New Geography

Category: Economics

  • Is the U.S. Capitalist, Socialist or Something In-between?

    During the Presidential campaign, then-Democratic candidate Barack Obama inartfully described his proposed federal income tax cuts for the middle class as “sharing the wealth.” His more strident right-wing opponents – including Vice Presidential candidate Sarah Palin – almost immediately labeled Obama “a socialist,” adding to a litany of alleged infirmities as a presidential candidate that included lacking executive experience; being a closet Muslim; and “someone who pals around with terrorists.”

    Yet in reality Obama’s middle class tax proposal may have been the least “socialist” concept that has been floated and acted upon by a broad array of elected officials and senior-level appointees since four weeks before and four weeks after the Presidential election. This includes not only the huge federal financial bailout and taking of ownership of major investment and commercial banks – something embraced by the establishments of both political parties and the putative ‘capitalist’ business elites – but a series of other proposals, including the bailout of the Big Three American automakers, that are far more socialistic than a tax cut.

    Of course, effective campaigning, like good television advertising, tends to have at least two fundamental characteristics in common – oversimplification and hyperbole – so one might forgive or ignore the campaigns for taking liberties with such terms. Yet the ready and frequent use of the term “socialist” by a variety of sources does raise serious questions as to whether anyone out there really understands either capitalism or socialism as concepts or political constructs. This might help us know how much we should apply either label to the U.S. given the prevailing economic malady and the series of palliatives being offered up by the current and future Administrations, respectively.

    Socialism, of course, places primary ownership of the means of production in the hands of the state, or in some cases, corporate entities controlled by the state. In its extreme cases, such as in North Korea, this reality is absolute; in many other countries, state control is predominant and preeminent but pockets of private enterprise, usually small-scale and concentrated in agriculture or business services, still exist.

    Capitalism is a much more vague idea but essentially reverses priorities, putting the predominant role in the hands of private interests such as investors and corporations. State power in a capitalist country usually focuses on the creation of standards, public health, safety, and welfare, such things as regulating the currency, protecting the environment, and assuring the health of the populace.

    In contrast to the 19th Century, the US already operates on a much-diluted form of capitalism. Our markets are not free; they are highly regulated (and yet many would today argue they are not highly regulated enough). The exchange rates and values of our currency do not float freely but are heavily manipulated through federal government rate-setting activities. Investment decisions are not driven purely by return expectations or classic risk/reward analyses; rather they are incentivized or discouraged by a byzantine system of rewards and penalties affectionately known as the Internal Revenue Code. In other words, the federal government – under both Democrat and Republican Administrations and supported by both Houses of Congress – intervenes routinely in how markets operate and how capital is deployed. In this sense the federal tax code is fundamentally a mechanism for wealth redistribution, so candidate Obama’s statement about his proposed middle-class tax cut simply represented a shift to one set of priorities, much as the Bush Administration’s tax cuts represented another.

    If you accept the premise above that the U.S. already had one foot out the doorway between a more pure form of capitalism and socialism as it is widely practiced in other Westernized countries, it now appears that the U.S. is being pulled at warp speed through that doorway, as a consequence of the myriad plans (schemes would be a more accurate description, given how little thought appears to be devoted to them before rolling them out at press conference after press conference) for bailing out various classically capitalistic institutions.

    Bailing out a completely broken mortgage finance system that rewarded handsomely (some would say shamelessly) myriad private-sector entities and the mortgage industry represents a shift towards socialism. Providing over $100 billion in taxpayer support for AIG is socialism, not capitalism. Providing $200 billion of taxpayer support to prop up consumer credit, so that Americans can return to a false economy predicated upon unbridled, conspicuous consumption, is socialism not capitalism.

    The fact that these and other extraordinary moves by the federal government are undertaken in the name of saving our capitalistic economy and staving off a severe economic depression does not change the fact that we are experiencing – first under Bush and soon under Obama – a powerful drift towards extended state control of the economy. Free-wheeling and unfettered profit-making and corporate greed on the way up, backstopped by enormous government bailouts on the way down, represents in some ways the worst of both worlds .

    We now add to this series of attempts to solve our economic crisis the so-called “New, New Deal” proposed by President-elect Obama the week before Thanksgiving. Focused on fixing America’s infrastructure improvements, technological innovation, and education – as well as the creation of 2.5 million new jobs in the process – the New, New Deal basically supplants a failed, quasi-capitalistic economy with one that is driven primarily by government spending on government projects, in part for the purpose of creating new government jobs.

    There will be two silver linings if all of these government bail-out strategies and the implementation of Obama’s New, New Deal succeed: The U.S. could emerge from this economic abyss in which we find ourselves; and pass, at last, a comprehensive, universal healthcare reform that will not look nearly as socialistic as it may have appeared only six months ago.

    Yet there are some real dangers as well. A massive government program that extends more and more into every aspect of the economy could bring enormous inefficiencies as political decisions overtake market-based decision-making. It is not beyond the pale, for example, that banks may make loans to customers not based on their fundamental ability to pay but their ability to shift their risks to the government. Land use and other decisions once left to markets and localities could be placed in the hands of federal regulators, where the influence of well-connected developers and special interests (including such laudable causes as environmental protection) could be profound.

    Of course, this is a situation that could also change our national geography in profound ways. Parts of the country well-plugged into the new ruling party – the Northeast, coastal California, and most of all Chicago – could be huge beneficiaries. But the real winner, as I have argued before, may be the Nation’s Capital and its environs, whose power over the private economy would be greater than at any time since the Second World War.

    Of course, it may perhaps be both overly simplistic and somewhat hyperbolic to suggest that Washington, D.C. is morphing into “Pyongyang on the Potomac.” However, unless the federal rescue of our fundamentally capitalistic economy and society is not very carefully orchestrated, we may see greater similarities with another centrally planned economy – the one run from Paris. In that case, similarities between Paris and Washington, D.C. may extend well beyond the boulevarded street network and classical scale bestowed upon us by Pierre L’Enfant; we could also end up with something more akin to France’s centrally controlled dirigiste system than anyone could have expected.

    Peter Smirniotopoulos, Vice President – Development of UniDev, LLC, is based in the company’s headquarters in Bethesda, Maryland, and works throughout the U.S. He is on the faculty of the Masters in Science in Real Estate program at Johns Hopkins University. The views expressed herein are solely his own.

  • Auto Bailout: Help Mississippi, Not Michigan

    We should be getting used to the depressing spectacle of once-great corporations begging for assistance from Washington. Yet perhaps nothing is more painful than to see General Motors and other big U.S.-based car companies – once exemplars of both American economic supremacy and middle-class aspirations – fall to such an appalling state.

    Yet if GM represents all that is bad about the American economy, particularly manufacturing, it does not represent the breadth of our industrial landscape. Indeed, even as the dull-witted leviathan sinks, many nimble companies have shown remarkable resiliency.

    These include a series of small and mid-sized firms – in fields as diverse as garments and agricultural machinery, steel and energy equipment – that have managed to thrive in recent years. It also includes a growing contingent of foreign-owned firms, notably in the automobile industry, that have found that “Made in America” is not necessarily uncompetitive, unprofitable or impossible.

    Indeed, until the globalization of the financial crisis, American manufacturing exports were reaching record levels. Overall, U.S. industry has become among the most productive in the world – output has doubled over the past 25 years, and productivity has grown at a rate twice that of the rest of the economy. Far from dead, our manufacturing sector is the world’s largest, with 5% of the world’s population producing five times their share in industrial goods.

    So what is the problem then? If it is not the effort and ingenuity of American workers or our infrastructure, Detroit’s problems must lie somewhere else, largely with almost insanely bad management.

    We have to remember that the Big Three have been losing market share through even the best of times. Their litany of excuses is as tiresome as their product lines. Back in the 1970s it was “cheap” Japanese labor, something that can no longer be cited as an excuse. European car makers, if anything, have even higher wage costs.

    Then there is high gas prices – a good excuse, it appears, back in the 1970s, as well as more recently. But the Detroit auto industry has now had three decades to come up with fuel efficient products that are also fun to drive and reliable. While they have slumbered, the Japanese, Koreans and now the Europeans – with products like the new Volkswagen Jetta – have made enormous strides.

    Now it is the credit crunch, the car makers say. OK. Will increased credit mean that people will suddenly scoop up the same products they have been deserting in droves for decades? Keep in mind that the desertion could get even worse if the congressional greens – led by new Energy and Commerce Committee Chairman Rep. Henry Waxman – impose stiffer taxes on gas, which will hurt the guzzlers that have generated most of Big Three profits.

    So why the push to bail out the Big Three? It’s basically about regional politics. The deindustrializing states of California and New York may not care much, but the big car companies’ operations are overwhelmingly concentrated in the politically volatile Great Lakes region, an area that proved decisive in President-elect Obama’s victory. Another big reason may be that up to 240,000 jobs in Illinois, the nation’s new political epicenter, are tied to the big automakers.

    Sadly, dependence on the Big Three has had long-term tragic results for this entire region. Between 2000 and 2007 – before the onset of the financial crisis – the nation’s largest percentage losses of manufacturing jobs were concentrated in Big Three bastions like Detroit, Warren-Farmington Hills, Saginaw, Flint and Cleveland. In the five years before the onset of the financial crisis, Michigan alone had lost one-third of its auto manufacturing jobs. Now that figure is up to half.

    Worse still has been the psychological dependency that has grown from this troubled relationship. By their very nature, declining businesses – particularly unionized ones – tend to protect their older members and encrusted bureaucracies more than they look to the future. This also creates a political environment where the incentive is not to spur innovation, but to protect the already established.

    Michigan, for example, has met the challenge of its Big Three habit with a combination of farce and failure. Under the clueless leadership of its governor, Jennifer Granholm, the state first hoped its “cool cities” program would keep young, educated workers close to home. After that failed to work, the governor then pushed the highest tax boost in state history, a reliable job-killer.

    So let us be clear. It did not take a world financial crisis to sink Michigan; it was getting there very well on its own. Nearly one in three residents, according to a July 2006 Detroit News poll, believe that Michigan is “a dying state.” Two in five of the state’s residents under 35 said they were seriously considering leaving the state.

    Fortunately, the Big Three do not represent the entire picture of American manufacturing. Even within the Great Lakes region, Wisconsin, which ranks second in per capita employment in manufacturing, has held onto most of its industrial employment due to its large, highly diversified base of smaller-scale specialized manufacturers.

    If Congress and President Obama want to figure out how to restart our industrial economy, they need to travel not to Detroit but to an alternative universe that includes the South and Appalachia, where most of the new foreign-owned auto manufacturers have clustered. States like Alabama, with the second-largest per capita concentration of auto-related jobs, as well as South Carolina, Tennessee, Kentucky, Georgia and Mississippi, have been growing these high-wage jobs for a new generation. In the process, they have brought unprecedented opportunity to some of the nation’s historically poorest regions.

    Nor are these states looking to remain mere assembly centers. For example, they have launched bold new research initiatives, such as the recently formed International Automotive Research Center at Clemson University, which offers the nation’s only Ph.D. in automotive engineering, to make their region a major center of technological innovation for the industry. And the fact that the region will likely be producing the majority of the most low-mileage and low-emission cars certainly cannot hurt their future prospects.

    However, it is also critical to see beyond merely autos. If you look at the period between 2000 and 2007, as we did at the Praxis Strategy Group, much of the fastest growth in manufacturing was taking place in areas tied to energy production like Midland and Longview, Texas, and Morgantown, W.Va., all of which enjoyed 15% or more increases in manufacturing jobs. Already states like Arkansas, Alabama, Iowa and Mississippi boast more per capita industrial jobs than either Michigan or Ohio.

    Another strong performer has been the Great Plains. Places like Dubuque, Iowa, and Fargo and Grand Forks, N.D., experienced substantial growth in industrial jobs during the past decade. The base here, as in Wisconsin, is highly diverse and includes agricultural and construction equipment, electronics as well as a burgeoning sector in the renewable fuels sector, such as LM Glasfibre, a Danish firm with a large operation in Grand Forks. Washington state has been another bright spot, powered by Boeing and other manufacturers attracted to its low-cost, low-emission hydropower.

    If the country is serious about enhancing U.S. industrial might – as it should be – it might want to ask executives and entrepreneurs in these areas, as well as foreign investors, what they need to keep growing and expanding exports. There is clearly a demonstrated global market for Boeing airplanes and Caterpillar construction and agricultural machinery, as well as a host of high-tech and fashion-related products now being churned out in factories scattered across the country.

    The people running these firms should be those at the congressional hearings, not the pathetic losers from companies like General Motors. They might even have some helpful ideas, like streamlining regulations, investing in critical infrastructure and research facilities, expanding support for training a new generation of skilled blue collar workers and using incentives to encourage firms to improve their energy efficiency. These are the steps we can expect our competitors in Europe, Asia and the developing world to take as well.

    Rather than looking for ways to bail out the most egregious serial failures, let us find ways to provide incentives for those successful at creating new jobs and saving existing ones.

    This article originally appeared at Forbes.com.

    Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

  • L.A.’s Big-Bucks Plan for Upper Floors on Broadway Overlooks Facts at Ground Level

    City officials and private business owners recently gathered to celebrate the extended holiday hours of the Metropolitan Transportation Authority (MTA) Metro Red Line train service between Hollywood and Downtown. Private businesses put up $50,000 or so to pay for the Red Line to run an extra two hours — until 3 a.m. — on weekends through December 27. The local business community also came up with private funds for free service on city-operated DASH buses that will offer connections to late-night Red Line riders and others.

    There’s room to question the timing of those moves amid an economic slide. Yet there’s just as much reason to see good sense and courage behind efforts to kick-start economic activity in the face of the frozen confidence of consumers. The effort falls within the realm of a privately financed gamble, too, so that’s fair enough.

    It’s another thing altogether for our city officials to take such chances on an economic stimulus program, as they apparently intend to do with a plan to make $150 million a year available for loans to property owners along the Downtown stretch of Broadway.

    The plan, as stated by 14th District Los Angeles City Councilmember Jose Huizar, is to provide incentives for property owners to renovate some of the long-empty upper floors of buildings along the thoroughfare, where many of the structures have few tenants besides ground-floor retailers.

    Huizar has noted that the empty spaces provide no jobs and little tax revenue, and that he hopes to reverse that by lending money to property owners from a pool of federal funds. The funds would finance renovations in hopes of drawing commercial tenants and jobs to the upper floors on Broadway.

    It remains unclear why any of the property owners who didn’t see incentives to renovate their properties during Downtown’s recent boom years would find reasons to do so now. It’s also unclear what sort of tenants would fill the empty spaces. It could be several years before we see anything resembling a hot economy in these parts.

    Again, there is always room for bold ideas that are counter-intuitive. Fortune magazine launched in 1930 — just four months after the stock market crash that signaled the Great Depression — and the publication has done just fine all these years. There’s also room to figure that renovations take awhile, and such work along Broadway might be ready just as the economy picks up.

    This economic mess of ours is big and immediate, though, causing extreme difficulties for folks everywhere. There’s some irony here, because you can get a picture of the pain by walking along Broadway. Don’t bother looking at those empty spaces on the upper floor. Take a gander at the ground floors, where many of the retail shops that buzzed with customers just a short while ago have closed, and those that remain face uncertain prospects.

    It’s enough to make you wonder whether $150 million might be better spent on something other than loans to property owners on the hopes that renovations will someday bring jobs from somewhere to the upper floors along Broadway.

    Meanwhile, there’s never been a better chance of getting a change on the rules that come with federal funds. That should be enough for Huizar and other city officials to re-think their plans. They should consider that Broadway — while it’s not everybody’s cup of tea — has been one of the busiest commercial streets in the city for years. It’s a place where merchants sell, workers earn, and shoppers spend.

    Maybe the action is mostly bargain retail on the ground floor, but Broadway is a working street — and we need all of those we can get right now.

    So why not focus ways to help retailers hang on, and draw more to fill the new gaps at street level? How about renovations for storefronts, with merchants allowed a voice in the process? Or more cops for the area to help improve the atmosphere for shoppers? Or aggressive promotions of the retail scene? All of that might even entice a few more mid- and upper-scale merchants to set up shop on Broadway, sparking some organic changes in the marketplace.

    Pick a program, but keep in mind that this is no time to overlook — quite literally — Broadway’s long-standing role as a street-level heartbeat of our city.

    Jerry Sullivan is the Editor & Publisher of the Los Angeles Garment & Citizen, a weekly community newspaper that covers Downtown Los Angeles and surrounding districts (www.garmentandcitizen.com)

  • The Recession Hits the Plains

    On Monday, Creighton University’s Economic Forecasting Group released the latest installment of the Mid-America Economic Survey. The survey of supply managers in nine plains states has been conducted monthly since 1994 to “produce leading economic indicators of the Mid-America economy.” The survey provides a snapshot of economic activity in the states of Arkansas, Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, Oklahoma and South Dakota.

    For November, the economic picture was less than positive. The survey’s primary index hit a second straight all-time low in November, recording a score of 37.8. Any score below 50 “indicates a contracting economy over the next six to eight months.” Only one state surveyed, North Dakota, showed a growing economy, with an index reading of 55.7, down from both September and October.

    Employment prospects in the area were also negative, with the region showing “job losses for the tenth time in the past 11 months.” This led to a “very weak” November employment index figure of 39.0, down from 49.7 in October, another record low. Creighton economics professor Ernie Goss, a member of the forecast group, expects “regional job losses to mount in the months ahead with rapidly rising unemployment rates for most states.” According to Goss, the area is “now in a recession and I expect it to rival the recession of 1981-82 in terms of joblessness and job losses.”

    Echoing such findings today, the Federal Reserve released the latest edition of the Summary of Commentary on Current Economic Conditions, more commonly referred to as the Beige Book. According to the report, “overall economic activity weakened across all Federal Reserve Districts,” with declines in retail sales, manufacturing activity, and housing prices being reported in nearly all districts. On the plains, the Minneapolis and Kansas City Fed districts both reported weaker overall economic activity.

    Hopes for a quick rebound are subdued. According to the Kansas City Fed, their “business contacts expressed little optimism about economic activity going forward.” The Mid-America survey reports that economic optimism “captured by the confidence index, slipped to another record low of 22.4” in November. While pockets of strength such as North Dakota remain, communities across the plains now face the prospect of a significant economic downturn.

  • Back to Basics in Orlando

    By Richard Reep

    For the last decade the City of Orlando has been concentrating form, trying somehow to displace its image as the ultimate plastic city. Although tourism helped insulate Central Florida from the slowdowns of the 1970s and 1980s, the last three recessions hit Orlando harder than the national average. This metropolitan area has now been taking on a more essential task of morphing slowly away from its status as ephemeral support city for the theme parks.

    One sign of this new appreciation for the basic necessity of good jobs can be seen in two new districts: one concentrated around medical research and practice; the other concentrated around digital media.

    Both districts will greatly enhance the city’s core offering of service jobs, and are being nationally scrutinized for their viability as a new home for technological research and application. In the next phase of city-making, Orlando can make important steps towards a sustainable economy, if it grows good jobs while focusing on the basics of safety, security, and a spiritual core for its citizens.

    The first growth district, on Orlando’s ring road, is Lake Nona. Private interests have combined with institutions of higher education to create a core of medical research and technology. The most recent star addition to this, Nemours Children’s Hospital, will anchor part of the development. Medical research laboratories by Florida’s major public universities flank the hospital, and more medical facilities are on their way.

    Surrounded by residential communities and scrub pine, the medical district is in its infancy. This community already boasts two promising features. For one, the focus on good jobs sets the fundamental stage for organic and meaningful growth created. This seems logical enough, but the employment element has been largely missing from most new developments of regional impact. Secondly, the residential community, currently less than 10% developed, appears to be growing unmolested by the need to conform to pre-set ideas about cities. Lake Nona’s Master Plan promises an 11-acre oval “town center”, likely to be a mixed-use district typical of recent Southeastern town centers: shops, offices, residential, and of course, the local supermarket, Publix.

    Thankfully, the developer is leaving the town center to the future, and this new core will have a chance to reflect Lake Nona’s mature identity, rather than be thrust upon the community by the Master Developer in some kind of bland neohistorical form. This is reminiscent of Valencia, planned in the late 1950s and developed in the 1960s, where core community functions such as hospitals, government offices, and schools were built first by the Newhall family near Los Angeles. Residential areas filled in the 1960’s and 1970s; but the original Town Center, designed by Victor Gruen, was not built until the late 1980s, after Valencia matured. The lesson of Valencia is that organic growth can yield a vibrant, successful development plan. Valencia remains today a positive addition to the Santa Clarita Valley and southern California in general.

    Switch focus to the inner city: forgotten, chaotic, grim residences; sagging front porches and weedy lots. Orlando’s own inner city, Parramore, did not benefit very well from the run-up in the last six years, and by the looks on the faces of the residents who watch you as you drive by, they know it. The City of Orlando has decided that it is now their turn.

    This will be an interesting experiment to see whether the greenfield results of New Urbanism can be translated to what is essentially a classic, 1960s urban renewal project in reverse: Demolition of 20-year-old event center slums, to be replaced by new construction to further the cause of virtual reality.

    The City’s bonding capacity, sadly, has been tapped for major venues (a new sports arena and a performing arts center), but failure of the event center has led to a healthy focus on higher skilled jobs. The city envisions a partnership with higher education and the private sector to create a digital media village, similar to Laval, a suburban community just north of Montreal. Laval, an existing neighborhood in search of new life, benefited from a similar effort when the city focused on developing its bioscience and information industries. Now Laval’s status has begun to show some basic street life and has a highly successful retail complex that draws shoppers from throughout the region.

    This concept of a technopole has now been borrowed by the City of Orlando to create a similar district centered around digital media: movies, gaming, and other pursuits. The city must be careful to make sure that, like Laval, it concentrates on jobs growth first, and then seeks to integrate those jobs with the community. As a city with a strong, form-based planning outlook, Orlando will certainly be anxious that the Media Village conforms to the concepts of New Urbanism.

    The trend is ominous: Cities that allow their job base to become concentrated in a small handful of industries are risking their economic lives on a set of very outdated assumptions. On the other hand, cities that have sought out high technology jobs have become the “survivors” of the economic downturn.

    In the year 1980, there were only nine research parks in America. Today there are more than 200 in the United States, and competition from overseas is heating up fast.

    It is important to remember what a giant head start that we gave to other cities. The Triangle Research Park near Raleigh / Durham was founded back in 1959, and now houses more than 150 research and technology companies. Although Orlando is the “new kid” on this particular block, if we focus on what the employers need, we still have a lot to offer besides tourism.

    With the economy stagnating, a growing focus on jobs – and building an environment that promotes growth – should have a strong appeal. As in the 1930s, slower growth can begin to get the community to look beyond New Urbanist form-obsession and look to more fundamental elements that create jobs and wealth as opposed to seeking to win accolades from developers and the architectural and planning establishments.

    Richard Reep is an Architect and artist living in Winter Park, Florida. His practice has centered around hospitality-driven mixed use, and has contributed in various capacities to urban mixed-use projects, both nationally and internationally, for the last 25 years.

  • New Zealand Voters Swing Right: John Key’s Shower Power

    Reason magazine’s Jesse Walker opens his commentary on the New Zealand election by saying: “At least one country is responding to the financial crisis by moving to the right, not left.” This is factually correct but may overstate the case.

    Certainly, New Zealanders elected a conservative National-led coalition government and removed from office a Labour-led coalition which had served three terms of three years. While it is appealing to contrast this move to the right with America’s move to the left, it is probably unwise to claim that these were contrasting responses to the international financial crisis. Indeed, I suspect the analysis of both the New Zealand and American elections is equally flawed.

    The key mood in the New Zealand electorate was simply that it was “Time for a Change”. And given that the incumbent Government was a left-of-centre Government, the change could only be to the right of centre. In this regard, there is a strong parallel with the American Presidential race where the mood was equally that it was “Time for a Change.” In the US this meant a move from the Republican right to the Democratic left.

    The mood for change was probably stronger in New Zealand because for a three-term government (nine years) to win a fourth term is most uncommon here; Helen Clark’s nine years as leader of that Government was a record, and had she won a fourth term as a Labour Prime Minister it would have been unprecedented. The historical odds were against her. On the other hand, all US Presidents must move aside after two terms, so change is thrust upon them.

    Now that both elections are over, the new US president and the new National Government, led by John Key, must face up to the harsh reality of the inevitable recession or depression resulting from the collapse of the housing and financial bubbles that dominated both economies during the last decade. This focus may encourage analysts to believe that the financial crisis was the cause of the electoral outcomes, even if the ideological swings were opposite.

    However, I believe that Barack Obama would have won the Presidential race had there been no financial crisis, and that John Key would also now be Prime Minister of New Zealand. But both their victories might have been less emphatic.

    In both countries voters were faced with a generational change. Obama is a young man in his early prime; McCain is an old man whose mortality worked against him. Helen Clark is younger than McCain (58 vs 72), but because she entered Parliament in 1981, became Deputy Prime Minister in 1989, and has been Prime Minister since 1999, she was seen as one of the old guard. She has stepped down as leader of the Labour Party as part of conceding defeat on election night. John Key is a young man of 47 who has been in parliament only since 2002, and Leader of the Opposition only since 2006.

    The role of the financial crisis in this New Zealand election was an ambivalent one. By law, our full-on election campaign is brief – only three months – compared to US campaigns, and Parliament goes into recess during the whole of the campaign. As it happened, the full impact of the financial crisis on the NZ economy became apparent at about the same time as campaigning began, although the collapse of the housing market had begun somewhat earlier. The campaigning politicians had little time to develop solid policies in response to the threat and, given that Parliament was in recess, could do nothing about it anyhow.

    Helen Clark argued that her Labour Government had successfully managed the economy for nine years and her team had the experience to manage the New Zealand economy through the next three years. John Key argued that his party had more skills in the field, and that the Labour party benches were full of academics and trade unionists, most of whom had never run a business.

    Clark’s response was that the National Party, and John Key in particular, were part of the problem. Her trade union base saw Key as a Wall Street banker and a cause of the problem. Key’s business base saw him as a man who understood the industry and had the skills and know-how to deal with the problem.

    National Party heavyweights included Don Brash, who had stepped aside as Leader of the Opposition to allow John Key to take over. Brash had been Governor of the Reserve Bank for 14 years; since resigning from Parliament in 2007 he had served as an adjunct professor of Banking at the Auckland University of Technology (and Chairman of the Centre for Resource Management Studies). John Key began working as a foreign exchange dealer at Elders Finance in Wellington, then moved to Auckland-based Bankers Trust. In 1995, he joined Merrill Lynch as head of Asian foreign exchange in Singapore. He was promoted to Merrill’s global head of foreign exchange, based in London, and was a member of the Foreign Exchange Committee of the New York Federal Reserve Bank from 1999 to 2001.

    On election night Key’s Centrist but Conservative National Party, (combined with the soft, somewhat libertarian Act Party as a coalition partner) scored a decisive victory – probably about as decisive a victory as is possible, given our system of Mixed Member Proportional representation (MMP).

    There is widespread agreement, at least among the supporters of the new regime, that Labour’s massive defeat was primarily caused by New Zealanders’ rejection of the “Nanny State,” which has increasingly interfered in our daily lives. And here may lie the real lesson for the new President of the USA.

    While the US is a genuine Super Power, and New Zealand is a mere pimple on the global body politic, we always aspire to punch above our weight, and frequently do. Helen Clark had decided that New Zealand would be a world leader in fighting climate change (anthropogenic global warming), and that we would become the world’s most sustainable economy with a carbon neutral footprint. So, for some time, New Zealanders responded with some enthusiasm to this new challenge of leadership on the world stage. We were proud to be Clean and Green, and of our Tourism Board’s promotion of New Zealand as 100% Pure – presumably we are free of even impure thoughts.

    However, as commentators as diverse as the late Aaron Wildavsky and Vaclav Klaus have warned, Global Warming is the mother of all scares because it enables Government to interfere in every aspect of our lives – to claim that no price is too high if necessary to save the planet for our grandchildren. Inevitably, the High Priests of “Sustainability” began to demand that we break our “addiction” to private automobiles and learn to love public transport; that we learn to love high-density apartments and abandon our home gardens; and that we stop doing anything which consumed fossil fuel. It soon became clear to many that the main concern of these New Puritans was that someone, somewhere, might just be enjoying themselves.

    Our unsubsidized grass farmers who pay most of our way in the world began to wonder why our belching cattle should be penalized by Kyoto rules, when subsidized European cattle were not. After all, cows have been belching since the first ruminants walked the earth, and they don’t run on fossil fuel.

    Rodney Hide, leader of the Act Party, began to argue that we should dump the Emissions Trading Scheme and withdraw from Kyoto because the whole Global Warming fear was a massive scam. This was supposed to be political suicide, but the polls showed that Act’s support suddenly increased. Act is now part of the new government, and their extra five seats consolidate John Key’s comfortable majority in the 120 seat Parliament.

    If President-Elect Obama becomes a High Priest of Climate Change, he too may find that 95% of Americans, just like New Zealanders, believe that other people should use public transport so that there will be more room on the road for them. He may also find that while the costs of Kyoto are scary and may drive even more energy intensive industries offshore to non-complying countries like China and India, it is the minor interventions in daily life which are the real irritants that could turn the electorate against him and make him a one term President.

    Because when it comes down to it, John Key’s majority may have been cemented in place by New Zealanders’ affection for taking a shower.

    A few weeks before the election, the Labour Government, largely at the behest of the Green Party on whose support they depended to maintain their majority in Parliament, proposed regulations which would limit the flow of water through a shower head to about 1.5 gallons per minute. The aim was to save both water and energy and thus make our houses more “sustainable”. The standard “low flow” rose in most showers at the time delivered about 3.5 gallons per minute.

    This proved to be the last straw. The grumblings about the proposed mandatory replacement of incandescent light bulbs with compact fluorescents, similar to the rumblings in the US, exploded into a furor on blog sites, talk-back radio and letters to the editor. A popular blogger drew up a list of 85 things the Greens want to ban. People recalled how a Green Party official had endorsed a petition calling for the ban of Dihydrogen Monoxide…which just happens to be water.

    The proposal was not just irksome; it soon became evident that it probably would not even achieve its objective. People would stay in the shower longer or alternatively run a nice deep hot bath. As is so often the case in political campaigns, this single minor proposal came to symbolize a whole range of discontents, and people could use it as a focus for their latent rage and fury against the Nanny State.

    So Jesse Walker’s comment that triggered the request for this commentary on the New Zealand election might more properly have read, “At least one country is responding to global warming alarmism by moving to the right, not the left.”

    Our recent experience in New Zealand should give Barack Obama reason to pause. A stance against Global Warming is popular, right up until it starts to bite. Then the American public too, might just bite back.

    Owen McShane is a Resource Management Consultant based in New Zealand

  • Bailout or Just in Time Delivery?

    Toyota is careful in its ways; it didn’t get where it is today by idly locating manufacturing plants. And, so it chose Georgetown, Ky. – 12 miles north of Lexington on I-75 – for the location of its first and largest U.S. plant. It was followed in the ensuing years by numerous other foreign auto plants locating in the South – BMW, Mercedes, Saturn, Hyundai and yet another Toyota (in Mississippi).

    Why, you may ask, did they come to the South? The easy answer is that they came for cheaper land and labor. They were also drawn by large and much criticized tax incentive packages as the South decided – value judgments aside – to get in the game and establish a manufacturing base to replace the sagging agriculturally based small farm economy. Here in Kentucky, the less than bright future for tobacco was ample motivation for welcoming Toyota.

    But I believe there is more to this move. They came also for laborers eager to find the good paying auto jobs that had escaped the South for too long. The influx reversed a trend of Southerners leaving for the great factories of the North as my father did 60 years ago as he fled Appalachian Kentucky for Dayton, Ohio.

    Also, contrary to East Coast “attitudes” they came for another reason – the work ethic common to this region. In Kentucky workers from 116 of its 120 counties were hired when Toyota began operations – 7,000 strong. They wanted to work, and were willing to move, commute, or hitchhike for the opportunities. Just as importantly, Toyota created a new employment strategy of hiring a “cushion” of temporary employees to insulate full-time employees from the impact of an eventual economic downturn.

    This image contrasts that of Southerners – particularly those in Appalachia – as generally lazy, fat, dumb, happy, pregnant, barefoot, toothless, racist, sexist or any combination thereof. Speaking of lazy, we can thank Gary Tuchman and CNN for the latest contribution to stereotyping our Commonwealth when they chose to find poor sad people on a front porch in Clay County Ky., to enunciate in butchered English their discouragement with the state of the world.

    So when we hear about the bailouts, first for the financial industry and now the Detroit-based U.S. auto industry, we have reason for skepticism. Our auto industry – that is the generally healthy industry created by Japanese, Korean and German manufacturers – doesn’t seem on the bailout list. Neither do our local banks. They’re not too big to fail and not stupid enough to follow the lead of Wall Street.

    Of course, we don’t want to see any part of America fail, including Detroit. According to one Toyota executive, the webbing of the auto industry is so intertwined that the failure of the U.S. auto industry would bring down the entire house of cards, including the supplier plants that Toyota and other “new age” manufacturing plants call “just in time delivery” facilities.

    But others do see the bailout as undermining a trend that favors efficiency in manufacturing – and the wise investment Toyota and other companies have made in developing smaller, more fuel-efficient cars. Still others are baffled about what they would do if it was their congressional vote. The global economy has grown complex in many ways. Among the most vexing issues are those surrounding present and future government involvement in private companies.

    Ultimately we wonder what the attitude of the new administration will be toward Kentucky and the South. Kentucky in particular stood out once again with early poll closings, to be declared “red,” by a large percentage as it went to McCain. Obama tiptoed only once into the state, and that was in “blue” Louisville. He made no effort to win us over as Kennedy and Clinton had in earlier presidential campaigns. We will soon learn if he remains true to his rhetoric that proclaims that we are neither “red” nor “blue” but one America.

    There’s much our new President could do for this part of the world. The mega car factories might show what our workforce is capable of but they have not been enough to reverse our relatively low per capita incomes. New investments – roads, waterways, freight rail lines, skills training – could help lift our region up even further. We just hope that the new President realizes that all of America will benefit if the South can build on its automotive industry success to achieve a much broader prosperity.

    Sylvia L. Lovely is the Executive Director/CEO of the Kentucky League of Cities and the founder and president of the NewCities Institute. She currently serves as chair of the Morehead State University Board of Regents. Please send your comments to slovely@klc.org and visit her blog at sylvia.newcities.org.

  • Blame Wall Street’s Phantom Bonds for the Credit Crisis

    The “credit crisis” is largely a Wall Street disaster of its own making. From the sale of stocks and bonds that are never delivered, to the purchase of default insurance worth more than the buyer’s assets, we no longer have investment strategies, but rather investment schemes. As long as everyone was making money, no one complained. But like any Ponzi Scheme, eventually the pyramid begins to collapse.

    For the last couple of months trillions of dollars worth of US Treasury bonds have been sold but undelivered. Trades that go unsettled have become an event so common that the industry has an acronym for it: FTD, or fail to deliver.

    What’s the result? For the federal government, it’s an unnecessarily high rate of interest to finance the national debt. For states, it’s a massive loss of potential tax revenue. And for the bond buyers, brokerage houses, and banks, it’s yet another crash-and-burn to come.

    First, a primer: The Federal Government issues as many bonds as Congress authorizes (the total value is an amount that basically covers the national debt). Many are purchased by brokers and investors, who then re-sell them in “secondary” trades. The way the system is supposed to work is that the broker takes your bond order today and tomorrow takes the cash from your account and ‘delivers’ the bonds to you. The bonds remain in your broker’s name (or the name of a central depository, if he uses one). If there is interest, the Treasury pays the interest to your broker and he credits your account for the amount.

    What is happening today that strays from this model? Because the financial regulators do not require that the actual bonds be delivered to the buyer, your broker credits you with an electronic IOU for them, and, eventually, with the interest payments as well. But the so-called “bonds” that you receive as an electronic IOU, called an “entitlement”, are phantoms: there aren’t any bonds delivered by your broker to you, or by the government to your broker, or by anyone.

    The significant result of the IOU system is that brokers are able to sell many more bonds than the Congress has authorized. The transactions are called ‘settlement failures’ or ‘failed to deliver’ events, since the broker reported bond purchases beyond what the sellers delivered. Since all of this happens after the US Treasury originally issues the bonds, the broker’s bookkeeping is separate from US Treasury records. That means there is no limit on the number of IOUs the broker can hand out…and there are usually more IOUs in circulation than there are bonds.

    The ramifications are far reaching for the national budget. Wall Street, by selling bonds that it cannot deliver to the buyer — in selling more bonds than the government has issued — has been allowed to artificially inflate supply, thereby forcing bond prices down. These undelivered Treasuries represent unfulfilled demand by investors willing to lend money to the US government. That money — the payment for the bonds — has been intercepted by the selling broker-dealers. The subsequently artificially low bond prices are forcing the US government to pay a higher rate of interest than it should in order to finance the national debt.

    The market for US Treasury bonds has been in serious disarray since the days immediately following September 11, 2001. Despite reports, reviews, examinations, committee meetings, speeches, and advisory groups formed by the US Treasury, the Federal Reserve, and broker-dealer associations, massive failures to deliver recur and persist. Somehow, government, regulators and industry specialists alike believe that it’s OK to sell more bonds than the government has issued. It shouldn’t take a PhD-trained economist to tell you that prices are set where supply equals demand. If a dealer can sell an infinite supply of bonds (or stocks or anything else for that matter), then the price is, technically-speaking, baloney. And the resulting field of play cannot be called a “market”.

    If regulators and the central clearing corporation would only enforce delivery of Treasury bonds for trade settlement — payment — at something approaching the promised, stated, contracted and agreed upon T+1 (one day after the trade), there would be an immediate surge in the price of US Treasury securities. As the prices of bonds rise, the yield falls. This falling yield then translates into a lower interest rate that the US government has to pay in order to borrow the money it needs to fund the budget deficit and to refinance the existing national debt.

    This week’s drop in the yield on US Treasuries was accompanied by a spike in bond prices. The data won’t be released until next week, but you can expect to see that a precipitous drop in fails-to-deliver occurred at the same time. Don’t get your hopes up, though. One look at the chart above will tell you that the good news won’t last until real changes are made to the system.

    As a bonus insult to government, consider the $270 million in lost tax revenues to the states. This is because investors (unknowingly) report the phony interest payments made to them by their brokers as tax exempt; interest earned on US Treasury bonds is not taxed by the states.

    For the bond buyer, the situation poses other problems and risks. As an ordinary investor, you’re not notified that the bonds were not delivered to you or to your broker. Of course, your broker knows, but doesn’t share the information with you because he or she plans to make good on the trade only at some point in the future when you order the bond to be sold.

    The electronic IOU you received can only be redeemed at your brokerage house, and no one knows what will happen if it goes under, although I suspect we’ll find out in the coming quarters as more financial institutions get into deeper trouble. You’re probably not aware that, in order to cash in that IOU when you’re ready to sell, you depend not on the full faith and credit of the US government, but on your broker being in business next month (or next year) to make good on the trade. In other words, you’re taking Lehman Brothers risk, and receiving only US Government risk-free rates of return on your investment.

    Your broker, meanwhile, enjoys the advantages of commission charges for the trade, maybe an account maintenance fee and – more importantly – they use your money for other purposes. Wall Street is not sharing any of this extra investment income with you. In my analysis of Trade Settlement Failures in US Bond Markets, I calculate this “loss of use of funds” to investors at $7 billion per year, conservatively.

    Despite this, rather than require that sold bonds be delivered to the buyer, the Treasury Market Practices Group at the Federal Reserve Bank of New York merely points out FTDs as “examples of strategies to avoid.”

    Now for the really bad news. The tolerance for unsettled trades and complete disregard for the effect of supply on setting true-market prices is also responsible for the “sub-prime crisis,” which everyone seems to agree on as the root of the current global financial turmoil. You see, there are more credit default swaps — CDS — traded on mortgage bonds than there are mortgage bonds outstanding. A CDS is like insurance. The buyer of a mortgage bond pays a premium, and if the mortgage defaults then the CDS seller makes them whole. CDS are sold in multiples of the underlying assets.

    A conservative estimate is that $9 worth of CDS “insurance” has been sold for every $1 in mortgage bond. Therefore, someone stands to gain $9 if the homeowner defaults, but only $1 if they pay. The economic incentives favor foreclosure, not mortgage work-outs or Main Street bailouts.

    In the same process that is multiplying Treasury bonds, sellers are permitted to “deliver” CDS that were not created to correspond with actual mortgages; call them “phantom CDS”. According to October 31, 2008 data on CDS registered in the Depository Trust & Clearing Corporation’s (DTCC) Trade Information Warehouse, about $7 billion more CDS insurance was bought on Countrywide Home Loans than Countrywide sold in mortgage bonds. That provides a terrific incentive to foreclose on mortgages.

    Countrywide is the game’s major player: The gross CDS contracts on Countrywide of $84.6 billion are equivalent to 82% of the $103.3 billion CDS sold on all mortgage-backed securities (including commercial mortgages) and 90% of the total $94.4 billion CDS registered at DTCC sold on residential mortgage-backed securities.

    General Electric Capital Corporation is the fifth largest single name entity with more CDS bought on it than it what it has sold; someone is in a position to benefit by $12 billion more from consumer default than from helping consumers to pay off their debt. Only Italy, Spain, Brazil and Deutsche Bank have more phantom CDS than GECC, according to the DTCC’s data.

    The US auto manufacturers also have net phantom CDS in circulation: $11 billion for Ford, $4 billion for General Motors, and $3.3 billion for DaimlerChrysler (plus an additional $3.5 billion at the parent Daimler). Of course, these numbers change from week to week and only represent CDS voluntarily registered with the DTCC, so the real numbers could be much greater.

    Who stands to gain? There is no transparency for CDS trades, which means that we don’t know who these buyers are. But in order to get paid on these CDS, the buyer must be a DTCC Participant… and that brings us to Citigroup, Goldman Sachs, JP Morgan and Morgan Stanley – all Participants at DTCC and instrumental in designing and developing CDS trading around the world. By the way, these firms are also in the group that reports FTDs in US Treasuries; the top four firms represent more than 50% of all trades. You can do the math from there.

    The US government and regulators are in the best position to end these fiascos, turn us away from casino capitalism, and return our financial industry back into a market. It won’t require any new rules, laws or regulations to fix the situation. If someone takes your money and doesn’t give you what you bought, that’s just plain stealin’, and we already have laws against that.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

    More on the US Treasury market’s structural failure: The US treasury market reaches breaking point

  • Michigration: It’s Not About Out-migration in Michigan

    Pertaining to brain drain hype, Michigan has no equal. So profound is the out-migration that a local broadcasting network coined a term: Michigration. This was in January of 2008. I did a little digging and discovered the fuel for the story was a United Van Lines study about Michigan’s net loss of residents.

    Net population loss is often confused with emigration. Upstate New York, another brain drain case for a future article, is no exception. The Federal Reserve Bank branch in Buffalo issued a report that tried to clear up the confusion, explicitly stating the challenge is attracting more people instead of the assumed issue of retention.

    Michigan is in the same boat. There is nothing remarkable about the rate of out-migration from the state. What is shocking is the lack of newcomers. Most of the Rust Belt has a problem with a distinct lack of in-migration.

    Another oversight of the media is the aging population. Rarely does natural decline make the news. Of course, that “problem” doesn’t lend itself to political gain. That is too bad because making better use of an aging workforce is a missed opportunity. Shouldn’t talent retiring in Michigan be celebrated?

    A third misconception about shrinking cities is that the best and brightest are heading to hip out-of-state destinations. The truth is many graduates go no further than the suburbs, resulting in the donut pattern of urbanization. Those that venture beyond likely end up in the next state over, not halfway across the country. A lot of talent moves from one Rust Belt city to another. Much of the rest – although perhaps not the offspring of the remaining economic and cultural elite – shifts to those areas that have been creating jobs, particularly places like North Carolina, Texas and, before the recent bust, Arizona and Florida.

    In and of themselves, reports of Michigration are harmless. But popular perception is often used to push various initiatives such as Michigan’s Cool Cities:

    Building vibrant, energetic cities that attract jobs, people and opportunity to our state is a key component of Michigan Governor Jennifer M. Granholm’s economic vision for Michigan. Governor Granholm kicked-off the “Cool Cities” initiative in June, 2003 throughout the state, in part as an urban strategy to revitalize communities, build community spirit, and most importantly, retain our “knowledge workers” who are leaving Michigan in alarming numbers.

    The promise is that cooler cities will keep talent from leaving the state. I challenge Governor Granholm to list the top-10 Cool Cities in the United States and their respective out-migration rates. How do Michigan cities compare? How do you quantify “alarming numbers”?

    US cities with the fastest growth rates in population tend to have the highest rates of emigration. Ironically, shrinking cities have relatively weak out-migration. Furthermore, the college educated are much more likely to leave any state or metro than people with just a high school education. Knowledge workers leaving Michigan is normal. The low number of knowledge workers arriving, from out of state, is abnormal. Neither better urban place-making nor more tolerance on its own shows any strong positive correlation with less brain drain. In fact, the opposite may be true. Cool Cities simply hasn’t delivered.

    We do understand that knowledge workers are geographically fickle. But Governor Granholm fails to put the attraction of talent on top of the agenda. She continues to play to fears of Michigration as justification for significant investment in the state’s cities. I’m not anti-urban. On the contrary, I’d like to witness the revitalization of Rust Belt downtowns. But sprucing up an aging downtown in a region with massive job losses will not get the job done.

    The most promising research I’ve read comes from Edward Glaeser, an urban economist at Harvard University. The best investment of public money would seem to be in human capital, education. What would attract well-educated parents would be better schools, something the suburbs have mastered. Inner city Detroit’s main competition for talent is the communities ringing around it.

    Michigration will not be stemmed by being “cool” but by providing some sort of opportunity for a decent middle class life. If Michigan could combine its excellent Universities, skilled workforce and low housing costs with a decent business climate, and significant school reform, perhaps the state would again become a beacon for entrepreneurs and knowledge workers.

    Read Jim’s Rust Belt writings at Burgh Diaspora.

  • California’s Inland Empire: Is There Hope in the Heart of Darkness?

    Few areas in America have experienced a more dramatic change in fortunes as extreme as Southern California’s Inland Empire. From 1990-2008, the Inland Empire (Riverside & San Bernardino counties) has been California’s strongest job generator creating 20.1% of its employment growth. The area also consistently ranked among the nation’s fastest growing large metropolitan areas. However in 2008, the mortgage debacle has sent this area, which had not seen year-over-year job losses in over four decades, into a steep downturn. Understanding what happened and how to put the region back on its historical growth path offers an important public policy perspective not only for the Inland Empire but for other once fast-growing metropolitan areas.

    The Economic Problem. The California Employment Development Department (EDD) reported an Inland Empire loss of 17,900 jobs from August 2007-2008. The bulk of this was directly tied to the housing meltdown. Within shrinking sectors, the loss was 32,600 with 82% (26,800) tied to the demise of residential construction. This included construction losses (-16,000); non-vehicle manufacturing (mostly building materials: -5,600), non-vehicle retail sectors (mostly furniture or home supplies: -3,200); and financial groups like escrow, title, insurance and real estate (-2,000). By September 2008, unemployment was 9.1%, the highest in 49 metropolitan areas with over 1,000,000 people.’


    Note: EDD’s report is an underestimate as more accurate U.S. Bureau of Labor Statistics data show the area began 2008 with job losses 61.7% higher than EDD’s estimates.

    Housing Market Creates A Recession. Some history is necessary to understand how the housing sector got into trouble and set off the inland recession. The last housing downturn ended in 1996. Analysts agree that from 1997-2003, California’s many building restrictions prevented housing supply from matching demand by families needing homes. Prices rose to chase away excess potential buyers:

    • Seasonally adjusted homes sales rose from 13,227 quarterly units in early 1997 to 25,328 by late 2003, an annual rate of 10.1%.

    • In this period, median price increased from $105,643 to $246,807, an annual rate of 12.9%.

    Starting in 2004, speculators began wanting to capitalize on these 12.9% gains by buying and flipping homes. Simultaneously, foreigners awash in dollars from U.S. trade imbalances started flooding investment markets with cash looking for “safe” returns. A belief that home prices never fall led to the development of variable rate mortgages with extremely low “teaser” rates and loose underwriting standards, plus AAA rated mortgage backed securities based on them. The low rates financed the speculators and convinced many families to buy over-priced homes or borrow newly found “equity.” Thus:

    • Median home prices increased even more aggressively from $246,807 in late 2003 to a $404,611 peak in third quarter 2006, up at a 19.7% compound rate.

    • Seasonally adjusted sales increased from 25,328 in late 2003 to a peak of 29,670 in fourth quarter 2005, up a modest 2.29% compound rate.

    • However, by first quarter 2006, volume began declining as affordability reached just 18% and even speculators no longer saw much upside.

    • By the price peak in third quarter 2006, seasonally adjusted sales were down 27.6% to 21,478 units.

      Once the fall in demand became evident, median prices started down. The descent began slowly. However, by mid-2007, with the myth of ever-rising prices debunked:

      • Housing demand plunged.

      • Housing supply took-off as sub-prime mortgages began resetting from teaser to market rates with investors and homeowners trying to sell homes they could no longer afford.

      • Price declines thus accelerated causing ever more homeowners to be upside-down on their homes.

      • Unable to sell, many houses entered foreclosure and were aggressively marketed by the lenders, further accelerating price declines.

      By 2008, the market began changing:

      • Supply, with 60% of inland activity from foreclosures, continued to overwhelm demand with prices falling to a median of $237,784 by third quarter, equal to the mid-2003 level.

      • Demand hit a trough in late 2007 at 11,398 units. By third quarter 2008, lower prices caused it to rebound to 18,453, up 61.9%, equal to volume in 2001.

      • Demand rose as inland housing affordability reached 50% (assuming 3% down, 6.19% mortgages, 1% taxes, $800 property insurance, 0.5% FHA insurance, payments 35% of income).

      Crucially, by third quarter 2008, home construction all but halted as price competition from foreclosures caused developers to lose money on every unit built -even with land treated as free. Hence, the steep downturn and a 9.1% inland unemployment rate. In the short run, conditions will worsen as office construction stops once existing projects are completed. Already, the loss of tenants in fields like escrow and finance has pushed vacancies from 7.0% to 19.9%.

      The Routes Out? With the Inland Empire’s construction sector shutting down, economic hardship has spread far beyond those whose terrible decisions created the crisis. This is also is true in numerous markets, particularly in Arizona, Florida and Nevada.

      Until national action reduces the rising flow of foreclosures into the supply side of the nation’s housing market, supply will continually overwhelm demand sending prices downward. Residential construction will not return until markets see fewer foreclosures and prices move to higher levels. Two strategies are available:

      • Mortgage servicers can lengthen the term of mortgages and reduce rates. allowing families to afford staying in homes. However, given the principal owed, they will not be able to move until prices return to recent highs. Many are thus walking away.

      • Servicers can reduce the principal owed, allowing families to refinance and both remain in their homes and have equity in them.

      Modern housing finance has generally barred the second and more effective strategy. When banks originate mortgages, they typically sell them to Fannie Mae, Freddie Mac or investment houses to get their money back and make more loans. They are paid to service loans they no longer hold. Meanwhile, secondary mortgage holders often formed them into groups and then sell “mortgage backed securities” (MBS) worldwide. Both the originating bank and those creating MBS’s signed contracts barred them from harming investors. Unless a servicer owns 100% of a mortgage or MBS, they cannot lower mortgage principals.

      Unless national policy can convince secondary mortgage holders and/or MBS investors to allow the principal owed them to be reduced, the foreclosure crisis and residential construction depression will persist … prolonging the recession. The state attorneys general, Congress, some major banks and the FDIC have tried to lure mortgage investors to allow this or to buy them out. The results have been very mixed. The idea of allowing bankruptcy judges to lower principals has been offered as a club to force this result. Yet this raises fear of long term damage to international belief in the consistency of U.S. contract law.

      Finally, at the local level, officials could favorably impact construction costs through the developer impact fees imposed on new homes. These are justified by the need to build the infrastructure required by population increases. Inland Empire fees are $40,000 to $50,000 per home. An analysis shows that at today’s low prices, a fee holiday of 80% by local agencies and 40% by schools would put the industry profitably back return to work. The re-imposition of fees could be tied to an index like median existing home prices.

      So far, the reaction of local decision makers has been that this is legally, programmatically and politically impossible. Their traditional worry is not having the money to build the infrastructure needed as new homes cause population growth. However, for construction dependent economies like the Inland Empire, the choice appears to be temporarily foregoing such funding, or finding a broader source of infrastructure financing. Otherwise, they must face the reality of a multi-year deep recession with double digit unemployment.

      John Husing, Phd. is president of Economics & Politics, Inc. based in Redlands, CA