Grim forecast for economy, housing

<p>The U.S. economy is likely to slip into recession by next spring and home prices in Sonoma County could drop by as much as 25 percent before recovering, a prominent economist told Sonoma County business leaders Friday.</p><p>Slowing job growth, sluggish consumer spending and continued fallout from the subprime mortgage market create a 75 percent chance of a recession by the end of this year or the first quarter of 2008, said Chris Thornberg, a principal with Beacon Economics in Los Angeles.</p><p>"Housing is getting worse. This is not over by any stretch of the imagination," Thornberg said.</p><p>If the recession turns "nasty," home prices could tumble 35 percent from their peak before recovering, he said. Home prices in Sonoma County have already declined 10 percent since their high in August 2005, when the median home price hit $619,000.</p><p>Thornberg, formerly with the UCLA Anderson Forecast, was one of the first economists to warn of a housing bubble in California and the consequences of a real estate slump.</p><p>Last year, he pegged the chance of a recession in 2007 at 50 percent.</p><p>Since then, however, the meltdown of the subprime mortgage market has increased the risk that consumers who have relied upon home equity to fuel their spending will pull back.</p><p>About 4 percent of all consumer spending in recent years has been attributable to homeowners tapping equity in their homes. But household debt has risen to unsustainable levels, exceeding 19 percent of people's disposable income, compared to just over 15 percent in the early 1980s, he said.</p><p>The combination of slow home sales and consumers reining in spending could create a ripple effect that washes over other industries, including construction and retail, he said.</p><p>The notion that the real estate market will make a rapid recovery is little more than wishful thinking, he said.</p><p>"The history of housing cycles is very clear. Housing markets don't bounce. They never bounce," Thornberg said. "Housing bubbles are years in the making and years in the unmaking."</p><p>Housing downturns typically last three years from the peak to the trough, and Thornberg doesn't have a high opinion of those who preach otherwise.</p><p>"How anybody can stand on stage and say 'In three months, we're going to burn off inventory and everything's going to be fine.' Well, they're either dumb or corrupt," Thornberg said.</p><p>Kathy Hayes, director of government affairs for the North Bay Association of Realtors, said she's not hearing anyone in her industry talk about that quick of a turnaround.</p><p>"Most economists are saying 2008 is not going to be a bumper year," said Hayes, who attended Thornberg's talk.</p><p>Thornberg's projections are more pessimistic than other forecasts, Hayes said. The California Association of Realtors, for example, predicts home prices will drop 4 percent statewide next year.</p><p>The debate now centers around how deep the downturn will go and how long it will last, and only time will tell, she said.</p><p>"I don't think there's anybody out there that works in the real estate community that doesn't understand that we're in the middle of a correction," she said.</p><p>Ben Stone, executive director of the Sonoma County Economic Development Board, said Thornberg has been right in the past, and there's no reason to think his latest analysis isn't on the money.</p><p>"There obviously is going to be some adjustment coming up," Stone said.</p><p>Thornberg wasn't all doom and gloom. He highlighted several factors that suggested the Bay Area and Sonoma County might not be hit as hard as other regions. Both economies are diverse and strong in the technology sector, which will likely continue to be a bright spot, he said.</p><p>"The trends in Sonoma and the trends in the Bay Area are some of the best in the nation," he said.</p><p>He also noted that recessions can create market opportunities for savvy investors, who in the current climate might want to hold cash until the "fire sales" that may happen by early 2009.</p><p>One of the key reasons the recovery is so far off is the number of subprime loans adjusting to higher interest rates won't peak until the third quarter of 2008, Thornberg said.</p><p>Many homeowners with such loans are finding it difficult make the payments after their interest rates soar, leading to the spike in foreclosures currently plaguing the market.</p><p>Thornberg offered a scathing analysis of the subprime mortgage meltdown as being a direct result of people who had incentives to keep money flowing into mortgages at all costs.</p><p>Real estate agents and mortgage brokers had an incentive -- through commissions -- to get people to buy homes. The investment banks backing the mortgage companies had incentives to continue funding the loans because they received commissions selling the loans as mortgage-backed securities, known as collateralized debt obligations.</p><p>And the rating agencies like Moody's and Standard &amp; Poor's also received hefty commissions when they gave AAA ratings to securities, Thornberg said.</p><p>"These are three groups of individuals that made a commission but had no long-run stake in the game," Thornberg said. "Humans respond to incentives and I can tell you right now these are bad incentives."</p><p>The mortgage industry was "making money hand over fist," he said, and they relaxed lending standards when prices got too high or qualified borrowers became too scarce.</p><p>"What this industry did was they had the money-pump going like nobody's business . . . and they weren't going to let it stop," he said.</p><p>Many fundamentals of the U.S. economy remain strong, however, and Thornberg said he has every reason to believe the economy will bounce back.</p><p>"The primary message we should take away from this is 'Yes, we have a mess but it's a temporary mess,' " he said.</p><p>You can reach Staff Writer Kevin McCallum at 521-5207 or kevin.mccallum@pressdemocrat.com.</p>