Panel: Credit Crunch to Continue into Next Year

The mounting troubles plaguing the nation’s economy will likely continue through at least the early part of next year, according to a conference call with economists and legal professionals. In fact, Lewis Feldman, chair of public/private development for Goodwin Procter L.L.P.’s New York office, views the current economic meltdown as even tougher than the fiscal calamity that took place early in the decade. “The financial crisis that we face in government is far worse than the 2001 recession because of the declines in income and also retail spending, which impacts sales tax collections,” the panelist said. “With property taxes declining and sales taxes declining, each state then has more difficulty issuing its debt into the marketplace.” On the other side of the equation, “governments may have to issue more debt as a result of their financial difficulties, and there is likely to be a major drop in income tax revenue in the April to June 2009 quarter that’s going to make the current fiscal difficulties even worse for local government,” he said. Ross DeVol, Los Angeles-based regional economist for the Milken Institute, described the state of the economy as moving from a “Where’s Waldo” stance of identifying holders of toxic debt to a position of knowing where the debt is, but now trying to determine its worth. “Businesses can’t get access to working capital,” he said. The volatility of the economy in recent months has been extreme. Just over the past several days, additional evidence of the nation’s fiscal meltdown surfaced, including the announcement that U.S. retail sales plummeted 1.2 percent in September, the largest drop since sales dove 1.4 percent in August 2005. Moreover, the four-week moving average for initial jobless claims hit 482,500, the highest mark since October 2001, and industrial production decreased 2.8 percent in September, its heftiest decline since late 1974–much of which was tied to Hurricanes Ike and Gustav–but still a notable drop. While DeVol noted that export growth has been considerably strong and has kept the economy from clearly showing that the country is in a recession, he exhibited no signs of skepticism as to whether the economy has actually sunk into one. “People are realizing that there’s no question that we’re in a recession,” he said. “It’s just a question of how bad will it be,” he continued, adding that he expects to see declines lasting through the first quarter of 2009 and maybe into the second quarter. The state of the housing market hasn’t made matters any better. Home prices have fallen across all of California’s major cities, with prices in markets including Bakersfield, Fresno, Riverside, Sacramento and San Bernardino getting hit hard and prices in coastal markets holding up better, noted Delores Conway, director for the University of Southern California Casden Economic Forecast. While the number of home sales is down, the Central Valley areas are seeing investment funds purchase foreclosures and rent them out, she added. The multi-family sector in California, however, is still relatively healthy, as rents have remained fairly flat and vacancies have risen only slightly, according to Conway. She added that California still has a housing shortage except in the Inland Empire, where there’s a huge shadow market of additional apartment supply in the form of leased condominiums and leased homes. “What is of particular concern in the housing market in California is that unemployment has sharply risen,” she said, slotting the unemployment rate in Los Angeles at 8.2 percent, in Riverside at 9.7 percent and in Orange County at 8.5 percent. Office vacancies are also on the rise, while “a lot of deals are not getting done,” she said. Conway continued by underscoring the marked decline of mortgage-backed securities. “The deals are all changing. They used to be value deals where there was enhanced leverage. People would go in, put in value and then flip it. That has all changed, especially in the multi-family market, and now pension funds and other investors are particularly concerned about streams of income. They’re changing the strategy from a value-added strategy to more of a buy-and-hold strategy.” Gilbert Menna, co-chair of real estate capital markets for Goodwin Procter’s Boston office, maintained that the only deals garnering interest are those that do not require any financing, and even in the context of those transactions there is a lot of uncertainty in the general REIT market. “No one really knows where capitalization rates are, in large part because without liquidity and without any debt, real estate can’t really trade and no one can really get a sense of what values are,” he said. For his part, Robert Insolia, partner, real estate capital markets for Goodwin Procter’s New York office, noted that although there are distressed funds out there, they have not been putting out much capital because they cannot get the leverage needed, he added. Things may begin to pick up next year, but not without a catch. “[Commercial real estate] projects that have been started seem to be still moving toward completion, but there’s just a dearth of new deals getting done,” DeVol said. “ We’re going to see the commercial market be very weak next year in terms of new construction, especially. Capital is not available. It will begin to loosen up certainly by mid next year. But at that point we will have gone through a recession.”