Housing drags on local economy

The housing market's decline has accelerated as other economic indicators are worsening across Sonoma County, increasing the chances the region will dip into a recession.

After sustaining the county through the economic downturn earlier this decade, the housing market today is sapping consumer spending and contributing to both rising unemployment and slowing income growth, economists said.

What began as a correction from an eight-year run of record home sales and price increases has been made worse by soaring loan defaults and tighter credit, the consequences of loosened mortgage lending standards.

"It's becoming a drag. There is a rising risk of recession," said Steve Cochrane, regional economist for Moody's Economy.com.

Chris Thornberg, a Los Angeles economist, said rising unemployment and housing's tumult are hammering the state's economy, including Sonoma County. There is now a 75 percent chance of recession by early next year, he said.

"This thing is already in the process of creating a recession in California," he said. "Consumer spending will be the ultimate driver, but consumer spending slows because of housing price declines. It is housing that is the show stopper."

Home sales have been falling for more than two years in the county and price declines have kicked in the past 15 months, yet the economic blow is just beginning to hit here.

Sonoma County homeowners are pulling out less equity for home improvements, new cars and other spending. Falling home values mean households have less spending power. Ten percent of the typical homeowner's income comes from equity pulled out of a home, down from 19 percent a year ago, Moody's estimates.

Sinking home sales have triggered layoffs by mortgage and construction companies in the county and real estate agents are leaving the business. Those job losses have helped drive up unemployment to 4.5 percent, up from 3.7 percent a year ago. Moody's estimates unemployment will be 4.3 percent next year.

Home and apartment construction is projected to drop 33 percent next year to 1,149 new units in the county, according to Moody's.

Income growth is slowing. Incomes are expected to rise 4.4 percent next year in Sonoma County, smaller than the 6.9 percent increase projected this year, according to Moody's.

The local economy is expected to get worse before it gets better as the housing downturn deepens.

"We are in the heart of the storm. I think there's still more pain to be felt," said Greg Jahn, who tracks the economy as chief investment officer for Exchange Bank. "That leads to less jobs in the housing industry, less consumer confidence in the ability to go out and spend. It's just a vicious cycle."

Housing had a more kindly impact on the county's economy when high-tech companies were shedding jobs and unemployment was taking off during the two-year recession that lasted until spring 2003.

Home sales paused when the recession first hit. Then federal monetary regulators began cutting interest rates to help spark economic growth and mortgage rates steadily fell to historic lows.

Adding fuel to the sector were subprime loans that hit their height from 2004 to 2006 as housing peaked. These interest-only and payment option mortgages featured low initial monthly payments, often for two to three years, allowing buyers to qualify for larger loans as homes became increasingly expensive.

Housing sizzled, becoming an engine for creating jobs and boosting home values. Prices for the typical Sonoma County house doubled during the first half of this decade. This generated a wealth effect that led more homeowners to pull equity out of homes for spending.

"This is what has supported consumer spending at a strong pace. It has become an outsized factor," he said. "So when mortgage equity fades, they no longer have that access to extra equity to supplement their income."

Another recent drag on consumer spending is the rise in monthly payments on interest-only and option mortgages. These adjustable loans are exploding on more homeowners as initial payment periods expire and high interest rates kick in.

"We're going through a pretty hard spot right now and that will continue into 2008," said Mark Fleming, chief economist for FirstAmerican CoreLogic, a real estate research company.

Adjustable-rate financing has long been a legitimate tool to enter a home, Fleming said. What too many borrowers and lenders lost sight of, he said, was the likelihood that the riskier adjustable loans would become more expensive and whether the homeowner could afford higher payments.

Even if home prices didn't fall, one-third of interest-only and payment option loans made from 2004 to 2006 will default, according to a FirstAmerican study. About 10 percent of all subprime loans will default, the study projected.

Falling home prices, however, will push even more homeowners with these loans into financial difficulty. They likely won't have the equity needed to refinance and must either make the higher payments, sell or face foreclosure.

Hardest hit are those who purchased when home prices were around record highs.

"It's the Johnny-come-latelys to the party that are caught," Fleming said.

Housing markets in regions with higher concentrations of those loans, including Sonoma County, already are suffering even deeper defaults and foreclosures. But housing's decline is taking an even broader toll on the economy as falling home values lead even homeowners not facing the loss of their residence to take a closer look at their finances.

The latest national consumer confidence survey hit a two-year low this month. Conditions are no better in Sonoma County. The region's economy may not bounce back until 2009 because the mortgage mess is expected to extend housing's downturn, Cochrane said.

"The key is how well national and international demand holds up for key sectors in the county – wine, tourism, technology," he said. "If the U.S. does fall into recession, such demand will falter."

You can reach Staff Writer Michael Coit at 521-5470 or mike.coit@pressdemocrat.com.