It appears that the longest stalemate in California’s circus like budget process is now coming to an end. Before you throw up your arms in glorious celebration, a large part of the proposal seems to rely on cuts and more financial gimmicks. Yet with no actual financial reform since the real economy flew off the overpass, it is likely that California is in for a long drawn out decade. Of course all of this can change if we can find another bubble or another Enron-scheme to trade worthless contracts to enrich the state at the expense of others but the game of easy money seems to be coming to an end. We still need to plug the $19 billion gap and merely having the budget is the first step. The hard part is enacting the proposal. Anyone was able to sign on the dotted line for a $750,000 toxic mortgage but keeping up with the payments for the long haul was a losing proposition. Housing cannot recover without the real economy recovering first. Today we are going to look at 5 reasons why it appears that California is going to face austerity for the next decade.

Construction and finance jobs back to 1997 levels

We have the same number of people working in construction as we did in 1997. Of course the state has added over 5,000,000 people since that time. The contraction in construction has been incredibly severe. And the issue here can’t be resolved overnight. We basically built enough housing to keep us going until 2015 and ate up the money during the good times. Another industry that is tied to the hip to housing was the financial industry:

I can’t tell you how many people were making large incomes during the heyday of the housing bubble by pushing people into toxic mortgages but it was a good number of people. What was interesting psychologically is many of these people in the industry believed their own rhetoric and went out and bought incredibly expensive homes with the toxic mortgages they were selling. This was fine when $200,000 a year was flowing in but it was unsustainable. Just go on Craigslist and take a look at the used auto sections. You’ll find a large number of foreign luxury vehicles being sold at fire sale prices. Like the California budget, the issue is always around sustainable cash-flow. The state didn’t mind because it was winning on:

-Higher property tax assessments from home sales (reassessed value) -Big state income tax collections from commissions -Sales tax revenues from people spending this money

It was a game of musical chairs for the state and those in these industries. And make no mistake, these were good paying jobs. Yet in today’s market where the only game in town is government backed loans, many of these industries are gone for good. You tell me what other industry is going to pay people six-figures pushing people into inflated assets? Even good entry level jobs in healthcare don’t come close to what some people were making. So it is very doubtful that California will see this revenue stream comeback from this group anytime soon.

Shadow inventory will provide lower priced distressed properties for years

I’m not sure if the public fully understand the magnitude of shadow inventory on bank balance sheets. I suppose if they did, it wouldn’t be called shadow inventory. But take a look at the above snapshot. Currently in Southern California we have approximately 105,000 homes on the MLS. But if we include foreclosures (not necessarily on the MLS) the figure just flies off the charts:

What do you think is going to happen with the 160,000+ properties in the foreclosure pipeline? Do you really think these will cure and suddenly become current? The troubling fact is California is littered with many Alt-A and option ARM foreclosures that are now hitting the market. We’ve now shown a steady flow of high priced foreclosures selling for hundreds of thousands off their peak price.

You can run this data for up North as well:

San Francisco County, Marin County, and Sacramento County MLS: 8,314 Plus foreclosures: 27,656

The banks are merely hiding the junk. They’ve been slowly sweeping the toxic inventory under the taxpayer rug for the last three years hoping miraculously the market would recover. If they flood the market we’ll have a crazy few years. If they decide to leak properties out, you can rest assured we will have a lost decade in housing that will also serve as a drag on the real economy (i.e., Japan’s lost decades). The market will adapt to this hoarding behavior and eventually folks will start assuming holding out patterns waiting for the steady leak to hit.

State tax burden

The California tax burden is relatively high compared to other states. However the counter to this is the low property taxes as we will show shortly. In California, a large part of the state budget (over 50 percent) comes from personal income taxes. Other taxes include sales taxes which hit consumers yet again on the buying end. As much as people don’t want to hear it, there is only two ways to balance a budget; you either cut or you raise revenues (i.e.,taxes). I haven’t seen any solid argument showing an industry that will step in and employ 2 million unemployed Californians. So the new adjusted reality has to reflect this new structure. It doesn’t matter who is elected the next Governor, we have structural problems in the state.

Property taxes in California on par with Michigan

Because of Prop 13 property taxes in California are relatively low even though property prices are some of the highest around. California ranks near Michigan in terms of property tax rates per capita. Yet I’m not sure why so many people are confident that no one will ever change this in the future. We are beyond arguing economics anymore. The new changes will be politically motivated and states around the country are hurting for cash. The Federal Reserve is merely monetizing debt to help out their crony banker friends but the rest of the country doesn’t have access to this money machine.

Yet things haven’t changed here so we can only go by current law. Take a county like Riverside that has seen property prices fall from the mid-$400,000 range to $200,000. In this large area when people buy these homes taxes will be assessed on half the value. So these local governments are going to have to cut back on services. You can see why boom and busts are horrible for planning out financial strategy. This is like your family income being $250,000 one year and $35,000 the next year. How will you plan for the next year? California has basically used the strategy of spend everything as it comes in.

History nostalgia and jobs

I was listening to the radio driving on one of these oddly hot fall summer days and a radio guest said something that made me laugh out loud. The topic was people walking away from their debt. The person was trying to make a moral argument about how “bad” these people were and how they were hurting their neighbor’s home values. Of course, this myopic guest didn’t talk about how big banks were walking away from their bad debt and how immoral that was but that is another story. Yet the line that stuck in my head was, “it is sad because our parent’s generation would have never walked away from their mortgage.” Well no crap Sherlock! The past generations had to go in with 20 percent down payments and stick it out with either 15 year or 30 year mortgages. They didn’t have paper mill mortgage factories tossing out options ARMs, interest only loans, and other no-doc crap on their platter. They also didn’t operate against robo-signers and flat out criminal like behavior in the mortgage market. It is also the case that we’ve never seen a housing bubble like this thanks to a completely de-regulated Wild West Wall Street:

So to make the moral argument is nonsense. See, in the past if you walked away everyone would look at you like a financial newbie because you had to put 20 percent into your home (frankly, it was very unlikely except in extreme cases that a strategic default would occur). Today, if you bought a home for $500,000 with zero down and the home is now worth $250,000 why in the world would you stay in the place? It just doesn’t make economic sense. Banks have robbed the country blind and they are only standing because the public has bailed them out. Now there is this propaganda that TARP is nearly paid back. Well let us all do a happy dance! This is like someone betting $50,000 on one hand of blackjack and busting. They reach into their neighbor’s pocket, take out $50,000, make a bet again and win and then pay the money back. What good investor they are. And all we had to pay for their gambling was with our real economy:



This is straight from the BLS website. California’s U6 rate is close to 22 percent from the 3rd quarter of 2009 to the 2nd quarter in 2010. So in fact, this actually understates the true underemployment going on. We are now three years into the bailouts and Wall Street shenanigans and most Americans are now poorer than they have ever been. And someone is arguing that typical Americans should pay their mortgage no matter what? Give me a break. This is exactly why you have large down payment requirements to begin with.

If these history revisionists want to preach about something why don’t they talk about the 20 percent down payment that was typical in the past? Why don’t they argue for bringing back the separation of investment and commercial banking? It seems like their parent’s generation did well under this system. Of course they won’t argue this because they would rather argue a narrow focused ideological battle that has nothing to do with historical economic facts.

California is in for a long haul. I hope wiser heads will prevail going forward. It is rather clear what works and what doesn’t and now we need the actual reformation of the system to be implemented. I’ll believe it when I see it.

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