New Geography

Category: Policy

  • Housing Downturn Moves Into Phase II

    The great housing turndown, which started as early as 2007, has entered a second and more difficult phase. We can trace this to Monday, September 15, 2008 just as October 29, 1929 – “Black Tuesday” – marked the start of the Great Depression. September 15 does not yet have a name and the name “Black Monday” has already been taken by the 1987 stock market crash. The 1987 crash looks in historical perspective like a slight downturn compared to what the world faces today.

    On September 15 – let’s call it “Meltdown Monday” – the housing downturn ended its Phase I and burst into financial markets leading to the most serious global recession since the Great Depression. Indeed, International Monetary Fund head Dominique Strauss-Kahn now classifies it a depression.

    Phase I claimed its own share of victims; Phase II seems likely to hit many more.

    Phase I of the Housing Downturn

    Whether in depression or recession, parts of the United States housing market were already in a deep downturn well before September 15. Phase I of the housing downturn started when house prices reached an unprecedented peak in some markets and began fell into decline. By September of 2008, house prices in the “ground zero” markets of California, Florida Las Vegas, Phoenix and Washington, DC had dropped from 25 percent to 45 percent from their peaks. These markets represented 75 percent of the overall lost value among the major metropolitan areas (those with more than 1,000,000 population).

    The Varieties of House Price Escalation Experience: In Phase I, the house price escalation and subsequent losses were far less severe in other major metropolitan areas. This depended in large part to the degree of land use controls – such as land rationing (urban growth boundaries and urban service limits), building moratoria, large lot zoning and other restrictions on building routinely – that helped drive prices up to unsustainable levels. This effect, cited by a number of the world’s most respected economists, was exacerbated by the easy money policies adopted by mortgage lenders.

    On the other hand, in the “responsive” land use regulation areas, the market (people’s preferences) was allowed to determine where and what kind of housing could be built. In these areas housing prices rose far less during the housing bubble and fell far less during Phase I of the housing downturn.

    Leading to the International Financial Crisis: These radically differing house price trends set up world financial markets for ”Meltdown Monday.” The easy money led to a strong increase in foreclosure rates, an inevitable consequence of households having sought or been enticed into mortgage loans that they simply could not afford. Yet it was not foreclosure rates that doomed the market. It was rather the unprecedented intensity of those losses in particular markets.

    Foreclosures were not the problem: Foreclosures happened all over. Foreclosure rates rose drastically in California and the prescriptive markets, but had relatively less impact in the responsive markets of the South and Midwest, where house prices changed little relative to incomes.

    Intensity of the losses was the problem. The problem lay largely in the scale of house value losses in some markets, particularly the most prescriptive ones. Lenders faced foreclosure and short sales losses on houses that had lost an average of $170,000 in value in the ground zero markets. In the responsive markets, on the other hand, average house value losses were less than one-tenth that, at $12,000 per house (http://www.demographia.com/db-hloss.pdf).

    By the end of Phase I of the housing downturn, house value losses in the prescriptive markets had reached nearly $2.3 trillion, accounting for 94 percent of the total losses in major metropolitan markets (those with more than 1,000,000 population). If the market had been allowed to operate in these markets, the losses in the prescriptive markets could easily have been one-fifth this amount. Most likely the mortgage industry and the international economy might have been able to handle such losses, sparing the world the current deep financial crisis.

    True, the housing bust would not have happened without the easy money. Neither easy money nor prescriptive land use regulation were sufficient in themselves to send the world economy into a tailspin. But together they conspired to create the conditions for “Meltdown Monday”.

    Phase II of the Housing Downturn

    The Panic of 2008: By September 15, the “die had been cast.” The holders of mortgage debt could no longer sustain the losses that were occurring in the ground zero markets. This led to the Lehman Brothers bankruptcy and then to a financial sector that seems to be accelerating faster than the taxpayers can pick up the pieces. The ensuing “panic” – a 19th century synonym for a severe economic downturn – has led to millions of layoffs, decreases in demand across the economy and taxpayer financed bailouts around the world. Many have seen their retirement funds wiped out. Others have lost their jobs. American icons, such as General Motors and Bank of America have been relegated to begging on Washington’s K Street.

    Housing Downturn Broadens and Deepens: The panic has now brought about a new phase in the housing downturn – what I label Phase II. In Phase II, a deteriorating economy starts to kick the bottom out of the rest of the housing market. With evaporating confidence in the economy and the drying up of demand, house prices have begun a free-fall in virtually all markets, regardless of the extent to which their prices had bloated.

    Our analysis of National Association of Realtors data shows this. In almost all markets house price declines accelerated during the fourth quarter of 2008 (the first quarter following Meltdown Monday). In just three months, median house prices fell an average of more than 12 percent in the major metropolitan markets. In the ground zero markets, house prices dropped 14 percent, with the average loss from the peak exceeding 40 percent. In the responsive markets, prices fell 11 percent, approximately double the previous reduction from the peak (See Table).

    Thus, the difference is that in Phase I, house price declines were in proportion to the previous price escalation. In Phase II, the percentage declines are generally similar without regard to the house price increases.

    House Price Deflation from Peak
    By Phase of the Housing Downturn
    PRESCRIPTIVE LAND USE MARKETS
    RESPONSIVE LAND USE MARKETS
    Factor
    Ground Zero
    Other
    All
    ALL MARKETS
       
    Prices: To Phase I
    -31.70%
    -11.10%
    -20.80%
    -5.90%
    -17.90%
    Prices: To Phase II
    -41.40%
    -21.40%
    -30.80%
    -16.60%
    -28.00%
     
    Prices in Phase II
    -14.20%
    -11.60%
    -12.60%
    -12.40%
    -14.20%
     
    Loss per House: To Phase I
    ($193,800)
    ($42,400)
    ($96,300)
    ($12,200)
    ($66,900)
    Loss per House: To Phase II
    ($253,000)
    ($81,800)
    ($142,700)
    ($34,200)
    ($104,800)
     
    Loss per House in Phase II
    ($59,200)
    ($39,400)
    ($46,400)
    ($37,900)
    ($59,200)
     
    Gross Losses (Trillions): To Phase I
    ($1.82)
    ($0.46)
    ($2.29)
    ($0.16)
    ($2.44)
    Gross Losses (Trillions): To Phase II
    ($2.40)
    ($0.99)
    ($3.39)
    ($0.44)
    ($3.82)
     
    Gross Losses (Trillions): in Phase II
    ($0.58)
    ($0.52)
    ($1.10)
    ($0.28)
    ($1.38)
       
    Phase I: To September 2008          
    Phase II: To December 2008          
    Major Metropolitan Markets (over 1,000,000 population)      
    For markets by classification see: http://www.demographia.com/db-hloss.pdf    

    Recession or Depression?

    It’s critical to note that the decline is by no means as deep as in the 1930s. On the other hand, there is no indication that conditions are going to improve markedly in the short run. Millions of households who saw their retirement accounts devastated are likely to curb consumption for years to come. The key question is whether we are in the equivalent of 1933, in the pit of the downturn, or in the equivalent of the late 1930s, soon to begin a long, slow climb out.

    For housing though, this is a depression. Never before over the last half-century have house prices fallen as they have in the prescriptive markets during Phase I of the housing downturn. And since the bust, during Phase II, overall price declines are on a par with the worst years of the Great Depression. “Meltdown Monday” has incited a downward spiral whose course will be the topic of future commentaries on this site.

    The classifications of the major metropolitan markets and price declines for each market are shown in http://www.demographia.com/db-hloss.pdf.

    Also see: Mortgage Meltdown Graphic: http://www.demographia.com/db-meltdowngraphic.pdf

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris. He was born in Los Angeles and was appointed to three terms on the Los Angeles County Transportation Commission by Mayor Tom Bradley. He is the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

  • Nation Has $445 Billion in Unfunded Health Care Benefits, Nebraska Has None

    Nebraska was the 37th State to join the Union, is home to the “Cornhuskers,” and currently has a $3.5 billion budget and a $563 million cash reserve.

    In this time of economic hardship, the Cornhusker state has no debt, shunning all long-term financial commitments including retirement benefits.

    A recent USA Today survey of state financial reports found that the other 49 states combined “have an unfunded obligation of $445 billion” owed for the medical care of retired government workers.

    The formula accountants use to compute the financial health of a state government includes medical benefits, debt and pension liability. Medical benefits represent the Pandora’s Box of the three, with civil servants often retiring before Medicare benefits kick in at 65.

    In contrast, Nebraska is the “only state that doesn’t subsidize the medical care of retired government employees.”

    Other states and local governments have debts that range anywhere from New York City’s $60 billion obligation to Los Angeles’ $544 million sum.

    Some state and local governments have begun setting aside money to prepare to pay retiree medical costs. Some plan to pay nearly the entire cost, other will contribute a fixed amount, such as “$200 a month or 50% of the health insurance premium.”

    In defending Nebraska’s nonexistent retiree health care coverage, Senator Dave Pankonin distills his state’s approach simply: “Nebraska is a fiscally conservative, pay-as-you-go state, and that’s the biggest reason we don’t have this benefit.” Or, he might have added, deficit.

  • Oregon Fail: With Hard Times Ahead for Business and Real Estate, It’s Time to Look Small

    There is something about Oregon that ignites something close to poetic inspiration, even among the most level-headed types. When I asked Hank Hoell recently about the state, he waxed on about hiking the spectacular Cascades, the dreamy coastal towns and the rich farmlands of the green Willamette Valley.

    “Oregon,” enthused Hoell, president of LibertyBank, the state’s largest privately owned bank, from his office in Eugene, “is America’s best-kept secret. If quality of life matters at all, Oregon has it in spades. It is as good as it gets. It’s just superb.”

    As developer Shelly Klapper, a rare skeptic in the Beaver State, reminded me: “This is a state that buys its own hype.”

    Hype or not, however, Oregon is hurting – something that’s clear to even the most self-respecting narcissist. Over the past year, Oregon’s economy has fallen off a cliff just about as fast as any state in the union.

    A year ago, things seemed very different. Sunbelt boom states like California, Arizona and Nevada were already heading into deep recession, but green Oregon seemed oddly golden. Both its small cites and one big town, Portland, were outperforming the national norms. Oregonians saw their state as better – not only in terms of green and good, but also in terms of basic job growth.

    But since last winter, Oregon’s unemployment rate has soared from barely 5.5% to well over 8%, the sixth worst in the nation. Indeed, according to a recent projection by the University of California at Santa Barbara (UCSB), Oregon’s jobless rate could reach close to 10% by the end of the year.

    Well into 2010, Oregon’s overall economy will shrink more rapidly than the nation’s as a whole, notes UCSB forecaster Bill Watkins. He traces a sharp downturn there to many factors, including one of the toughest regulatory regimes in North America.

    In tough times, companies generally expand in localities that are friendly to commerce – say, states like Texas or nearby Idaho. Few would rate Oregon highly in that regard.

    “Oregon is mostly a place that focuses on the enjoyment of its space, and that makes [it] very vulnerable in these conditions,” Watkins says.

    The other big problem has to do with a lack of economic diversity. Oregon has been through tough times before. For much of its history, the state’s economy depended largely on harvesting its vast forests. Then, in the 1980s, the state developed a green bug, and decided it shouldn’t chop down Mother Nature for a living.

    In the ensuing decade, Oregon pioneered tough land-use regulations, curbing industries that relied on forest products and declaring war on suburban sprawl. Its main city, Portland, became the poster child of the “smart growth” movement by forcing up density, building an extensive light-rail system and restoring its urban core.

    Although widely praised, these stringent regulations also drove up land prices and, ironically, prompted many middle-class residents to move away, including across the border into Washington. Businesses, rather than cluster in the state’s core, continued to migrate to the outer rings; in the relatively healthy year of 2005, for example, barely 10% of Portland’s office space growth took place in the central district.

    “We give lip service to the economy here,” admits Klapper, a longtime Portland entrepreneur and a former official with the Port of Portland. “But, really, business is not a priority here.”

    For a while, Klapper notes, the tech sector seemed to offer the solution. In the ’80s and ’90s, chip makers fleeing even higher costs in California flooded into Oregon, which was proudly dubbed the “Silicon Forest.” In an unusual move, the state provided tax breaks to the chip makers, which helped. The state’s suburbs also proved attractive to tech workers who could afford a far better quality of life there, in terms of schools and housing, than they could in the Golden State.

    But as regulations tightened and costs to businesses and families increased, even the high-tech industry began to fade. Always a political bellwether state, Oregon has moved inexorably left, increasingly dominated by both its public sector and the particularly strong green movement. Semiconductor expansion soon started to go south – or in this case, further east (to Idaho) or across the Pacific to Asia.

    Only one thing remained to drive the economy: housing. A torrent of Californians were heading north – cashing out of the overpriced Bay Area, Sacramento and Los Angeles – and buying new homes in Oregon. Some sophistos sashayed their way into trendy places like Portland’s Pearl District, but many others looked to the charming smaller towns of the Willamette Valley and central Oregon.

    “When all else failed, it was people moving here that kept us going,” says Klapper, who was a major investor in the Pearl District renaissance. “California became our biggest industry.”

    This dependence turned into a debilitating addiction. When in 2007, the great California housing bubble collapsed, the inflow of people and dollars dropped off. Meanwhile, the remnants of lumber industry fell victim to the housing bust.

    Nowhere are the effects of this clearer than in Bend, a spectacular town of 75,000 located amid volcanic peaks in the center of the state. Californians had considered Bend a favorite spot for second homes and relocation. About a year ago, notes real estate appraiser Steve Pistole, prices were rising 2% a month, while those in Portland were “only” rising 8% a year.

    But to visit Bend now is to be in the eye of the housing hurricane, with nearly deserted housing tracts, woefully empty hotels and residential second-home developments. Unemployment in the housing arena, according to the UCSB, could reach 15% next year.

    We can also expect a further slide in housing prices. Oregon’s bubble, notes analyst Wendell Cox, inflated later than California’s, so prices, which have dropped more than 10% in the last year, could fall by that much or more in the next.

    Yet despite all these problems, many Oregonians remain optimistic. Some of this seems, at least fundamentally, a reflection of ideology. The inevitable huge surge of “green jobs” promised by the Obama administration has long been an article of faith in the state; it seems something like a story we’d tell our children to put them to sleep. State officials, for example, speak wistfully of replacing a recently shuttered Korean-owned Hynix chip plant with a facility to make solar panels.

    The bad news is this: 49 other states – some of which don’t pose such strong regulatory challenges – also hope to bring home some of these green jobs. So if business logic applies, the new factories that manufacture wind turbines, propellers or solar panels will end up in states like North Dakota or Texas, which have been the most successful, thus far, at attracting other manufacturing jobs.

    So what trail should Oregon blaze now? Pistole, the real estate appraiser, says it may be time to think small. Places like Bend, he notes, already attract former Silicon Valley veterans who like living close to trout streams, hiking trails and golf courses.

    “There is no magic bullet for Oregon,” says Pistole, who himself moved from California just three years ago. “But there could be lots of onesies, twosies, mom-and-pops. People still want to live here. We have to make it synergistic to live where you want and still make money. That’s the way we need to go.”

    Some entrepreneurs, like 38-year-old Michael Taus, are already setting up such small shops, some of them in their homes. A recent arrival from Los Angeles, Taus made it big as one of the founders of Rent.com, which was sold to eBay in 2005. He’s only lived in Bend for a few months, but he has already launched his own start-up and consults for several other local firms.

    Taus believes others of his generation will want to establish businesses in Oregon, lured by both its lifestyle and affordability. Some of the new business may be in software, Taus says, but others could sprout in specialty agriculture, wood products and other industries.

    “People are here for a reason. There’s a good amount of talent, and you can get more here,” he says earnestly. “There’s a great potential. We just have to get down to business.”

    This article originally appeared at Forbes.

    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.

  • The Recession: Fuzzy Thinking Delays A Recovery

    I keep hearing how the current recession will end in 2010 because the average United States recession from 1854 to 2001 has been 17 months. This is silly for a variety of reasons.

    One reason is that there is no average recession. Post-World War II recessions have lasted from a minimum of six months to a maximum of only 16 months. If we were to apply the “average recession” logic to post World War II recessions, the current recession, which the NBER — the National Bureau of Economic Research — says started December 2007, would have ended 10 months later, last October.

    Another reason is that few previous recessions have been accompanied by the financial sector collapse that we witnessed in September. Worldwide experience indicates that recessions associated with financial sector panics tend to be longer than those without panics.

    Since 1854, five United States recessions have been accompanied by financial panics. These are the recessions of 1857, 1873, 1893, 1907, and 1929. The average duration of these recessions was 31 months. The 1907 recession was the shortest, at only 13 months. The 1873 recession was the longest, at 65 months. For comparison, the 1929 recession was 43 months. Interestingly enough, J.P. Morgan was instrumental in ending the financial panics of the two shortest recessions, 1893 and 1907.

    If we were to engage in the same sort of fuzzy thinking as the “average recession” analysis applied to “financial Panic” recessions, and assuming we use the NBER recession start date of December ‘07, the current recession could be expected to end 31 months later in July 2010. Is that too long for you? You could use the average 20th Century recession accompanied by a financial panic length. That is 28 months, so maybe the recession will end in April 2010.

    Maybe we should look at foreign data? The point is that if you play this game long enough, you can find a date you like.

    Finally, the method of dating recessions changed with the 2001 recession. The new method is much more likely to declare an economy in recession. If the old method had been used — if previous criteria were applied to the current situation — I believe the recession would have commenced no sooner than July 2008. Recent data revisions increase my confidence that the NBER was wrong when they said the recession commenced in December 2007. If you have the wrong start date, any “average recession” method will be wrong.

    The facts are that we have a serious recession accompanied by a financial panic and continuing massive job losses. The correct way to analyze the current recession is to recognize that it was accompanied by financial panic, and that means we had a regime shift from a good equilibrium to a bad equilibrium.

    Game theory tells us that we can have multiple Nash Equilibria to certain games. A Nash Equilibrium is one where knowing your opponent’s decision you would not change your decision.

    Bank runs provide an excellent example. Suppose you have a bank that does not have deposit insurance. Most of the time things plug along. People make deposits, borrow, and the like. Everybody is happy with their decisions. Call this the good equilibrium. However, in the event of a bank run, everyone wants to participate in the run, because those who do not end up loosing. Call this the bad equilibrium. Furthermore, nothing real has to change. We can switch from the good equilibrium to the bad equilibrium on unfounded rumors.

    The financial panic we witnessed last September was exactly like a bank run. In an amazingly short time, we switched from a good equilibrium to a bad equilibrium. The bad news is that we have no idea how to switch from a bad equilibrium to a good equilibrium. It will surely happen, but we don’t know how to cause it. We don’t know what will cause it. We can’t predict when it will happen.

    We do know that a lot of assets need to change hands. These include financial assets, auto factories, and homes. Recessions are periods when assets are reallocated to better uses.

    Current policy, with its obsessive pursuit of bailouts, seems to be focused on delaying those reallocations. That will delay the recovery. So-proposed government efforts to limit the impact will be ineffective, if not counterproductive. That is why I don’t see any reason to expect a recovery in 2009.

    Bill Watkins, Ph.D. is the Executive Director of the Economic Forecast Project at the University of California, Santa Barbara. He is also a former economist at the Board of Governors of the Federal Reserve System in Washington D.C. in the Monetary Affairs Division. All recession dating data in this article is from the NBER website.

  • Industry And The Urge To Cluster

    What drives industry to locate in one region and not in the next?

    Economic geography – the distribution of economic activity over physical space – has always been central to economic development. Policy-makers trying to encourage economic activity to locate in under-developed regions want answers: Is it infrastructure? Fiscal incentives? Good business environment? Or could it be agglomeration – the compounding effect of industry clustering in a particular location?

    And if the key factor is indeed this critical mass, can the effect run from one type of industry to another? Do existing, more traditional manufacturing clusters attract newer services industry?

    The question of where and how services firms decide to locate themselves has become exceedingly central to understanding economic growth and development. Services, and especially knowledge-based services, now account for a greater proportion of advanced-country GDPs, and increasingly so for emerging economies.

    New Economic Geography (NEG) theory would argue that agglomeration advantages lock business activity into core regions. The core also supports the existence of intermediate industry in the periphery, and so specialized input-suppliers co-locate close by. For instance, think of Detroit’s production of automobiles and the auto-parts manufacturers who locate in geographically proximate Michigan, Ohio and Indiana.

    The theoretical business-economics literature would also argue that manufacturing and services are intricately linked in the production chain. For example, marketing services add the finishing touches in the final stages of a manufacturing process, or research and development services result in increased production within the “real” economy. Service inputs into production, such as design, technological refinements, and branding, account for a major part of value added in manufacturing industries. The result is that it is becoming difficult to identify where the product ends and where the service begins.

    These theories have been challenged by claims that services, as compared to manufacturing, are liberated from the tyranny of space, owing to advances in information and communication technologies. In addition, the ability to splice the service production chain more thinly, goes the argument, means that proximity may cease to be an important factor with regard to these industries.

    But some empirical research suggests that agglomeration forces may actually be stronger in the case of services – that service industries actually tend to cluster more strongly and more closely to existing urban or manufacturing agglomerations.

    How do we know this? It is true that while the interest in urban, regional and spatial economic theory has grown dramatically in the last few decades, empirical research has followed in fits and starts. Some historical evidence shows that manufacturing does indeed precede services, specifically producer services, in a city or city-region. Research in the United States in the mid-1990s, and then more recently, also demonstrates that financial and professional services firms often chose to locate themselves in geographic proximity to established manufacturing industrial areas.

    More macro-level North-South models of development also seem to lend credence to the idea that services cluster close to existing manufacturing companies. Research on firm location in Sweden has shown that producer services locate themselves close to manufacturing industry to benefit from accessibility to their customers, but that many producer services also look to supply other service industries. Similar research in Denmark shows that manufacturing and services can be so intricately linked in their production chains that firms across both types may decide simultaneously to choose one location over another.

    And there is yet another possibility. Research in Japan’s urban areas revealed that the presence of a large and growing service sector in an existing urban cluster could lead to the displacement of manufacturing units.

    There are two basic causes of clustering. The first is regional endowments such as land, climate, and waterways. The second is circularity in location choice, implying that firms want to be where large markets are, and large markets are where many firms are located.

    This logic may seem obvious now, but, as economist Paul Krugman notes, that wasn’t really the case before 1991. In the latter half of the 19th century, the emergence of the manufacturing belt in the United States was a turning point in the economic geography of the country. The belt – mainly New England, Middle Atlantic and east-North-Central regions – contained the majority of manufacturing employment up until the first half of the 20th century. It was a classic example of how concentration of firms in one region increased local demand and thus made the area attractive for other firms. Services industries, catering to both final consumption and to manufacturing, soon followed.

    What does all this tell us about how governments should focus their energies? If the whole point of policy were to encourage industrial growth in regions that were not previously favored by economic activity, then a multitude of factors would need to be considered: investments in educational infrastructure, and training and development of skilled labor are just some examples.

    If policy was aimed at the development of producer services industries, then it seems that a healthy manufacturing sector is vital to a healthy services sector. There is, however, an ongoing blurring of the distinction between what constitutes manufacturing and what constitutes services, and this transformation has stimulated new support functions that feed the production processes of both.

    If so, and if the different types of industry do simultaneously co-locate, then…the discussion is akin to going round the Mulberry bush.

    Megha Mukim is currently reading for a Ph.D at the London School of Economics. Prior to this she was a visiting fellow at the MacMillan Center for International and Area Studies at Yale University.

  • Fool Me Once, Geithner, Shame on You, Fool Me Twice…

    Treasury Secretary Timothy Geithner revealed the new “Financial Stability Plan” on February 10, 2009. It’s thick with “why we need it” and thin on “exactly what it is.” He told Congress that he would open a website to disclose where all the bailout money was going. When asked if he would reveal where the first $350 billion went, he was a little vague on the details.

    Senator Grassley (R-IA) asked him at the confirmation hearings about the Maiden Lane LLCs and the money he passed out to private, non-regulated companies. His written response then was “Confidentiality around the specific characteristics and performance of individual loans in the portfolio is maintained in order to allow the asset manager the flexibility to manage the assets in a way that maximizes the value of portfolio and mitigates risk of loss to the taxpayer.” In other words, he wouldn’t say. When asked “What specific additional disclosure would you support?” Tim’s response was “If confirmed, I look forward to working with you and with Chairman Bernanke on ways to respond to your suggestions and concerns.” Variations on the “If confirmed, I look forward to working on it” answer was cut and pasted into his 102 page written responses 104 times, or more than once per page.

    Back in 2008 when the big bailout bucks were being passed around, we (and Congress) were led to believe that this was all being done to fix problems in housing and mortgage markets. Speaker of the House Nancy Pelosi (D-CA) said this in her speech on the floor before the vote: “We’re putting up $700 billion; we want the American people to get some of the upside. …[we] insisted that we would have forbearance on foreclosure. If we’re now going to own that [mortgage-backed securities] paper, that we would then have forbearance to help responsible homeowners stay in their home.” Three million homes went into foreclosure last year.

    Speaker Pelosi went on to tell us that the bill would include “an end to the golden parachutes and a review and reform of the compensation for CEOs.” Excuse my cynicism but Tim Geithner took a $500,000 walk-away bonus when he left the Federal Reserve Bank of New York, the maximum earnings allowed under President Obama’s suggested compensation cap; but that was on top of his $400,000 salary which would put him over the limit. Obama appointee Deputy Secretary of State Jacob Lew took home just under $1.1 million last year as a managing director at Citi Alternative Investments, a unit of Citigroup, which so far took $45 billion in bailout money.

    So, let’s add this up. Tim hides $330 billion from us while he’s at the Fed, refuses to tell Congress who it went to, refuses to tell Congress who Paulson gave the money to, and takes more than his share of compensation.

    Now he wants us to believe that Treasury can “require all Financial Stability Plan recipients to participate in foreclosure mitigation plans.” Fool me once, shame on you. Fool me twice, shame on me. I, personally, don’t believe a word of it. And neither should you. It’s all baloney, bogus, phantom. They are paying lip service to the American taxpayers so you won’t send those faxes to Congress or throw shoes at the new President. They are passing the money to the same Democratic big wigs that paid for their election campaigns – just as they did in the past to the Republicans. Tim is shoveling more money to the same private companies that he previously sent freshly-printed Federal Reserve notes. Now he can also pass out Congressionally-approved money. While Congress struggled with spending $800 billion to directly stimulate economic activity in the US, Tim thumbed his nose at them by presenting a plan to spread around more than $2.5 trillion that won’t require their approval. That’s the way it is and I think it would be a very bad idea to stop him.

    Yes, you read that right. I said it would be a bad idea to stop. I’m a fan of NASCAR racing. When a driver begins to lose control of the car and is sailing head first into a concrete wall at 190 miles per hour there is only one way to save it – stand on the gas. Your every instinct is to hit the brakes, to stop the car before you slam into the wall. But if you hit the brakes you’ll lose traction and control. By pressing down on the gas, you put power to the wheels which (hopefully) are still in contact with the track – with traction comes control and you can steer away from the wall. Oh, but it isn’t easy! Every cell in your monkey-cousin brain will scream: “Slam on the brakes!”

    So, it’s like the economy is heading for the wall. And Tim has decided to hit the gas – another $100 billion for the banks, $1 trillion for private capital to put in junk bonds, $1 trillion for private investors to spend on junk loans, $600 billion for Fannie and Freddie’s debt – yet only $50 billion to reduce mortgage payments for “middle class homes” in foreclosure.

    But even if we avoid hitting the wall, that doesn’t mean we don’t need to change the course. For years I have argued we need to fix the race track and improve the aerodynamics of the cars so they won’t head into the wall in the first place. I would insist that broker dealers have to deliver what they sell. I would prohibit the sale of derivatives in excess of the underlying assets. But that’s technical stuff, like requiring roof flaps in NASCAR (little flaps that come up when the car spins backwards to keep it from going airborne). It would prevent the really bad wrecks, but then no one would tune in on Sunday if there weren’t any wrecks, right?

    Enjoy the show as Tim tries to keep from crashing into the wall. But don’t be fooled that he is fixing anything. Even if he pulls the economy out this time, the track is still broken and the cars are still not aerodynamically sound. They’ll wreck it again – as they did in 1981 (inflation so high that Treasury bonds paid 19%), in 1987 (October stock market crash of 23% was worst of all time), in 1991 (junk bond collapse and credit crunch) and in 2000 (the dot.com bust).

    This will keep happening until we take the time to understand the real causes and put in real solutions. The solution is not now and has never been to throw money at it. This is the “junkie cousin” approach that Amy Poehler (Saturday Night Live) compared to the Original Bailout package: “It’s like you lend $100 to your junkie cousin to pay his rent. And when you run into him at the racetrack next week, you lend him another $50.”

    At what point do you “get it” that your cousin is gambling away the money you lent him for the rent, that this is not really helping your cousin to kick junk? The solution is not throwing money around but accounting for all the money already out there (including the stocks, bonds and derivatives). It’s not more regulation, it’s enforcing rules that are already on the books. Real solutions take real work. I’m not hopeful that the US government and markets are willing to do the work. So, I’ll make sure I’m wearing a helmet with my seat-belt buckled for the next crash, say just around 2017.

    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.

  • Housing Price Bubble: Learning from California

    In a letter to The Wall Street Journal (February 6) defending California’s greenhouse gas (GHG) emissions policies, Governor Arnold Shwarzenegger’s Senior Economic Advisor David Crane noted that California’s high unemployment is the result of “a bust of the housing bubble fueled by easy money.” He is, at best, half right.

    The “bust of the housing bubble” occurred not only because of “easy money,” but also because of the very policies California has implemented for decades and is extending in its battle against GHG emissions.

    The nation has never had a housing bubble like occurred in California. The Median Multiple (median house price divided by median household income) in California’s coastal metropolitan areas had doubled and nearly tripled over a decade. Housing costs relative to incomes reached levels twice as high as those experienced in the early 1990s housing bubble, which was bad enough.

    This is all the more remarkable because even before the bubble the Median Multiple in the Los Angeles, San Francisco, San Diego and San Jose metropolitan areas was already elevated at 1.5 times the historic norm.

    “Easy money,” by itself, does not explain what caused the unprecedented housing bubble in California. If “easy money” were the sole cause, then similar house price escalation relative to incomes would have occurred throughout the country.

    Take, for example, Atlanta, Dallas-Fort Worth and Houston. These are the three fastest growing metropolitan areas in the developed world with more than 5,000,000 population. Since 2000, these metropolitan areas have grown from three to 15 times as fast as Los Angeles, San Francisco, San Diego and San Jose. While 1,800,000 people have moved out of the four coastal California metropolitan areas to other parts of the country, 700,000 have moved to Atlanta, Dallas-Fort Worth and Houston from other parts of the country. This is where the demand would have been expected to produce the bubble. But it did not. House prices remained at or near historic norms and average house prices rose one-tenth that of the California coastal metropolitan areas.

    These three metropolitan areas were not alone. Throughout much of the nation, in metropolitan areas growing both faster and slower in population than coastal California, house prices simply did not explode relative to household incomes.

    In touting “smart land use” as a strategy for greenhouse gas emissions, Crane misses the other half of the equation. Indeed, it is so-called “smart land use” (“smart growth”) that intensified the housing bubble in California. “Smart land use” involves planners telling the market where development will and will not occur. In the process it ignores the price signals of the market. Owners of land on which development is permitted naturally and rationally raise their asking prices, while owners of land not so favored can expect little more than agricultural value when they sell. The result is that the land element of housing prices exploded, fueling the unprecedented bubble. Restrictions on supply naturally lead to higher prices, whether in gasoline, housing or anything else.

    California has placed restrictions on development with a vengeance. For nearly four decades, California has woven a tangled web of land use restrictions that have made the state unaffordable. When the demand rose in response to the “easy money” the land use planning systems were unable to respond and a rapid escalation in housing prices followed. The same thing occurred in other areas with excessive land use regulation, such as Las Vegas, Phoenix, Seattle, Portland, New York, Washington and Miami, though the house price escalation was not so extreme as in coastal California.

    On the other hand, where land use still allowed a free interplay of buyers and seller (consistent with rational environmental requirements), the housing bubble was largely avoided. Average house prices in Atlanta, Dallas-Fort Worth and Houston rose only one-tenth that of Los Angeles, San Francisco, San Diego and San Jose.

    When the bubble burst, the far higher house prices naturally tumbled more than in other areas. The price was paid well beyond California and the other “smart land use” markets around the nation. From Washington to Wall Street to Vladimir Putin and Chinese Premier Wen at Davos, everyone knows that the international finance crisis was precipitated by the US mortgage meltdown.

    It all might not have occurred if there had been no “smart land use” markets with their exorbitant and concentrated losses. Overall, the “smart land use” markets represent little more than 30 percent of the nation’s owned housing stock, yet produce more than 85 percent of the housing bubble values at their peak. California style “smart land use” intensified the overall mortgage losses by more than five times. If the losses had been more modest, there might not have been anything like the current mortgage meltdown. With more modest losses, the world financial system might have been able to handle the damage without catastrophe, just as it did with the “dot-com” bubble earlier in the decade. The many households that have lost much of their life savings or retirement income would not be facing the future with fear. And even personally frugal taxpayers of the world would not be the principal stockholders in failing banks.

    California needs to wake up and face the reality. The intensity of the housing bubble was of its own making. More “smart land use” is just what California does not need. This is the lesson the rest of the nation needs to learn rather than repeat.

    Sources:
    David Crane letter to the editor: http://online.wsj.com/article/SB123381050690451313.html
    Domestic migration data: http://www.demographia.com/db-metmic2004.pdf
    Analysis of the housing bubble: http://www.heritage.org/Research/Economy/wm1906.cfm
    House price losses by peak Median Multiple: http://www.demographia.com/db-usahs2008y.pdf
    Las Vegas Land Market Analysis: http://www.demographia.com/db-lvland.pdf
    Phoenix Land Market Analysis: http://www.demographia.com/db-phxland.pdf

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris. He was born in Los Angeles and was appointed to three terms on the Los Angeles County Transportation Commission by Mayor Tom Bradley. He is the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

  • Stimulus Plan Caters to the Privileged Public Sector

    Call it the Paulson Principle, Part Deux.

    Under the now thankfully-departed Treasury secretary, we got the first bailout for the undeserving – essentially, members of his own Wall Street class.

    Now comes the Democratic codicil to the P. Principle. It’s a massive bailout and expansion of the public-sector workforce as well as quasi-government workers in fields like health and education. Not so well-rewarded – except for expanded unemployment benefits – will be those suffering the brunt of the downturn, such as construction and manufacturing workers, whose unemployment is now heading north of 10%.

    Indeed, a close look at the current stimulus plan shows that as little as 5% of the money is going toward making the country more productive in the longer run – toward such things as new roads, bridges, improved rail and significant new electrical generation. These are things, like the New Deal’s many construction projects, that could provide a needed boost to our sagging national morale.

    Instead, we are focusing once again on those who have been getting the best deal for doing the least. The Bureau of Labor Statistics reports state and local government workers get paid 33% more than their private sector counterparts. If you add in the pensions and other benefits, the difference is over 40%. In New York alone, public-sector wages and benefits since 2000 have grown twice as fast as those of the average private-sector worker.

    Egregious stories of overpaid public workers are legion. In suburban Chicago, for example, some school administrators are making over $400,000 with benefits and incentives. Recent reports out of Boston suggest hundreds of firefighters and police officers make well in excess of $100,000 a year. And of course, there are the California prison guards who can make upwards of $300,000 a year with overtime.

    Of course, most public sector employees are not so lucky. But, for the most part, these workers enjoy protections, like health care for life, that most others could only dream about. Many also have pensions that allow them to retire in their 50s, while some of us will be hod-carrying well into our 70s.

    This all means that the potential price tag for swelling the public workforce could ultimately run into the trillions, a number Washington and Wall Street now use the way we used to talk about billions. At very least, we should be asking new public workers, or those whose jobs are being bailed out by the stimulus package, to make the kind of sacrifices demanded, say, of those working at General Motors. We could, for example, make them wait ’til age 60 or even 65 to retire.

    To no one’s surprise, much of this favoritism has to do with party politics. The basic truth is that auto and other industrial workers, like those in construction, have become somewhat expendable in the eyes of some Democrats – in part because they do not always follow the party line. In contrast, public-employee unions are the politically correct rock upon which much of the party now rests.

    This oversized influence is relatively recent. Yet as private-sector unions have waned, those in the public sector have waxed. They have been able to extort enormous benefits out of City Halls, counties, states and, of course, Congress.

    In the process, they have become – like the Wall Street financiers before them – a kind of privileged class. In the case of some Chicago garbage men, they often don’t work anything near 40 hours a week but are paid as if they did. Others engage in elaborate schemes to take advantage of injuries, real or imagined. Who would have thought that punching tickets for the Long Island Rail Road would be so hazardous that many retired employees use these “injuries” to collect disability money – in order to play golf or take another job?

    This can all get very expensive, especially given the poor immediate prospects that the stock market can finance these additional pensions. Some day the millennial generation should initiate a class action suit for placing this unconscionable burden on them.

    Right now, though, there’s little reason to expect President Obama and the majority Democrats will change direction. The public sector unions are often among the largest contributors to Democratic campaigns. They have also cultivated strong ties with the Washington media – some of whom, like The Washington Post’s Harold Meyerson, have argued over the years that these public workers are increasingly synonymous with the future middle class.

    There’s certain logic to this. Insulated from global competition, public employees have the ability to ratchet up their demands almost without serious limit. After all, even the most radical Republicans are not proposing to have the postal system transferred to Vietnam. We certainly don’t want to outsource our police services to China or Russia.

    So what’s not to like? Well, nothing – if the Roman Empire or China’s Qing Dynasty is your idea of a historical role model. Those regimes epitomize what happens when most of a nation’s wealth goes to support an ever-expanding bureaucracy and associated private-sector rent-seekers at the expense of both private commerce and public infrastructure. Look in the dictionary under the word decline.

    We can already see its early signs. Across the country, cities are being forced to choose between maintaining their basic infrastructure and honoring the medical, retirement and other pension obligations owed to retired public workers. The head of the Atlanta Fire Fighters’ Pension fund described groups like his as “the 800-pound gorilla in the room.” This primate has the power to stomp on the ability of states, cities and counties to put money into improving much of anything or even considering lowering taxes.

    Over time, though, one can hope President Obama will adjust his course. At some point, the middle- and working-class stiffs in the private sector – unionized or not – will question a stimulus that neglects their aspirations at the expense of protecting the imagined rights of yet another privileged class. Individually, public employees may not be as noxious as John Thain, but there are more of them. And over time, they could cost us even more.

    As a charismatic leader with strong union support, Obama could try to pull a “Nixon in China” and insist on reforming the benefits enjoyed by public workers as a condition of federal help. He wouldn’t be the only leader attempting a return to sanity. The idea of challenging public sector privilege has gained some currency in Ireland and France, as well as among the Liberal Democrats in the U.K.

    Such a bold initiative would earn President Obama not only gratitude from private sector workers but also posterity. But it would take courage, too; the mere suggestion of reform could result in a rash of strikes (as in Greece) and ceaseless yammering from union lobbyists and their allies on Capitol Hill.

    Of course, public-sector unions and their supporters will argue that they constitute an important part of the nation’s middle class and that their benefits are therefore sacrosanct. Yet it’s increasingly evident that this strata of middle-class workers live in a different reality than typical private sector shmoes. As George Orwell suggested in Animal Farm, it seems some animals are more equal than others.

    This article originally appeared at Forbes.

    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.

  • Wisconsin Checks Out The Finland Club

    Our Central Wisconsin delegation journeyed to Finland in October, 2008. We definitely learned a few lessons that we’ll apply here at home, with the hope of moving our ability to compete globally to a much higher level.

    “Finland is not a country, it is a club” stated one of the many presenters we heard during our study tour. This perspective of how Finns see themselves says something valuable about what they believe it will take for them to compete in the changing global economy: a whole lot of cooperation, strong relationships and inter-connectedness!

    The notion of a “club” is that a group comes together around a common interest and finds value in the network, which the club provides by further fostering that common interest. This is what we found was happening in Finland. Similar in size to Wisconsin, the country rallies together to be competitive on a global scale. They view themselves as a club, in the context of bringing bright people together as a key to innovation and commercialization. They have developed, and continue to further develop, systems in their “club” to allow this to happen.

    Although Nokia is definitely the poster child in Finland’s quest to become a top performer in global competition, the country’s business community is not resting on its laurels. Instead, there’s a very clear, shared vision of the future of the country, with a focus on the investments that can make this future a reality.

    One example is the Oulu region’s concept of a Triple Helix to foster business development and innovation. The Triple Helix intertwines business, education and government in cooperation and collaboration to deliver a support system that fosters innovation for business development. We heard presentations from about 15 agencies, government departments, educational institutions, and business associations. Each one succinctly communicated the common vision of the Triple Helix and the plan for the region to compete globally and grow its economy. Within this shared vision, everyone understood their particular agency’s role, and knew what role others played.

    Our small, rural Central Wisconsin community has had a Finnish connection since 2000, when Stora Enso Oy purchased the Fortune 500 Wisconsin Rapids-based paper company conglomerate, Consolidated Papers. This sale shook up the century-long paternalistic culture and insulated economy. And the loss of more than 4,000 jobs made the community immediately face the reality of global competition.

    In response to the crisis, the Heart of Wisconsin Business & Economic Alliance, in partnership with the Community Foundation of South Wood County, kicked off the Community Progress Initiative, which incorporates systemic approaches similar to the Triple Helix model, and uses common vision as a compelling inspiration to actively engage the community in moving forward collaboratively, kind of like a “club.” The approach has had some proven success, with opportunities for bigger breakthroughs yet to come. Our Study Tour Team is comprised of representatives from business, government, education (K-12, technical college and university levels), engineering, sustainability, philanthropy, and economic development. We are all focused on implementing the concepts on innovation and project learning gained on the tour.

    Outaniemi Technology Hub, in Espoo, provides another example of a “club” type of approach to fostering innovation to compete globally. It bridges innovation and business, uniting academia, startups, SMEs (Small and Medium Enterprises) and anchor businesses in a meaningful way to market and promote technology business development. Outaniemi comprises the biggest concentration of R&D (research and development) and innovation services, facilities and hi-tech infrastructure in the Nordic Region. It links these entities together to create cooperative productivity that is greater than the sum of its parts. The Outaniemi linkage of 32,000 people – 16,000 students, 16,000 hi-tech professionals – 600 companies, and several world headquarters, together with world class research, has resulted in a highly functioning and successful ”innovation club.”

    How did Finland develop this ”club” culture? In the 1990’s, after suffering a serious recession, Finland applied Michael Porter’s industry cluster theory to look at their industries and areas of potential competitive advantage. In Porter’s book, Competitive Advantage of Nations, he had argued that successful firms are seldom alone. Frequently, a company’s dominant market share and accelerated growth are supported by a unique combination of firms tied together by knowledge and production flows. According to Porter, competitiveness originates from these unique combinations, clusters or development blocks. Their typical features are numerous interconnections between firms, technological spillovers, and externalities.

    While many of the connections are of an economic nature, social and environmental benefits are important as well. Defining formal boundaries for these clusters may be cumbersome and even irrelevant; the main feature of a cluster is interaction and interplay among the participants. The Finnish refer to this as “co-petition.” Through cooperation — working together in industry micro-clusters that interface with other micro-clusters — they become more effective at competing in a global marketplace. The “club” concept cross pollinates the clusters to inspire innovation.

    Here in Wisconsin, our Community Progress Initiative integrated a comprehesive system of community and economic development programs to develop relationships and a synergy across the community. This sparked interest in developing an entrepreneurial and small business support system and in forming industry cluster networks. Spinning out of the industry clusters has been the Ideas Incubator and Innovation Think Tank as vehicles through which to foster innovation for business applications. We are still at the infant stage in this process, although, with the foundation set, we are poised to advance our efforts. Lessons from Finland’s experience are guiding us to results. We’ve learned to grab that low hanging fruit and take steps towards long-term gains and bold innovative wins for our ”club.”

    A successful club has the belief and willingness to invest in making itself better. Finland is doing this, supporting innovation and entrepreneurship in public policy, and investing in R&D to the tune of more than $3200 Euros (that’s over $4,000 USD) per capita in some regions. The government investment arm, TEKES, grants money to private firms exploring innovation with good business model applications. Finland invests in its bread and butter, small business, concentrating on growth sector businesses of 20-100 employees. Some of the firms receiving investment from TEKES are not Finnish owned. For example, a Wisconsin Rapids-area firm could set up a Finnish branch office and apply for TEKES R&D funding. Hmmm, I think this could be worth exploring….

    The business of fostering innovation is long-term work. Finland has been successful at fast-tracking the moves that hold the competitive edge in technology innovation, and at applying the results to build economic prosperity. The country’s innovation system successfully converts R&D and educational capacity into industrial strengths.

    By applying some of these lessons learned in Finland to the impressive foundation we have laid through the Community Progress Initiative in our region, we hope to be as successful as they have been. We, too, are now working to foster innovation that assists our businesses, to work together in co-petition, and to grow our region’s economy.

    Anyone want to come join our club?

    Connie Loden is the Executive Director of the Heart of Wisconsin Business & Economic Alliance that coordinates community economic development projects in Central Wisconsin. An internationally recognized leader in rural development, she holds leadership roles with the Community Development Society and National Rural Development Partnership.

  • Reviving the City of Aspiration: A Study of the Challenges Facing New York City’s Middle Class

    For much of its history, New York City has thrived as a place that both sustained a large middle class and elevated countless people from poorer backgrounds into the ranks of the middle class. The city was never cheap and parts of Manhattan always remained out of reach, but working people of modest means—from forklift operators and bus drivers to paralegals and museum guides—could enjoy realistic hopes of home ownership and a measure of economic security as they raised their families across the other four boroughs. At the same time, New York long has been the city for strivers—not just the kind associated with the highest echelons of Wall Street, but new immigrants, individuals with little education but big dreams, and aspiring professionals in fields from journalism and law to art and advertising.

    In recent years, however, major changes have greatly diminished the city’s ability to both retain and create a sizable middle class. Even as the inflow of new arrivals to New York has surged to levels not seen since the 1920s, the cost of living has spiraled beyond the reach of many middle class individuals and, particularly, families. Increasingly, only those at the upper end of the middle class, who are affluent enough to afford not only the sharply higher housing prices in every corner of the city but also the steep costs of child care and private schools, can afford to stay—and even among this group, many feel stretched to the limits of their resources. Equally disturbing, even in good times, the city’s economy seems less and less capable of producing jobs that pay enough to support a middle class lifestyle in New York’s high-cost environment.

    The current economic crisis, which has arrested and even somewhat reversed the skyrocketing price of housing, might offer short-term opportunities to some in the market for homes. But the mortgage meltdown and its aftermath will not change the underlying dynamic: over the past three decades, a wide gap has opened between the means of most New Yorkers and the costs of living in the city. We have seen this dynamic play out even during the last 15 years, as the local economy thrived and crime rates plummeted. Despite these advances, large numbers of middle class New Yorkers have been leaving the city for other locales, while many more of those who have stayed seem permanently stuck among the ranks of the working poor, with little apparent hope of upward mobility. This is a serious challenge for New York in both good times and bad. A recent survey found the city to be the worst urban area in the nation for the average citizen to build wealth. For the first time in its storied history, the Big Apple is in jeopardy of permanently losing its status as the great American city of aspiration.

    This report takes an in-depth look at the challenges facing New York City’s middle class. More than a year in the works, the report draws upon an extensive economic and demographic analysis, a historical review, focus groups conducted in every borough and over 100 individual interviews with academics, economists and a wide range of individuals on the ground in the five boroughs. These include homeowners, labor leaders, small business owners, real estate brokers, housing developers, immigrant advocates, and officials from nearly two dozen community boards.

    Throughout the course of our research, the vast majority of New Yorkers—for the most part fierce defenders of the city—were alarmingly pessimistic about the current and future prospects of the local middle class. “What middle class?” was the quip we heard repeatedly after telling people about our study.

    But for all the valid concerns of those we spoke with, our conclusion is that a strong middle class remains in New York, and that there are considerable grounds for optimism about its future. In 2007, the city recorded the second highest total of building permits issued since it started keeping track in 1965, with Brooklyn and Queens hitting records—a clear sign that large numbers of people want to live in these long-time middle class havens. Home ownership rates in the city reached their highest levels ever in 2007, another testament to the city’s desirability—even if a not insignificant share of the recent housing purchases were driven by unfair and deceptive predatory lending practices. And in many communities, there have been long waiting lists for day care centers and private schools. While the economic crisis is already leading to sharp spikes in foreclosures, a precipitous decline in housing sales and, most troubling, a massive number of layoffs, it should not reverse the sense of many middle class families that New York now offers a safe environment to raise their kids—a key factor in the decision to stay in the city rather than decamp for the suburbs.

    “The perception of New York among young people is so phenomenal,” says Alan Bell, a partner with the Hudson Companies, a real estate development company that has built housing from the East Village to the Rockaways. “It used to be that automatically you’d get married and had kids and you were out to Montclair, New Jersey or Westchester. Now they want to stay. The question is how they stay since it’s so expensive.”

    Set against this picture of progress, however, are some alarming trends. Most of the people interviewed for this report told us of middle class friends, relatives or colleagues who had recently given up on the city. “I work with a lot of people who moved to Philadelphia and commute each day,” says Chris Daly, a media director at Macy’s who now lives with his wife and three kids in Tottenville, Staten Island but plans to move to New Jersey. “It’s the cost of living. You’re going to see more people moving to Philadelphia, the Poconos and commuting.”

    Unless we find ways to reverse some of the trends detailed in this report, the New York of the 21st century will continue to develop into a city that is made up increasingly of the rich, the poor, immigrant newcomers and a largely nomadic population of younger people who exit once they enter their 30s and begin establishing families. Although such a population might sustain the current “luxury city”—as Mayor Michael Bloomberg famously described New York—it betrays the city’s aspirational heritage. Further, a New York largely denuded of its middle class will find it nearly impossible to sustain a diversified economy, the importance of which is clearer than ever in light of the current finance-led recession.

    As a final consideration, a large and thriving middle class has always provided the ballast that a great city requires. Throughout modern history, such cities at their height—for example, Venice in the 15th century and Amsterdam in the 17th—have nurtured a large and growing middle class. But no city has had a greater history as a middle class incubator than New York. As the legendary urbanist and long time New York resident Jane Jacobs once noted: “A metropolitan economy, if working well, is constantly transforming many poor people into middle class people, many illiterates into skilled people, many greenhorns into competent citizens… Cities don’t lure the middle class. They create it.”

    Although some may suggest that this is a role New York can no longer play, we believe it is one that the city needs to address if it is to remain a truly great city.

    Released by Center for an Urban Future, this report was written by Jonathan Bowles, Joel Kotkin and David Giles. It was edited by David Jason Fischer and Tara Colton, and designed by Damian Voerg. Mark Schill, an associate with Praxis Strategy Group, provided demographic and economic data analysis for this project. Additional research by Zina Klapper of www.newgeography.com as well as Roy Abir, Ben Blackwood, Nancy Campbell, Pam Corbett, Anne Gleason, Katherine Hand, Kyle Hatzes, May Hui, Farah Rahaman, Qianqi Shen, Linda Torricelli and Miguel Yanez-Barnuevo.