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Clearing the wreckage of the 'Great Recession' will take years

The 'Great Recession' may be over, but like a hurricane that has battered a coastal city, the wreckage left behind will take years to fix. "Although 2010 could be described as a 'recovery year,' most indicators will be weak for Arizona and the Valley," said Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business and editor of Economy@W. P. Carey. "Although Arizona and the Valley are reeling from the recession, the fundamentals of a strong economy are still present. The state is attractive to new residents and entrepreneurs, and by 2015 we will most likely be among the top five strongest economies in the country. Getting from here to there will be painful in the next couple of years." McPheters and economist Elliott Pollack delivered the regional outlook at the 46th Annual Economic Forecast Luncheon on December 2.

2009-12-02

The 'Great Recession' may be over, but like a hurricane that has battered a coastal city, the wreckage left behind will take years to fix. "Although 2010 could be described as a 'recovery year,' most indicators will be weak for Arizona and the Valley. When we say indicators are 'weak' that means in comparison to other parts of the country, or when compared to the usually strong economic growth in Arizona," said Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business and editor of Economy@W. P. Carey.

"Although Arizona and the Valley are reeling from the recession, the fundamentals of a strong economy are still present. The state is attractive to new residents and entrepreneurs, and by 2015 we will most likely be among the top five strongest economies in the country. Getting from here to there will be painful in the next couple of years."

McPheters was one of three top economic experts who presented his 2010 forecast for Arizona and the nation on December 2 at the 46th Annual Economic Forecast Luncheon, co-sponsored by the economics department at the W. P. Carey School of Business and JPMorgan Chase.

While McPheters looked at the Valley and state economy, Anthony Chan, managing director and chief economist for JPMorgan Chase Private Client Services, commented on the U.S. economy and the financial sector. Elliott D. Pollack, CEO of Elliott D. Pollack and Company, spotlighted the state and Valley real estate and construction sectors. During his presentation, McPheters summarized the brutal year that was 2009 and what can be expected in 2010.

More job losses

According to McPheters, the national recession hit Arizona's economy harder than any other state. In terms of percentages on a year-over-year basis, Arizona's job losses were the worst or next-to-worst of all the states in every month of 2009, while absolute job losses were third highest in the Western region. And those actual numbers are startling.

In no other economic downturn in recent memory has Arizona lost as many jobs as it did in the Great Recession. According to McPheters, more than 57,000 jobs were lost in 2008, and three times that many — 183,100 — are expected to be lost in 2009. In a state and a metro area that rely heavily on population growth, the housing bubble burst like an atomic bomb. The construction industry accounted for the greatest number of jobs lost in the state, down by more than 45,000 compared to 2008.

Since the peak of the boom economy in 2006, the state's construction industry has lost more than 100,000 jobs. For 2010, the consensus forecast for Arizona calls for a decrease of 24,300 jobs, a loss of 1 percent over 2009. Combined with the job losses from 2008 and 2009, McPheters said next year's declines will result in a total loss in Arizona of more than 260,000 jobs since 2007.

"Arizona has the weakest labor market in the country, if measured by the percent of jobs lost in the past 12 months. And the Valley has the weakest labor market among all large metropolitan areas. Losses for Arizona and the Phoenix area are greater than 7 percent year-over-year and these losses have persisted for months. Unemployment is likely to rise, and may exceed 10 percent," McPheters said in an interview before the luncheon.

"Our unemployment rates have been below the national level, most likely due to a higher proportion of discouraged workers and extensive use of furloughs and reduced hours for workers. If hours are reduced, incomes fall, but the unemployment rate isn't affected," he added.

"Employment in Arizona and Phoenix peaked in 2007 just before the recession began. Then, 2008 and 2009 were years of job losses, and our forecast is that 2010 will be a year of job losses for the overall year (although the second half may show some gains). After 2010, growth will slowly return. We don't expect that Arizona and the Valley will return to pre-recession employment until 2013, that is about four years from now."

Retail sales and personal income

In 2009, the state's retail sales fell by more than 10 percent, according to McPheters. It was the second consecutive year of losses as Arizona consumers wrestled with shattered confidence, frightening unemployment rates and tepid personal income growth. In fact, McPheters said, in 2009 personal income in Arizona decreased for the first time in four decades of modern record keeping.

This year, Arizona personal income is expected to fall by 1.5 percent, based on data from the U.S. Bureau of Economic Analysis. In 2010, Arizona's personal income is projected to increase by 2 percent. While that's better than 2009, McPheters pointed out that during the robust, mid-decade economic expansion, Arizona personal income increased at a double-digit pace.

With personal income remaining anemic, McPheters expects consumers in 2010 will continue the 2009 trend of saving money and bringing down their debt. But, they will also cautiously reenter stores. As a result, he sees retail sales increasing by 5 percent in 2010. Despite that, retail sales next year will total only about $52 billion — more than $10 billion below the level set in 2007.

Weak personal incomes, high unemployment and lagging retail sales spell more bad news for the state's budget in 2010. "Consumers have become ultra cautious nationally and here in Arizona, increasing their savings rate, cutting back on debt, and reducing spending on big ticket items, as well as luxuries such as eating out and entertainment," McPheters said.

"Is this a permanent change? Probably not, but until consumers feel better off, consumer spending will not be a strong force for recovery. Sales taxes are an important source of government revenue, along with income taxes, and both are on the decline now and will be weak through 2010."

Construction and real estate

The recession started when the housing market went bust, and nowhere was that felt more keenly than in four states: Florida, Nevada, California and, of course, Arizona. As McPheters pointed out, single-family home permits in Arizona suffered a 40 percent drop in 2009, after plunging 49 percent in 2008. In addition, home prices in the Phoenix metro area were down approximately 50 percent in mid-summer 2009 from a peak in 2006.

McPheters' forecast calls for single-family home permits to increase in 2010, after bottoming out in 2009, but the increase will be below Arizona's historic averages. "Home values are expected to continue to decline, at least through the first part of 2010. This makes housing more affordable, and resales will be strong, especially in the lower end of the market," he said.

"While lower home prices are good for buyers, they are bad news for homeowners. Recent figures show that almost one-half of Arizona mortgages are 'underwater,' with negative equity second only to Nevada. For the Valley, the negative equity percent is actually greater than 50 percent. This means more foreclosures and still more turmoil in the housing market."

Interviewed before the luncheon, Elliott Pollack said the housing market in the state and Valley would remain fragile through 2010, and possibly 2011, as a result of 60,000 to 80,000 excess homes on the market, the large number of improved lots and the continuing high rate of foreclosures.

"The result is there is going to be a continuing supply of existing housing coming on-stream. On top of that, you have population flows; net migration has slowed dramatically, so the absorption of those homes has slowed. What you are seeing now is that the buyer of homes is falling generally into one of two categories," Pollack said.

"Instead of being mainly people moving into the market, people moving into town, what you're seeing is a third to about 40 percent of buyers being investors, and probably another third to 40 percent are people being induced by this $8,000 [housing tax] credit who are at the very eye-level of affordability," he explained.

"So the people who are moving into homes are moving into homes because they are more affordable and they're getting an $8,000 tax credit. That's not a problem at all. The only problem is that with the investor market you're probably going to see some of those homes come back on the market."

Pollack added that before supply and demand are rebalanced in the housing market, population flows have to increase to the point where excess supply is absorbed and there is demand for 30,000 new units a year. He said that rebalance could occur in 2014. But even as the residential real estate market digs itself out, the commercial real estate sector remains in freefall.

"The commercial decline is going to take several years to fully resolve. The worst is still in front of us. The worst appears to be behind us for housing," Pollack said. "Commercial real estate is a disaster. There is huge excess supply because it takes so long to bring these things on-stream that there's still a good number of stuff in the pipeline, even though vacancy rates are very high," he said.

"On top of stuff still being in the pipeline, given the decline in employment, absorption of industrial space and office space and retail space is actually negative. It could take years to correct. I don't think there will be another major office building built in Phoenix in the next five years. It will take that long to absorb the excess supply." "The flip side of that is the availability of cheap industrial and office space will make us more competitive for companies looking to move to town," he added. "So there is a positive."

Federal stimulus

The federal stimulus program enacted this year won't really take hold until 2010, McPheters said. Still, the program has helped cushion the state somewhat from its economic woes. But there is a major caveat. "There is an imbalance in the program that has not been good for Arizona. Although we have one of the weakest job markets here, we are still only projected to get about 2 percent of the total national stimulus distribution, since the size of the state is a factor," McPheters said.

"It may be that a second stimulus program is proposed in 2010 if unemployment rates remain high, and Arizona could benefit if the funds are targeted to areas with the most economic difficulties."

But the state can't pin its hopes for a quality recovery on stimulus dollars — or population growth alone. McPheters said quality growth will depend on the state having an educated work force, a competitive tax structure, affordable energy, water and land, a solid transportation infrastructure, and a strong national and global brand.

Bottom Line:

Arizona Forecast Summary:

• More jobs lost in 2010
• Unemployment rises
• Job recovery in 2013
• Budget problems persist
• Quality growth requires more than population increases

Economics Faculty