California Financial Dreaming: 5 Exhibits Showing Why California will be in a recession until 2011: Revenue Projections, Housing Inventory, Unemployment, Toxic Mortgages, and Consumer Psychology.
It took California only three weeks after passing a $41.6 billion budget deal to fall back into the financial rabbit hole. How much did analyst miss? Try $8 billion. You need to remember that the budget battle started back in fall of 2008 and lingered for months so when the budget passed, it had rosy assumptions from a few months ago. Of course, things since then have deteriorated even further. More and more toxic mortgages in California are imploding and people are walking away from their homes. The California median home price is now off by over 50 percent and much of this occurred in one devastating year. Unemployment now stands at 10.1 percent and nearly 2 million people are out of work in the state. What the $8 billion short fall tells us is people are still too optimistic in their economic projections of our present predicament.
California benefited the most from the housing bubble. Sales on the most expensive homes, mortgage equity withdrawals from these inflated homes spurred sales on other items, and employment directly linked to the debt bubble expanded. So it would follow that the bursting of the housing bubble is hitting the state harder than any other state especially in industries directly related to the housing market. We also had state revenue projections that are directly tied like a scout knot to massive consumption which of course, are contracting as we speak.
In this article, we are going to dig deeper why California is going to have structural problems for years to come. We’ll examine revenue projections, the housing market, rising unemployment, and the change in consumer psychology. Michael Jackson is coming back on tour just in time to see fans moonwalk away from their mortgages.
Exhibit #1 – Revenue Projections
The above chart comes from the budget agreement reached in February of 2009. The problem for California is that it draws an unusually high percentage of its revenue from the personal income tax and sales tax. Of course, after the massive wealth destruction last year and rapidly changing employment climate, you can see why the number one source of revenue has fallen off dramatically. In fact, they have massively miscalculated the employment situation. Let us go back to the initial budget projections back in the fall:
That is a major miscalculation. They were projecting a high unemployment rate nationwide of 8.2 percent being reached in 2010 and statewide of 9.4 percent being reached at the same time. Well as you all know, the unemployment rate as of February of 2009 is now 8.1 percent nationwide and 10.1 percent statewide. That is a massive understatement especially when you consider that personal income tax is your number one source of income. So it isn’t any surprise that the projections are off and we now face a $8 billion short fall.
Yet look at the initial chart once again. The state is projecting that we will have a $4.4 billion increase in personal income tax collections and $3.8 billion in sales tax collections. Keep in mind this is for the fiscal year that begins on July 1st. Are you telling me the state is still buying that second half recovery notion? Personally, I think these projections are still much too optimistic. Yet the reason why this is occurring is the experts in the field are failing to look at unprecedented changes:
“(SignOnSanDiego) As an example of how bad it is, Taylor said his office projects a slight decline – one-tenth of 1 percent – in personal income this year. Although not much, Taylor said he looked back as far as 1950 and could find no prior year in which personal income declined in California.”
They’re projecting a slight decline in personal income tax? There is the problem. What do you think people are going to be doing with the massive losses of 2008? Many of the wealthy California contingent lost money in the stock market in 2008. In fact, many of these people are going to be able to write off a sizable portion of losses and will cut their tax liability lower and lower. Those that are unemployed aren’t paying taxes but instead are drawing on unemployment insurance. So this is a cash flow problem.
Yet even the new proposals are betting on high time again:
“This assumes not only a turnaround that doesn’t begin until (the first quarter of) 2010, but very modest growth thereafter,” Taylor said. “We don’t see anything like the kind of recovery we’ve had in past recessions, where we can bounce back with 8 percent, 10 percent growth.”
Interesting that they now have modest projections yet the revenue in the budget still reflects a rosier picture. These projections are still betting on some sort of new industry rescue. In the 1980s we re-emerged and had the technology bubble in the 1990s. California took in massive amounts of money but developed a structural budget deficit that bet on these high times. When things were settling out in the early 2000s, we get another whiff of a bubble with housing and we were riding high again. I think many of these people think some other bubble is going to save us but we may be reaching a bubble fatigue point.
My colleague John Rubino over at DollarCollapse put out an excellent book called Clean Money examining the new technologies that will emerge from green technologies. I correspond with John on a weekly basis and he was spot on regarding the housing bubble so I tend to listen to people that have been right for many years. Reading the book, you realize that many of these technologies will require massive government spending which I’m not sure is priority number one at this time. In addition, the drop in oil has pulled back that vigor that we had when oil was at $147 a barrel.
In the moment, I think some of our politicians are clinging for a third bubble but I just don’t see it happening. The wizard behind the curtain of our economic system has been shown and I think most Americans will now have a hard time believing in the way things once were. If we want something, we will need to pay for it out of more immediate financing.
Exhibit #2 – Housing Inventory and Sales
California still has a glut of homes. In fact, more homes are coming onto the market that will keep us from reaching a bottom for many years. The 10 reasons for a California housing bottom in 2011 still hold true, especially given these budget deficits. Why? The only way to fix the problem is with job cuts or tax hikes. Most likely we’ll have a painful combination of both. What that means is we will have more tax hikes and job cuts in the upcoming years. How does this bode well for housing, which we have just pointed out, was part of the reason California gained so much wealth this past decade? Much of that bubble wealth is now gone.
In January of 2009 29,458 new and resale homes and condos were sold in the state. The median price for the state has now fallen to a stunning $224,000. This is a far cry from the peak reached in May of 2007 of $484,000. That is a $260,000 drop or a 53.72 percent decline. We’ve been in this decline for close to 21 months now. Keep in mind the above data is from DataQuick. If we look at the California Association of Realtors (CAR) data we find that the peak was reached in April of 2007 at $597,640 and their current median price is $253,350; that amounts to a drop of 57.44 percent. Either way, the housing market is falling across the state faster than most would have imagined.
So let us try to figure out how much inventory is in the state. First, there is some suspect business going on because banks are not putting up all their REOs for sale at least in places where the public can see it. In fact, many are selling them to private investors in bundles and never listing them on the MLS. How so? Let us do a bit of investigative reporting here:
February 2009 California Data
Notice of Defaults filed: 43,072
Notice of Trustee Sale: 18,831
Real Estate Owned: 18,872
Total distressed for Feb 2009: 80,775
Total Sales for January of 2009: 29,458*
*60.4 percent of all the January 2009 sales were foreclosure re-sales.
What this means is 17,793 homes sold were once foreclosed homes. Meaning, only 11,665 homes sold were naturally done. That is, a seller puts the home up for sale and a buyer purchases it. No bad history. So even looking at this, we realize that only with the February distress data, we have 4.5 months of inventory with one month of distress properties! So let us now look at what is currently on the MLS:
Keep in mind this data is not complete. We are missing parts of northern-northern California but this is only to give you a sense of the inventory in the larger areas. With this data, we see that a total of 165,000 homes are on the market not including many of the distressed homes. So assuming only 11,665 home are selling naturally each month, we have 7 months of this natural inventory. But that isn’t the entire picture. Most of the distress homes do end up REOs so let us aggregate the data:
165,000 + 80,775 = 245,775
Sales for January of 2009: 29,458
Total months of inventory: 8.3 months
Keep in mind that we are uncertain how big the REO portfolios of many of these banks are. We are simply using a lower rung estimate here and we have already found 8.3 months of inventory. I would venture to estimate that we have anywhere from 12 months to 14 months of inventory if we had a clearer way of gathering all the data.
Bottom line? Until we start seeing 4 to 6 months of true inventory, we are not anywhere close to a bottom. Prepare yourself to hear many people start quoting this but beware of the shadow inventory.
Exhibit #3 – Employment
California now has one of the highest unemployment rates in the country. The current unemployment rate is 10.1 percent and 1,863,000 Californians are out of work. This is up by 754,000 since last January. How big of a jump is this? That means in raw numbers, there are now 67 percent more unemployed Californians in one year. Stunning numbers. Of the unemployed 990,600 were laid off, 126,700 left voluntarily, and the rest were new entrants into the job market or were on temporary assignments. However you slice it, the unemployment situation is dire:
We are now back to the early 1980s level of unemployment. In fact, the highest unemployment on record with the BLS is 11 percent reached in November of 1982. We will breach that. Some are calling for massive cuts and that will only flood the market with more unemployed. We already have 1,863,000 people without work in the state. Those on unemployment insurance reached a record 717,525, a jump from 480,858 from only one year ago. It is harder and harder to find work for many. And of course, those 1.8 million are people that are not paying personal income taxes at normal levels or are probably buying stuff and consuming thus lowering the sales tax the state collects. All in all it is a difficult situation.
As I have argued before, the only way to solve this mess is with a combination of cuts but also tax hikes. This is the worst of both worlds and we shouldn’t be here in the first place but we are. Those calling for no spending cuts are simply living in a different planet. We are in a deep hole and many will need to cooperate to help. Those calling for no tax hikes fail to examine the depth of our problem and don’t bother to examine that we already have nearly 2 million people unemployed. Adding more people to the unemployment lines is not cost effective either. There has be a balanced approach but seeing how the state has failed to see this $8 billion short fall tells me that they are too optimistic with their projections. While millions suffer in a silent depression many are looking for that next perma-growth model.
There is one growth area for California housing. Housing for prisoners:
One thing that we know how to do as a nation is provide housing for prisoners:
I think at this point we as a society need to examine where we want our money to be spent. We need to strategically think of what to cut and be smart about it. Instead, we have ideologues on both sides saying “no cuts” or “no taxes” yet fail to miss the nuisances of this problem. Given how things are moving, I have little hope that we will come up with smart solution and instead will continue on this path of measured resistance that will keep our economy depressed for years to come.
Exhibit #4 – Alt-A and Option ARMs
The sliver of good news with the new mortgage and housing plan is that most Californians in toxic option ARMs or exotic mortgages will receive little help. And before thinking this is callous, just realize that many of these people went with zero down or very little down so they technically will lose nothing except their credit scores. Of course, there are exceptions but the data doesn’t support this view. So what will occur is they can stay in their place until they are evicted or move, and then they will become renters. California has one of the lowest homeownership rates and this bubble bursting will bring us back to the lows again.
These toxic mortgages are the worst of the worst and the irony is after all the shenanigans in the global markets, we have yet to decide how we will deal with them. The problem is that the only way to deal with theses mortgages in a morally fair way is to have them go back to the bank and have them sell it off. Yet that is the issue. With the flood of these mortgages coming back to the banks books, we are going to see numerous bank failures (of course those too big to fail will get unlimited lifelines which is even worse than nationalization which I have been calling for). Banks are running on razor thin margins so further write-downs will be enough to sink many.
And we still have people saying “no nationalization” failing to realize that we have some quasi-form of nationalization where the taxpayer is subsidizing the losses and allowing the banks to keep the profits. Awesome! Great thinking. The fact that Citigroup and Bank of America claimed they have a profit is laughable. Assuming what? Zero write-downs? We’ll find out soon enough once the Q1 earnings start rolling out. Remember BofA is now owner of Countrywide, the uber-perveyor of toxic mortgages especially here in California. What is going to happen when all those mortgages recast?
There is still an enormous amount of toxic loans in California:
Subprime loans in California: 391,959
Average balance: $323,117
Total outstanding: $126,648,616,203
Alt-A loans in California: 666,386
Average balance: $441,909
Total outstanding: $294,481,970,874
So combining Alt-A loans and subprime loans, we still have over $420 billion in toxic mortgages residing in the state from the January 2009 data. Many of those option ARMs are in the Alt-A category. Many banks used optimistic models since Alt-A borrowers had “better” credit and therefore their loss ratios are just as optimistic as the state’s models on the economy of California.
Now do the quick math. If the median price of a home in the state is now $224,000 and the average balance of a subprime loan is $323,000 and for Alt-A loans it is $441,000, do you think we have a tiny problem? The new mortgage program only goes up to 105 percent of the home’s market value. So most of these loans are not going to qualify, as they should not. If we help these mortgages out, it is bailing out bubble priced homes. This is like bailing out Pets.com during the tech bust at a high share value.
The irony here is the average Alt-A credit score is 709. Bwahahahaha! Now that is a good one. It doesn’t matter, 50 percent will be recasting in the next year or so.
Exhibit #5 – Consumer Psychology
Finally, we come back full circle to consumer psychology. We have heard many pundits claiming that our political leaders should be “optimistic” and more “positive” regarding our economy. I agree that our politicians should not be downers but I rather have someone be honest and straightforward than a Pollyanna ideologue who is preaching the gospel of infinite prosperity. It is hard to believe someone when they are so wrong and frankly, many Americans I think simply want someone that can be upfront about the facts. Look, we have a major crisis on our hands and I think most do not expect miracles. Just don’t tell us to go out shopping because it is patriotic.
The thing is, most Americans have an accurate assessment of reality:
Most Americans are having a hard time economically but also, this has filtered down to their quality of life. Consumer mood is at a record low. This does not bode well for a country where approximately 70 percent of our GDP depends on consumers running a non-stop marathon of consumption. Yet another disturbing number is that 53 percent of Americans now say they are struggling. This again highlights the reality of the silent depression that many are dealing with. The silent depression is a more accurate test of the state of our country because many people are living paycheck to paycheck and realize they are only one missed check from eviction. Many realize that they are simply moving along because of access to credit. Yet as we know, many credit card companies are now cutting back.
The truth of the matter is many Americans are now shifting into an austerity mindset. And make no mistake about it, many baby boomers (those with wealth to spend) are now more reluctant to save or invest because of very public cases like that of Bernard Madoff. I’m sure many of you saw the public smack down of Jim Cramer by Jon Stewart this past week. If you haven’t seen the clip, you can watch it here but it strikes once again at what is happening with consumer psychology. I have talked about Jim Cramer and Ben Stein many times and how they ridiculed those that saw a housing bubble or saw things in a different light from them. Now, it is very easy to be apologetic. I know one of the internet memes going around is “but they are entertainers!” Of course they are. But keep in mind that we are bailing out many companies that they were pumping up and using for “entertainment.” There were consequences. If you invested following their advice, the market has punished you enough. Yet it is another thing when they are advocates for the same institutions that ALL of us are now bailing out (i.e., Bear Stearns).
One clip found in the interview is the notion of pumping and moving stocks through hedge funds. The clip is simply reminiscent of the crony capitalism that has been pervading our system for too many years. Ultimately, the show was one of the most watched shows on The Daily Show in its 12-year history. Why? People are flipping angry and want to see some sort of justice even if it comes in the form of a comedy show. Many of our politicians are bought. I am stunned that we have yet to see any CEOs going to jail. In fact, instead of claw-backs we are still giving bonuses out! AIG just announced they will be paying out $165 million in bonuses after receiving $170 billion in taxpayer money! You can’t make this stuff up. The fact that we now have a realistic push for legislation forcing the Fed to disclose amounts given out to institutions is a step in the right direction. It is starting to look like the oligarchs in power are facing populist resistance.
Just look at the consumer sentiment indicators above. People are struggling. They don’t trust the markets anymore. So the markets had a technical rally last week. Does that mean the housing market problems are gone? Does that mean banks are now coming clean? Does that mean we stop bailing out the toxic institutions? I doubt it. Either way, consumers on the ground are pulling back and I see this as a permanent change in the psychology of many. People won’t forget this crisis that easily. Sure, we’ll go back and do crazy things because that is human nature. But people act as if we are out of this mess already. I don’t see a recovery until 2011. And after that, it will be moderate growth.
Here in California, I have seen people pulling up in Escalades full of aluminum cans and plastic at recycling centers. Something I have never seen. In fact, this weekend I saw a middle-aged couple pulling up in their Mercedes with Hefty bags full of crushed aluminum cans at the recycling center. And I think things like this is what will make this recession different from those in the past. You see many people in leased or newer cars driving around but they are flat broke and in debt. That is something you would have never seen in the Great Depression. Pain was very apparent then with people losing farms and soup lines everywhere. Now, we have people with a negative net worth driving around in $75,000 cars. It just doesn’t compute but the outcome is the same. Many people are broke especially here in California. The fact that we are now $8 billion in the hole after a $41.6 billion budget passed three weeks ago tells you a lot.
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