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No more tiptoeing around the 'R' word, but local economy faring better than rest of California

Local consumer confidence is only half what it was a year ago and the index of leading economic indicators has fallen 28 out of the last 29 months, but San Diego is still doing better than Los Angeles, San Francisco or New York, according to local economists.

"Even though the most recent drop, at six-tenths of a percentage, is the smallest we have had so far, it is still negative," said economist Alan Gin, who compiles the index for the Burnham-Moores Center for Real Estate at the University of San Diego.

The four factors he uses to gauge the economy are consumer confidence, unemployment rates, help wanted advertisements and the national economy. Once the most recent bad news is digested, he expects these factors to be worse for next month.

Jobless rate will signal rise, fall of recession

"The unemployment rate is at 6.4 percent and it's been at this level for three straight months," Gin said. "We're still below the state average of 7.6 percent, but we are above the national average of 6.1 percent. I expect it to approach 7 percent by the end of this year or early 2009."

With the rise in foreclosures, Gin considers the situation to be fairly serious. He predicts we will not see the bottom of this downturn until the second half of 2009, after which he expects it will stay flat for a while.

"I don't see a turnaround until 2010. It's a tough call right now, to predict a turnaround," he said. "A rough rule of thumb is that the economy is turning around when the unemployment rate drops significantly, by about one percentage point.

Marny Cox, chief economist at the San Diego Association of Governments (SANDAG) and a 15-year veteran of the agency who focuses on long range forecasting, financing and infrastructure, also expects unemployment rates to peak around 7 percent by December.

He said the recession began in the third quarter of this year and would be over only when this rate drops to slightly below 6 percent. He thinks that people have been hesitant to use the "R" word because while unemployment is one of the indicators, excess capacity figures were not alarming until the end of 2007.

"One of the things being talked about now is the Christmas season. The retail sector is a major employer. If it's a poor season, then there will be fewer opportunities for jobs, which will lead to higher unemployment rates," Cox said.

Up until July, San Diego's impact was contained to two areas, construction and real estate-related finance, according to Cox. After the Bear Stearns news, which took people by surprise, the impact began to spread, affecting the transportation and retail sectors, he said.

"Government is the only sector that still has jobs left to fill. School districts are responsible for 40 to 50 percent of all government jobs, and they haven't experienced the same job losses," Cox said.

He considers 1994 to have been the last major recession San Diego experienced, and said the current situation is comparable to that period.

How the financial crisis began

Cox traces the root of the current banking crisis back to the Community Deregulation Act enacted in the 1970s, which required banks to do business in so called "red line areas" --lines drawn around specific areas of the map, circling low income communities.

Following this regulation, banks such as Washington Mutual built their business on giving loans to low-income individuals. Then these banks packaged the mortgages as bonds, which were sold as credit demand obligations by investment banks and backed by derivatives.

"Unfortunately, it was sort of like my debt is someone else's debt," said Cox, explaining that the norms established for investment banks were more liberal than for traditional banking institutions.

Under the fractional reserve system, which stipulates the amount of capital a bank had to retain in order to cover its debt, traditional banks were rated 10 to 1, where as investment banks could leverage themselves far more with ratings of 30 to 1.

Limited effect on local banks

Economists do not expect local San Diego banks to be badly affected by the crisis, since they had limited exposure. However, the impact will be felt in terms of slowing sales, with fewer loans being made, which in turn will translate into lower revenues compared to previous quarters.

With the recent mergers and acquisitions, there will be a reduction in the number of branches in order to avoid having acquired banks competing for the same business.

"Where we'll lose is in the real estate areas related to finance," Cox said. "Also, most people anticipate 3 to 5 percent declines in the rate of growth compared to last year, since they can't match last year's growth. Others may have financial losses to contend with."

David Ely, a finance professor at San Diego State University, expects local banks will experience a fallout from the general deterioration of the market.

"There will be more competition for deposits, and with big banks offering higher rates for CDs, small banks will have to compete in order to attract deposits," Ely said.

Slow recovery

Ely added one other factor as a key indicator in signaling a turnaround in the economy.

"Any recovery here will also depend on the recovery of home prices, he said. "I think we are looking at a longer turnaround than expected just three months ago, well into 2009."

Banks are reining in lending, even to each other, which will affect local businesses that need loans to grow, he added. "It's a vicious cycle and it is going to be a while before the effects are felt in the economy."

Cox expects the first milestone will be year-end events that will determine if the bailout was sufficient and if the downtrend is arrested.

While there were slight variations in predicting when exactly the economy will recover -- from the third quarter of 2009 to early 2010, everyone agreed it is going to take a lot longer than previously expected.

Nagappan is a San Diego-based freelance business writer.

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