The Bay Area: Sunny Economic Skies with Housing Clouds
Ryan Ratcliff
Summary
In terms of jobs and real per capita personal incomes, the Bay Area economy has still not fully recovered from the recession of 2001. That said, year to date economic performance in 2006 is on par with the rest of the state for the first time since the late 1990s. Although still fairly anemic compared to five years ago, the local combination of technology and biotech is among the healthiest manufacturing centers in the state, and the technology-related service industry has also picked up steam in 2006. Within this overall recovery, the East Bay remains the fastest growing economy in the Bay Area.
However, the rapidly cooling housing market brings a hint of worry to this otherwise sunny picture. This is especially true in the East Bay, where Construction remains the biggest source of job growth so far in 2006 and new homes represent a significant share of total sales. With the median sales prices of all homes falling slightly year-to-date in the East Bay, real estate looks poised to move from an engine of local growth in 2006 to a drag on the rest of the economy in 2007. How big a drag will depend on whether other sectors of the East Bay economy can pick up the slack.
Employment: The Recovery Continues
So far in 2006, Bay Area job markets have been a classic good news / bad news story. The good news: in contrast to the rest of California, the Bay Area continues to see faster job growth in 2006 than in 2005. While the half-empty crowd will no doubt argue that this is partially due to the below average growth at the beginning of 2005, the Bay Area’s year-to-date job growth (January through August) compares favorably with any other local economy in California. The bad news? Throughout the Bay Area, total non-farm payroll employment has yet to recover to pre-2001 recession levels, though the East Bay should hit that milestone sometime early next year. Regional unemployment also tells a good news/bad news story: unemployment has been steadily falling as the Bay Area gets back on its feet, but is still a little high by historical standards – by just about every measure, there’s still some way to go in this recovery.
Figure 1: Year-over-Year Growth in Bay Area Non-Farm Payroll Employment
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East Bay Housing Markets Lose Their Fizz
As a whole, the Bay Area housing market has followed the pattern of the rest of California: sales volumes have dropped 33% from their peak in July 2004, and with median sales prices flat to slightly falling in 2006. The East Bay’s slowdown has looked similar on the sales side, with sales in Alameda County down 39% from their peaks, and sales in Contra Costa down 32%. However, the slowdown on the price side has been much more severe in the East Bay in 2006: through August, median sales prices have fallen 3.8% in Alameda County and 3.6% in Contra Costa County.
Figure 7: Bay Area Total Home Sales (area) and Median Sales Price (line) (SA)
Figure 8: Alameda County Total Home Sales (area) and Median Sales Price (line) (SA)
Figure 9: Contra Costa County Total Home Sales (area) and Median Sales Price (line) (SA)
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Home Prices, Housing Expenses and Personal Income: Who Ate My Paycheck?
As will be discussed in the California Outlook, personal incomes in the state are still reeling from the lingering effects of the 2001 recession. Although nominal per capita incomes in California have been rising in recent years, real per capita incomes have still not recovered to pre-recession levels: continued weakness in the Bay Area has more than offset the small gains in Southern California. And while the cost of living has risen in just about every category, the biggest increases have come in housing expenses, as measured by the Shelter component of the CPI (which is discussed in more detail in the California section).
While the same broad theme of sluggish real income growth holds true in the Bay Area, the severity of the 2001 recession means that the specifics are a little different. First, nominal income growth has been substantially slower. From 2000 to 2005, nominal per capita incomes grew by 16% in the U.S. and by 14% in California. In contrast, nominal per capita incomes rose by only 7.5% in the combined San Francisco and East Bay metro areas (i.e. the San Francisco Metropolitan Statistical Area), and actually fell by 5.7% in the San Jose metro area. While the aftermath of the 2001 recession has kept income growth weak in the Bay Area, it has also kept inflation in check. From 1999 through the first half of 2001, the internet rush pushed overall CPI inflation in the Bay Area well ahead of the L.A. region: the overall price level rose 9.4% in the Bay Area compared to 6.3% in L.A. and 6% in the U.S. as a whole. Most of this increase came from housing expenses: the Shelter component of the Bay Area CPI rose by 15% over this period, compared to 6% in L.A. Not surprisingly, the 2001 recession radically altered these trends. From 2001 through the first half of 2006, the Bay Area’s CPI Shelter Index has been almost flat, rising only 8%, which pales in comparison to the 29% increase in L.A.’s Shelter Index over the same period.
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Outlook & Conclusions
So far, the broader economic burden of California’s real estate slowdown has fallen outside the Bay Area. West of the Bay, real estate has not been a big contributor; in the East Bay, real estate remains the main source of job growth in 2006. 2007 in the East Bay will see the same trend most other parts of California have seen in 2006: real estate will move from being an engine of growth to a drag on the rest of the economy. This will most likely slow overall growth in the East Bay, but since there are no other sectors in the East Bay economy that look vulnerable to substantial job loss, the net result will be a slowdown, not a recession. Without recession-level job loss, history suggests that substantial declines in nominal home prices are unlikely: mix effects may exert some drag on median sales prices, but same home indices like the HPI will remain flat for the next several quarters.
Ryan Ratcliff
So far, 2006 has unfolded about like we predicted. The housing market has continued to soften, and real estate related employment has moved from a major engine of growth in 2005 to a drag on growth in 2006. High home prices continue to eat away at income growth – real per capita incomes in California have yet to recover even 5 years after the recession.
Looking forward, the forecast calls for a similar picture. Real estate sectors will continue to decline, but without significant declines in another sector, the net result will be a slowdown, not a recession. In the absence of recession, statewide home price are unlikely to experience significant declines. However, since builders are much more willing to lower home prices than owners, the handful of areas where new homes account for an above-average share of total sales activity could see some price declines.
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David Shulman
While the U.S. economy appears to have seamlessly downshifted to a soft landing, we suspect that there will be turbulence ahead. To be sure, we are not forecasting a recession, but the glide path of the economy is about to get bumpy as the housing market continues to deteriorate. We expect a sustained period of 1.5- 2% real growth, and before it is over there will be more than a hint of stagflation in the choppy air.
Specifically our forecast calls for real GDP growth to average 1.8% in the three quarters beginning in Q306 and ending in Q207, while core CPI will be increasing at an average rate of 3.2%. In this environment the unemployment rate would rise to 5.1% by the end of 2007, above the current level of 4.7%. While not a recession, it is hardly a pretty picture. The combination of sluggish growth and rising prices will have the look and feel of a low level stagflation. Although the term stagflation conjures up images of the mid-1970s, when output declined and inflation rose, the current cycle will appear rather mild. Nevertheless policy makers will have a great deal of trouble grappling with it. As we noted last quarter, the Fed remains in a box trying to simultaneously deal with weak output growth and an inflation rate higher than what it would like.
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