Sunday, March 20, 2005

An economy based on housing could soon blow up

Editorial: Beware the ever-burgeoning bubble
The Sacramento Bee

Most homeowners in California are feeling pretty rich these days, especially those who have owned their houses for five years or more.

The run-up in property values doesn't immediately put more money in people's pockets. But it makes them feel wealthier. Thus, they go out and buy a new car, a flat-screen TV and other perks of supposed prosperity.

In short, California's economy - which has hummed along nicely the last two years - is based on a false sense of wealth. That's the conclusion of the respected UCLA Anderson Forecast, which warns that reality could soon blow up this bubble.

Since 2002, real estate-related services have accounted for one of every two new jobs created in California's private sector. Employment for Realtors, contractors, suppliers and mortgage processors is fueling the economy. The tech boom is over. Military spending is down. So California has returned to its roots - real estate speculation.

Homeowners and small businesses aren't the only ones who should be wary. Gov. Arnold Schwarzenegger's budget for 2005-2006 assumes that general fund revenues will increase by $5.3 billion, or about 6.8 percent. That may be optimistic. While there is a danger in overreacting and inflating the size of California's revenue shortfall, the governor and state lawmakers must consider the prospect of a downturn, assuming they ever get serious about negotiating a budget.

Economists dispute whether the real estate bubble will blow up like the Hindenburg or have a soft landing. Much will depend on how the Federal Reserve handles interest rates. So far, Fed Chairman Alan Greenspan has reduced short-term rates, but that hasn't had much impact on the long-term rates, which affect mortgages.

If Greenspan is concerned about "irrational exuberance" in the real estate markets, he need look no further than California. In Sacramento County, the median price of a home has climbed 31 percent in a year, to $321,000. The median cost in Los Angeles County has climbed 20.5 percent, to $424,000.

Further fiddling with interest rates may be necessary but tricky business. Many homeowners already are overextended with car payments and other debt. If those same homeowners have a floating mortgage rate that soars unexpectedly, tens of thousands could suddenly dump their property, and the real estate market could deflate like a dirigible.

For California, the only answer is to diversify its economy. That means investing in education; re-examining regulations that hurt small businesses; encouraging more food processing to add value to the state's agricultural bounty.

In the meantime, Congress is set to approve legislation that could make it harder for people to file for bankruptcy. It's not a pretty picture, especially for those inside the bubble.

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