The Bay is booming. Job growth in the East Bay accelerated to over 3% in the first quarter of this year, and worker incomes are growing faster than almost anywhere else in the state. San Francisco and San Jose are not growing as fast, but the last vestiges of the painful correction of a few years ago are rapidly fading. Even as the state government is enjoying unexpected increases in revenues, local governments are enjoying increases in their take as well. Things are good.
That cloud discussed in past reports has not gone away, however. Indeed the storm is coming upon us now. The housing boom that has been such a driving force in the California and U.S. economies has peaked and is starting to soften. Unit sales and new residential permits are starting to fall, and housing appreciation is slowing. Things are still hot, but the trend is clear. The only debate now is how hard the landing will be and what it will mean for the general economy. The good news is that the non-housing driven portions of the economy are starting to do better. Jobs in professional services are growing strongly, and while manufacturing is not adding many jobs, output continues to rise. Corporate profits are solid, and business spending is still strong. And a cooling housing market, a drop in retail sales and an associated softening of the exchange rate could be good news for California exports.
Still the external economy will not be enough to make up for the 200,000 jobs California is likely to lose in the construction sector as residential construction and remodeling slow markedly. The East Bay will experience a loss of something less than 10% of this number, not to mention real estate and mortgage banking which will also take hits. Reduced home appreciation will slow taxable sales growth as well. The State budget for ’06-’07, already tight, looks to go under water by the early part of next year, and with it much of the infrastructure dreams of the current administration. Still, there will only be a slowdown in revenue growth, not the substantial losses seen in 2001 and 2002. Look for employment and income growth to stay strong for 2006, but slow over the following two years, led by a weak construction industry.
Imagine that once upon a time you were a venture capitalist in the late nineties. You made a good living for a number of years starting up dot.com’s and spinning off IPO’s. Unfortunately, the collapse of the tech sector brought that income stream to a halt. With state employment and income in decline, a shattered Bay Area tech sector, not to mention the State’s terrible fiscal problem, you decide to take a few years off until things get a little better and jump into the cryogenic sleep chamber you picked up as a free gift at one of those tech conferences. You set the wake-up alarm for 2006, when you figure the slump will have ended. Your one major worry—what will happen to the price of your house given the economic mess the state is in? Surely it will fall after the strong growth seen over the last few years. ‘Ah well, as long as it’s still standing’ you think as the ice crystals form.
Waking up in 2006, you immediately notice your neighbor’s house for sale. You casually ask what they are selling it for, only to learn that it is listed for twice the price they paid for it back in 2001. Your immediate thought would be that the Fed had gone on an Argentinean-like bender and had been printing money like mad over the past few years causing a huge spike in inflation. But no, when you look in the paper the Fed has been worried about deflation, not inflation, and overall prices had been stable. How has this happened? You feel the hairs on the back of your neck rise and you expect Rod Serling to come out of the house and announce that you are in… (do you hear that annoying music?) the bubble zone.
This sounds like an implausible story—but that is indeed what has been happening. The state has seen one of the most impressive increases in real housing prices during a period of time when the economy has only gone from bad to moderate to okay. This lack of synchronization is unprecedented in U.S. or California history. Typically a hot housing market accompanies a hot economy and vice-versa, but not this time. The numbers are truly astonishing. In real (GDP deflated) terms the run up in real estate in the 70’s saw prices rise 73% from the bottom to the top of the market. After the peak, prices fell by 8% over the next 5 years. The late eighties saw prices rise by 58% from the bottom to the top of the market. This time the crash was hard and prices fell by 25% between 1990 and 1997. Since 1997 prices have risen 155%, with two thirds of this increase coming since the 2001 downturn began.
Now there were some legitimate reasons for the increases in prices. The late nineties saw a sharp rise in rental rates around the state, caused by a growing gap between production and demand. The late nineties saw the removal of tax liability on the sale of a home within a certain amount. Then there was the large drop in mortgage rates between 2001 and 2003. But since 2003 there has been little reason to believe the price increases we have seen are legitimate. Mortgage rates are rising slowly, rents are just now starting to recover and with the state permitting over 200,000 units over the last two years those housing shortages seem to be a thing of the past.
Residential Units Sales
New and Existing Homes
Source: Dataquick
A bubble is when the market price of an asset becomes misaligned with what the fundamentals say the asset should be worth. Bubbles form because of buyers who concentrate on trends, not fundamentals. Property prices may have risen for legitimate reasons in the past, but this past performance is being taken as a sign of things to come, even though the drivers of the market point in a different direction. But the force of people rushing into the market to collect what they see as ‘free money’ may be enough to drive up prices all on their own. This self-fulfilling prophesy cannot last forever though. Eventually the harsh reality will settle in, and the markets will come to a halt. It is just a matter of time. The irrationality of the market makes it tough to predict the when, only the eventual direction is known for sure.
The best leading indicator of a cooling real estate bubble is unit sales...
(Click here for more of "Is that a Pop I heard?")
At the beginning of each year, economists wait eagerly for the new employment benchmark to be released. The reason is that the sample used to calculate local area employment becomes substantially degraded over the course of the year due to the loss of many small firms to bankruptcy, with no replacements put into place. At the start of each year new firms are put into the sample, and the sample itself is re-weighted according to updated statistics from the large but highly lagged Quarterly Census of Employment and Wages (formerly ES-202) data. This allows us to get a better idea of what is happening locally. Economists will spend a lot of time thinking about how the data might be adjusted and what it implies for the economy. We may even place bets on which local economy will be upgraded and which will be downgraded. This is one of the reasons economists are often avoided at holiday cocktail parties.
The recent revisions to the state’s employment numbers substantially increased the overall 2005 growth rate from 1.3% to slightly less that 2.0% (fourth quarter to fourth quarter). Most of this upward adjustment occurred between August and the end of the year. What originally appeared to be a slowdown in employment growth now looks to be a continuation of existing trends. In comparison to other states, this puts California as the 19th fastest growing economy in percentage terms, and the 2nd largest in absolute terms with 300,000 new payroll jobs, behind only Florida, that distant land of blue seas and blue hair. While the growth rates are not as impressive as they were in the late nineties, nevertheless the labor markets look to be quite tight. Unemployment in the state dipped below 5% in January of this year. This is lower than at any time during the past two decades with the exception of 2000, when the labor markets were in a very overheated state due to that little tech bubble issue we had (for those of you who may have forgotten).
The Bay region also saw some serious revisions to their payroll employment data. The East Bay and San Francisco didn’t see any change in the level of their fourth quarter employment, but the histories of each changed, altering their current growth path. For the East Bay, like California, the path of growth last year was steadier, and the slowdown in growth initially seen in last year’s data now appears to be an acceleration which continued into the start of this year. For San Francisco the change pushed job losses into the end of 2004, and now shows steady growth since this trough. San Jose saw the most substantial revision, with 4th quarter 2005 employment increased by whopping 1.5%. As opposed to losing jobs over the past year, it is now seeing steady, if slow, growth since the end of 2004.
While the total number of payroll jobs in the East Bay remained steady, the distribution of jobs across sectors did change. Manufacturing and healthcare both saw substantial downward revisions, on the order of 5% for each sector. Manufacturing is now less than 10% of the total employment base in the East Bay, an all time record low. Healthcare also saw a sharp downward revision in the 4th quarter. This is not much of a surprise, as this sector has seen similar downward revisions almost every year. It still represents one of the fastest growing sectors of the East Bay economy. The downward revisions in manufacturing and healthcare were offset by upward revisions in construction, retail, professional services, and in government...
(Click here for more on Bay Area Labor Markets)
While payroll employment was revised up, at the same time employment for the state based on the household survey was revised down by something slightly less than 1%. Even with this change jobs estimated from the household survey still grew at a faster pace than payroll employment, 2.3% compared to 2%. One of the reasons that unemployment is so low in the state is the very strong increase in what we have labeled ‘informal’ employment in the state. For the East Bay the revision was down approximately 1.8%, with a similar decline in San Francisco. San Jose’s employment, as measured by the household survey, remained steady. Of course the labor force was also revised downwards, and therefore unemployment remains low in the region. As for the first quarter of this year the unemployment rate in the East Bay was 4.3%, compared to 4.1% in San Francisco and 4.7% in San Jose.
The number of informal workers in California is now at 1.6 million, up half a million since 2000. The informal workforce is now slightly over 10% the size of total payroll employment, larger than in any other state (other states with large informal sectors include Arizona, Texas and Florida). To put this in perspective, the informal workforce in California is about the same size as the entire workforce of Oklahoma, Iowa, Kansas or Nevada not to mention larger than the 19 other smaller states.
Where are these informal jobs that are revealed in the household survey? It is difficult to say exactly. Part of the reason is that the sample size is considerably smaller than the payroll numbers -- only about 4,000 to 5,000 workers are polled in all of California on any given month. Another problem is that ‘industry’ is a self-selected characteristic and most of those polled don’t understand the relatively arcane way by which payroll numbers are classified—by the primary task engaged in by the owners of the enterprise. For example many school teachers would naturally think that they are in the education sector, when in fact they work in the government sector. Similarly a worker employed in a temporary accounting job in a mortgage company might assume that they are in the financial industry when in fact they are in temporary employment in business services. We know that the jobs are in many sectors of the economy.
We also know that while a large immigrant population drives the sheer number of informal jobs, they have not been the only force behind the major expansion in the number of these jobs over the past few years. Instead the numbers have been driven in large part by the housing bubble, not unlike the overall economy. Financial activities now have the largest share of informal jobs, almost 20%. This is up by a whopping 130,000 new jobs over the last two years. This category, of course, holds real estate agents and mortgage brokers. If you were wondering where the record number of people who have obtained real estate licenses over the last few years were ending up in the statistics—well, here it is.
Construction and other services (including domestic help) together account for just slightly less, as does transport. All of these sectors seem to have added quite a few jobs over the last two years. It may be that the increase in international trade is playing a big role in the increase of jobs in transport. Informal jobs in manufacturing and information, on the other hand, have been declining over the past few years, not too mention agriculture. The potential pay increase for workers who shift from sewing garments and picking fruit to working in the hot building industry is pulling a lot of workers out of these two sectors. If this makes you think that the unemployment rate is likely to start getting worse as real estate cools--well, you are right on target.
The gap between employment calculated by the household survey and payroll employment in the Bay Area is slightly less than six percent. Given the number of people who commute into the region from outside counties, this is likely to be an undercount of the true level of informal employment. This is because commuters from outside the region will count in local payroll employment, but will NOT be reflected in the household survey, which captures informal employment, since it is only conducted at local residences...
(Click here for more on Informal Employment, Commuting and Infrastructure)
