgan Stanley announced it was "walking away" from five San Francisco office towers, giving them back to the lenders. These accounts address the impacts on real estate investors, banks and hard-hit locales such as Southern California. But a bigger, often-overlooked, risk is the potential for CRE to remain a drag on the U.S. economy for years to come, or its potential to trigger a slide back into recession -- the so-called double dip that many fear.

Four primary factors are behind the tumble in CRE prices -- and they're eerily similar to those that powered the residential housing boom and bust:
  • Overbuilding in marginal locales that lacked adequate jobs and services to support massive new commercial construction (malls, hotels, business parks, resorts, etc.)
  • Excessive valuations fueled by low interest rates and easy credit
  • Highly leveraged bets on future appreciation
  • A banking sector that's extremely vulnerable to write-downs and losses from foreclosures
How much have prices tumbled? According to Moody's/REAL Commercial Property Price Index, CRE prices have plummeted 41% from the peak in 2007. Or in many cases, even more. For example, a hotel in Hawaii that sold for $250 million with a $230 million mortgage a few years ago is now only worth about half that amount.
Companies small and large that service other businesses are now in the process of learning they are holding worthless receivables or their customers' phones are disconnected. Trucking, for example, is an industry that is just now showing significant signs of distress.

This past week Arrow Trucking shut down operations stranding about 900 of its drivers across the U.S. and Canada after the company canceled its fuel credit cards. It sent two short text messages to the drivers telling them to turn in their trucks to the nearest dealer and offering a bus ticket to get home. According to the Tulsa World
Arrow failed to pay employees, failed to reimburse their expenses, failed to forward medical insurance premiums to insurers for the three to four weeks leading up to the shutdown, and failed to make pension and 401(k) contributions.

Also this past week, the nation's largest U.S. trucking firm handling less-than-truckload shipments under other names like Reddaway, New Penn, Holland, YRC, YRC Reimer, YRC Glen Moore, and YRC Logistics barely avoided bankruptcy according to Reuters.

Over the next quarter we're going to see just how shallow The Great Recovery really is. The President, armed with the best economic research available, has already admitted we will have a double-dip recession which he and Congress are trying to mitigate.

I wish the President well, but the actions of the federal government beginning in 2008 have slowed the inevitable arrival of the double-dip second crash effect in the financial markets only. In the real world where people work for a living, labor statistics keep reporting net job losses for each month.

The second dip will create its own ripples. Sometime in the next few months2 it will become apparent to everyone that the nation's largest State, California, is truly. essentially, and totally a bankrupt operation, that all it can do from its General Fund is (1) pay it's debt payments, (2) fund the programs partially subsidized by the federal government if in some cases the administration waives maintenance of effort rules and (3) maybe sustain minimum levels of public schools, public health, and public safety services.

Courts have already taken over supervision of some some of the State's operations, but the lack of legal methods for states to file for an orderly bankruptcy will create further problems. According to a throrough Bloomberg report on California published Christmas Eve:

California Governor Arnold Schwarzenegger, anticipating a $21 billion state budget deficit, plans to ask President Barack Obama to ease mandates and minimums on social programs to save as much as $8 billion.

The Republican governor plans to seek the relief, according to a California official who asked not to be identified because details haven’t been resolved. Instead of seeking one-time stimulus money or a bailout, the most-populous U.S. state wants the federal government to reduce mandates and waive rules stipulating expenditures on programs such as indigent health care, the official said.
Of course, we Californian's aren't alone with our troubles. The Bloomberg article notes that 35 states and Puerto Rico have deficit problems. But California has the most intractable political problems.

In the meantime, we continue to read in December about the reality of The Great California Slump in newspaper articles:

At the present time, everyone in power says we are facing a $21 billion State General Fund deficit to be covered in the 2010-11 fiscal year. I believe they are $10 billion low, but in the spirit of Everett Dirksen "a billion here, a billion there...." It really doesn't matter as there is nothing that can be done about it given the split in the Legislature where a two-thirds vote is required to do anything meaningful.

So, enjoy the New Year's celebration now.

1 Before dismissing the idea that California is missing 2+ million jobs, let me explain. In November 2007 California had 17,209,617 people working according to the U.S. Department of Labor. In November 2009 California had 16,084,298 people working or 1,125,319 fewer jobs.

In addition, to maintain its economic growth at minimal levels California had to create about 210,000 net new jobs per year or about 420,000 more jobs since November 2007. That puts California in the hole as of November 2009 about 1.54 million jobs and counting. By this time next year California will be in the hole at least 2 million jobs that it will not recover in the next decade.

How can I be so sure those 2 million jobs can't be recovered in a decade? The math is simple. The first 210,000 net new jobs created each year don't count as they are the jobs needed to maintain minimal economic growth levels. We need to create 410,000 net new jobs each year to achieve full job recovery by the end of 2019. That's an average of 34,000 net new jobs a month. Indeed, we have done that for limited periods. But that is an average number that won't happen 120 months in a row.

The one thing that might save us is a population loss. If we lost 3 million job seekers, things would actually be better though State revenues would still be down.

2 The Governor will outline the nature of his request for help in his January 6 State of the State address and we'll see just how bad he thinks things are in his budget to be delivered January 8.

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