Sunday, March 13, 2005

Bay Area's economy bruised but still strong

Kathleen Pender

No regional economy has been harder hit since the Nasdaq crash -- which started five years ago on Friday -- than the Bay Area.

The Nasdaq composite index climbed from about 1,000 at the beginning of 1996 to a peak of 5,048 on March 10, 2000. In a swift collapse, it lost nearly all of that gain, hitting a low of 1,114 in October 2002. On Friday, it stood at 2,041.60.

Almost any chart of Bay Area economic activity -- from apartment and office rents to employment to venture capital funding -- mirrors the mountainous shape of the Nasdaq index.

"We've been up the hill and down the hill," said Steve Levy, director of the Center for Continuing Study of the California Economy.

The notable exception is Bay Area housing prices, which have defied skeptics -- and gravity -- and gone almost straight up, leading many to wonder if greed and speculation has simply moved from tech stocks to housing.

The Nasdaq bubble both reflected and contributed to an economic bubble that was caused, in large part, by massive spending on computers and electronic equipment to prepare for Y2K and take advantage of the burgeoning Internet, said Anne Wenzel, founder of Econosystems.

The much-anticipated Y2K meltdown never occurred, but an unexpected computer-industry meltdown did.

Because the Bay Area had become so dependent on technology -- and on tech stocks and options -- the decline here was magnified.

"I think the bursting has been harder on the Bay Area economy than any other in the nation," said Mark Zandi, an economist with "You can still see the fallout."

Although the Nasdaq peaked in March 2000, tech company earnings and forecasts did not begin falling until late 2000 and employment in the Bay Area didn't peak until March 2001 -- a full year after the Nasdaq crash.

Average annual employment in the Bay Area fell from 3.5 million jobs for all of 2000 to 3.2 million in 2004, a loss of roughly 10 percent.

The job losses were concentrated in Santa Clara County, where employment fell 20 percent from peak to trough.

"That is the greatest drop for any city since the Great Depression," Levy said. It exceeded the job losses in the Los Angeles area in the early 1990s following the collapse of the aerospace industry and in Detroit in the early 1980s "when the auto industry got eviscerated," Zandi said.

If that's true, then why doesn't the Bay Area look or feel like the Dust Bowl?

Why are our freeways still gridlocked? Why is it hard to get a restaurant or hotel reservation on the weekend? Why isn't Michael Moore out here filming a Bay Area version of "Roger & Me"?

To be sure, people who lost their high-paying jobs, ended up with worthless stock options or had too much of their college or retirement savings in technology are still feeling the pain.

So are state and local governments, which used their swelling income and sales tax revenue in the late 1990s to expand or create new programs that were hard to rein in when tax revenue fell.

"If you asked city managers, they would say these have been four really tough years for them. Schools would tell you the same thing," Levy said.

But for many in the Bay Area, life is still good.

"The unemployment rate numbers didn't come close to matching" the job loss numbers, said economist Joe Hurd. San Jose's unemployment climbed as high as 8 percent, but Los Angeles got to 10 percent during the aerospace recession and "Fresno hasn't been under 10 percent in 10 years," Hurd said.

Some people just left

One reason the Bay Area's unemployment rate didn't go higher was that many people became independent contractors or self-employed, or left the workforce altogether. And many people who had moved to the Bay Area for jobs simply left when their work disappeared.

The Bay Area unemployment rate overall has risen from 2.5 percent in 2000 to 5.3 percent last year, but that means almost 95 percent of the labor force is still working. And many of those people with jobs are enjoying big raises they were able to secure during the boom.

"The economy is still extraordinarily healthy," Zandi said. "We are comparing everything to the peak. It was through the stratosphere."

Levy points out that most of the boom -- in stocks and the economy -- came in 1998 and 1999. "That was the abnormal period," he said.

Many economic indicators, such as office and apartment rents and employment, are where they were in 1997 or 1998 -- not a bad time.

"We started as a very high-wage, wealthy area, and we remain a high-wage, wealthy area. It's not Appalachia," Levy said.

Housing, of course, is way ahead of where it was in 2000, and that has helped offset the decline in stock values and the economy. It has also been one of the biggest mysteries of the post-bubble era.

In a September 2000 research paper, "Tech Stocks and House Prices in California," San Francisco Federal Reserve economist Fred Furlong noted a statistical correlation between Bay Area house prices and stock prices of high- tech firms headquartered in the Bay Area.

He said the analysis "supports the commonly held view that Bay Area house prices have been driven in part by a wealth effect stemming from the stock price appreciation of high-tech firms in the region. Given this link, since stock market volatility in the spring of 2000 was a minor hiccup relative to the huge stock market gains that Bay Area companies have enjoyed over the past three years, wealth effects from high-tech stocks will likely remain a strong factor in the demand for housing in the region in coming quarters."

In his paper, Furlong didn't speculate on what would happen if tech stocks plummeted, since like many people at the time, he seemed to assume they would soon resume their upward trajectory.

But based on his findings, one would assume that a decline in tech stocks would put a crimp in the housing market.

I asked Furlong last week why that didn't happen.

One reason, he said, was that many high-tech workers exercised their stock options at the beginning of the downturn and had money to invest.

Another reason: Many companies, at least in the early post-crash years, simply repriced their options downward when their stock prices declined, so the options still had value.

He also cited the obvious reasons: Falling interest rates made houses more affordable, as did the debut of interest-only loans and other forms of creative financing.

Also, the supply of Bay Area housing has never kept up with employment growth. After the bust, the gap between supply and demand shrunk, but didn't go away.

Furlong pointed out that the rate of housing appreciation in the Bay Area has lagged some other regions, so "you can't say there hasn't been any impact" from the Nasdaq crash.

The future

Despite job losses, the median household income in the Bay Area today is slightly ahead of where it was in 2000. The hotel and tourism industry, an important part of the economy, is rebounding strongly.

But most economists say it will take three to five years -- and maybe longer -- before the rest of the economy recovers.

"At the rate we are creating jobs now, it will take a long time," perhaps three to five years, before employment reaches its pre-crash levels, said Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at UC Berkeley.

"I think it could be seven to eight years before we get those jobs back," Levy said.

Rosen said the office market may get back to its peak in about three years.

Wenzel said small companies will be the key to the jobs recovery.

"Mature companies don't create a lot of jobs. It has always been smaller companies that create new jobs. That hasn't happened in the last few years," she said.

She points out that venture capital funding of Bay Area companies was only $7.1 billion in 2004, down from $34.4 billion in 2000.

"That could be the biggest fallout from the Nasdaq crash," she said.

Wenzel said a substantial increase in venture capital funding will be good for the Bay Area, since it is an important source of growth for small companies. She added that she will be keeping a close eye on business confidence because business spending will be another key to the recovery.

The Bay Area Council does a quarterly survey of large businesses that has shown a promising uptick in sentiment, she said.

Most economists don't think the tech bubble will ever repeat itself, but they wouldn't be surprised to see some other mania descend on the Bay Area.

"California has a history of gold rushes, starting with the first one," Rosen said. "People are attracted to that, they come from all over the world trying to make this a new place. It's in our DNA."


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