Friday, July 31, 2009

133-TNG Radio - Christopher Thornberg 8-1-09

This week Bruce is joined by Christopher Thornberg. Christopher is an expert in the study of regional economies, real estate dynamics, and business forecasting. In 2006, he confounded Beacon Economics which is economic research and consulting firm that specializes in real estate markets, local economic development, and public and private policy issues.

Beacon Economics will be doing its first Los Angeles Forecast Conference in the last week of July. There will be a panel of CEOs representing health care and the financial industry who will be talking about the changes occurring in their industry. It will be their first annual event. They are partnering with the LA Chamber of Commerce and Pepperdine to make this event happen. Southern California is the economic center of gravity within this state, and the center of Southern California is Los Angeles.

Bruce asks if a company is looking to relocate would find California to be a leading option. There are some things you have to consider if you come to California. You have to worry about where your employees are going to live. Nowadays homes are much more reasonably price compared to a few years ago. Companies coming to California will be able to rent commercial property for a lower price per month as well. The prices have not come down as much as they should have though, because of the leasing situation, and because there are still some landlords who seem to be in denial about the shape of the economy. Residential and commercial property are two sides of the same coin, and yet they come at different stages of the business cycle. Residential leads the business cycle, and commercial lags it.

The commercial real estate market is about to feel the same hit that the residential market has taken, but it is taking more time to mature. Part of the reason the commercial market is taking longer to go down is because the banks are not pursuing bad debt. The banks have more incentive to be lenient towards people they have lent money to, because if you foreclose on a loan then you actually have to mark that loss down in your books, but if you do not foreclose then the FDIC will allow you to keep that on the books at face value. They call it extend and pretend.

In the residential market there are a lot of properties that have not begun foreclosure, and some people have not made payments for 18 months. There are some banks that are willing to delay the foreclosure process, and some banks just can’t catch up, and there is also a problem with moratoriums that are slowing this situation down. Christopher thinks that if you have a problem then you should be trying to work through it and move forward, but we seem to be fond of dragging this problem out. Some will tell you that you want this problem to be solved over time, because the economy is already so weak, but Christopher says that there is very little evidence that foreclosures significantly hurt the economy. Moratoriums on foreclosure make it a lot longer problem.

On Christopher’s website there is a quote saying, “It’s not what Wall Street troubles me to California, it’s what California troubles me to Wall Street.” When we had a big financial meltdown last year, many reporters called Chris saying “What does this mean for California?” Christopher laughed at this, because Wall Street has presented itself as the leader of all financial things, but that is nonsense. The stock market can change its direction in the afternoon if it gets afraid. California has been in a recession since 3rd or 4th quarter of 2007, yet Wall Street made many bad bets and it did not seem to affect the economy for close to a year. If you did have a true meltdown in the financial system then you would have massive deflation and things would be far worse than they are now. We had a depression expert in the Federal Reserve, and he wasn’t going to let that happen.

Trillion has replaced billion as the cost of solving problems, but Christopher says inflation does not seem to be a likely outcome of the spending we are doing. This is because a large portion of the money we are spending is being done through treasury bonds. That does not have an inflationary effect. What does have an inflation effect is the expansion of the money supply. The Fed, through its program of quantitative easing, has expanded its monetary base by 100 percent over the last year. If that money was to get into the real world then it would have an inflationary effect, but it hasn’t. Most of the money that the Federal Reserve has made has ended up in bank reserves. If the banks started lending that money then we would have an inflation problem, but Christopher thinks that if that ever happened that the Federal Reserve would start to get rid of that excess liquidity.

Bruce asks Christopher what the ramifications will be for 12 to 13 percent in California. Christopher does not think that unemployment is going to be a big problem. Unemployment is a lagging indicator. However, it does increase the amount of stress being put on the financial system. People over their heads in debt and underwater in their home but beyond that he doesn’t see a direct effect on the economy.

Bruce asks if he thinks lower wages will be an issue. Will renegotiation for lower union rates will come up? Christopher thinks it will have a little impact. Hours are already being cut for government and education jobs.

If California is one of the leading states in unemployment then it will affect migration patterns in the short run. The number one reason people move is for job opportunity. The number two reason is relative home prices. This means people will not have as much motivation to move into California for a while, but some people may start moving back into California because of the low home prices.

Builders couldn’t possibly be interested in creating building lots right now, so Bruce is worried that there will be a housing shortage around 2012 or 2013. Christopher thinks that is possible but he does not see us having an issue with single family housing. There are lots of lots ready out there, and as soon as someone sees the opportunity they will build. Christopher does think there will be problems with rental houses. When people start moving back, there will not be enough housing for low income families. Christopher hopes the state will make policy changes to encourage multi family production.

Bruce thinks that it might be a solution to give investors financing so that they can hold properties for a reasonable price because then the market would dictate what the rent would be. Christopher thinks we got into this mess because of too much financing but now there is not as much financing as people would like. Christopher wonders if there is a true market failure occurring right now or are people simply suffering from credit withdrawals. There was never too much financing for investors who buy and hold properties and eventually pay them off. The financing problems occurred when speculators and owner occupants got involved. If your goal is to find reasonable rentals, they are all over the place in Moreno Valley and San Bernardino, but the financing is not available for investors to get these homes. What seems like a sure deal to investors does not seem like a sure deal to the banks.

Bruce thinks that the number of bank owned properties is going to dramatically increase in the next year. Bruce asks if Christopher sees more price damage coming to California because of that. Christopher does not think that these bank owned properties are not going to really decrease prices but they will help hold prices down. There is pent up demand for housing. If you go to an auction, you will see people who want to buy foreclosed units. Bruce thinks that this is true in the short run.

Bruce wonders how we can have pent up demand when we have the most generous financing programs in existence. It is surprising to Bruce that there is this much demand when there are so many people who have been artificially allowed to participate before they were ready.

In Riverside and San Bernardino, rent is more expensive than the PITI payment. That has never occurred in California. This is occurring because there are many people who cannot qualify for mortgages because they already have a bad mortgage on their payment. Unemployment and foreclosures are at a record, so Bruce does not understand who is actually going to borrow the money to buy these homes.

Christopher thinks there are more potential buyers who smartly sat on the sidelines and waited for these opportunities to come up. There may be other people who are being co-signed by their parents. If you talk to bankers they will tell you that there are people coming through their doors who have a recent foreclosure, and they will look the other way because they know that these people have made a mistake and there is no point in turning down a potentially good loan. Bruce agrees with Christopher here.

Most of the mortgage market is being dominated by Fannie Mae and Freddie Mac. Unless Fannie and Freddie are willing to back mortgage product and buy them off of banks, there is going to be very little money available.

Current loan modifications in California do not change the principal balance. Christopher does not think these have any chance of working. You cannot expect to have a true recovery by simply modifying the payment. People are not fooled by these modifications. Even though we are modifying their payments, they are still in an incredible amount of debt. It will take many years for them to get rid of the debt they have taken on, and their credit score will heal faster than their equity position. In 2008, 7 out of 10 people who applied for a loan modification ended up in foreclosure eventually.

Bruce asks Christopher what he thinks will indicate that real estate is starting to get healthy. Christopher thinks that sales are important and mortgage delinquencies from the Mortgage Bankers Association. For California, about 9 percent of all mortgages are delinquent. That tells you that we are no where near the end of this problem.

We look forward to Christopher being on our panel for I Survived Real Estate 2009.

Christopher Thornberg is a founding partner of Beacon Economics. Dr. Thornberg is an expert in the study of regional economies, real estate dynamics, labor markets and business forecasting. He has been involved in a number of special studies measuring the impact of important events on the economy, including the NAFTA treaty, the California power crisis, port security, California water transfer programs and the September 11th terrorist attacks. Prior to launching Beacon he worked with the UCLA Anderson Forecast where he regularly authored the outlooks for California, Los Angeles and the East Bay as well as performing a number of specialized forecasts for regions and industries. Dr. Thornberg lectures on a regular basis at a variety of public and private events, has appeared on CNN, Fox News and CNBC and is widely quoted in the press. He received his Ph.D in Business Economics from The Anderson School and his B.S. in Business Administration from the State University of New York at Buffalo. He specializes in International and Labor Economics. Dr. Thornberg continues to teach in the MBA program at UCLA and previously held a faculty position in the economics department at Clemson University.

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