How Arnie's California dreaming turned sour

As the repo men come calling in the Golden State, and whole streets of homes lie empty, the property crisis gripping the US's economic powerhouse may spell disaster for the nation, writes James Doran James Doran

The Observer,
Sunday August 10 2008

As the brutal central California sun rose over the city of Stockton, Cesar Dias fuelled up his brightly painted tour bus and waited for the hordes to arrive.

'We get 20 or 30 people every Saturday by 10.30,' says Dias. 'By the end of the day we will have maybe 60 or 70. On a busy day I take the bus out three times.'

His guided tours are very different from the usual trips around the homes of Hollywood stars. Dias is a real estate broker and his tour buses ferry would-be house buyers, and the occasional gawker, around the scores of foreclosed properties dotted all over town: 'The number of foreclosures around here has made us into an attraction.'

Stockton has become known as Foreclosure Town, USA. With one in 25 houses in foreclosure, there are more properties with mortgages in default here than anywhere else in the country. And it is not as if there isn't some stiff competition for Stockton's dubious accolade in other corners of California, and indeed the rest of America.

In the past 12 months, the US housing crisis has spawned the credit crunch, which in turn has placed the entire economy in a stranglehold as the fear of sustained recession hangs over the nation.

But in recent weeks the ferocity of the downturn has been gathering pace in California, with the strain of economic unrest being felt at every level of society - all the way up to Arnold Schwarzenegger in the state governor's mansion.

'This whole state is in a terrible mess financially,' Dias concedes as he prepares to board his Repo Home Tours bus.

The stellar increase in house prices was inflated first, fastest and furthest in California. So it is not surprising, now that the bubble has burst and the market is in freefall, that places like Stockton are suffering more than most.

But the city is far more significant in the big picture of California's troubled economy than many realise.

The problems facing this part-old, part-new city are being duplicated all over the state, causing an economic ripple effect that could push America's biggest economy to the brink of collapse.

Indeed, a walk around this once prosperous commuter town 130km north of San Francisco is a frightening reminder that social destruction on a grand scale can happen in the blink of an eye, even in suburban California.

You can tell which are the houses in foreclosure. The paint on the white picket fences is peeling, the lawns are turning brown and the water in backyard swimming pools has become a stinking green soup of algae and mosquito larvae.

On one street the tour bus passes, all of the five houses are in foreclosure. Two of them are boarded up; one is missing its front door. A couple of stray dogs wander about in a semi-furnished living room, probably abandoned by owners forced to flee when the sheriff came calling with a notice to vacate.

In other empty dwellings, plates of food are left to putrefy on dining tables, another sign that one evening not too long ago, a perfectly ordinary family had to leave.

The economic problems of this now collapsing town cannot be laid entirely at the door of unscrupulous mortgage lenders or irresponsible borrowers who fed at the trough of rising house prices for too long. The construction industry, one of the biggest providers of employment and taxes to the state of California, must share the blame.

Stockton was a gold-rush city that sprang up in the mid-19th century. In the post-war years it became popular with commuters who could not afford pricier San Francisco Bay.

Then, about six years ago, a new gold rush gripped the town as developers snapped up cheap land on the outskirts and in shadier neighbourhoods downtown. The housing boom was in full swing, providing jobs and a healthy supply of new homes to keep voracious buyers satisfied.

But this was no ordinary gold rush; it was alchemy, with the developers turning piles of concrete, glass and steel into gold as if by magic.

This boom was great for state finances as taxes levied on the new buildings and on the tens of thousands of construction workers arriving in the state flooded in. But Stockton's newfound prosperity was just a flash in the pan. All too quickly the city became vastly overdeveloped, with so many empty houses and blocks of flats that the place started to feel like a ghost town.

The level of overdevelopment is evident in Stockton's run-down marina area. Here, the Sheraton Hotel - the centrepiece of a regenerated waterfront quarter - is in receivership and the 'luxury condominiums' that were supposed to sell for $750,000 (£375,000) apiece are unfinished.

The scale of foreclosure in Stockton is mirrored in the latest state housing statistics. Almost $1.3 trillion of homeowner equity has been lost in California since home prices peaked in December 2005. It is predicted that house price discounts of as much as 50 per cent will extend into 2010.

California led the US in default notices and bank seizures for the 18th straight month in June, and had seven of the 10 metropolitan areas with the highest foreclosure rates, according to RealtyTrac, an internet housing data firm.

Lenders started foreclosure proceedings on a record number of California homeowners last quarter, the result of declining home values and the rampant spoilage of especially risky home loans made in late 2005 and 2006.

Mortgage providers recorded 121,341 notices of default during the April-to-June period, a rise of 6.6 per cent from 113,809 in the first quarter, and up 124.9 per cent from 53,943 in the second quarter of 2007, according to DataQuick Information Systems.

California homeowners going into default on their primary mortgages were on average five months behind on their payments, while those in trouble on their second mortgages were about eight months overdue. Last quarter's default numbers were a record in almost all of California's 58 counties.

Of the homeowners in default, only an estimated 22 per cent emerge from the foreclosure process by bringing their payments up to date, refinancing, or selling the home and paying off what they owe. A year ago it was about 52 per cent. Foreclosure sales now account for 40 per cent of all California home sales activity in the most recent three-month period. A year ago it was 5.4 per cent.

So big was the glut of newly built property in California that it soon became evident that there were not enough people with the funds to buy. So the sub-prime mortgage industry was created in California, with all kinds of home loan products designed to attract people who did not qualify for an ordinary mortgage.

Adjustable-rate mortgages - ARMs - became very popular, as did so-called 'Alt-A' loans - ones that do not require the borrower to produce any documentation to support his or her application.

This type of mortgage is also known as a 'liar loan'. The best catch-all term for these dodgy mortgage products, though, is Ninja Loan - short for No Identity, No Job, no Assets. California-based IndyMac bank was one of America's leading providers of Alt-A 'liar loans'. It is not surprising, then, that it collapsed last month - the third-biggest banking failure in American history.

IndyMac was founded in 1985 as an offshoot of Countrywide Financial - one of the biggest sub-prime mortgage firms in America, which was itself almost forced to the wall by the housing market collapse and was only saved by a $4bn buyout from Bank of America.

Countrywide is another Californian institution that helped to create the rampant sub-prime industry that has wreaked havoc in credit markets and beyond all over the world. David Loeb and Angelo Mozilo, the bank's founders, have been pilloried in America for creating a virtual black hole of debt and one of the biggest economic nightmares of the past 80 years. But nobody was complaining when Countrywide was worth $24bn.

California - or at least its biggest cities, Los Angeles and San Diego - have also been particularly hard hit by the massive increase in the price of oil and, consequently, the price of petrol.

The state's towns and cities are built around the automobile. With the price of petrol more than doubling in the past year, it is no wonder that cash-strapped Californians are being pushed into bankruptcy at an alarming and historic rate.

'In southern California everybody drives everywhere - you have to,' says David Wyss, chief economist at Standard & Poor's, the New York-based credit rating agency, who adds that he is 'concerned' about the state's economic stress. 'There is a confluence of negative factors,' he goes on. 'The housing market and the price of fuel are the most significant ones.'

The state legislature is having trouble completing a budget this year because a massive decrease in taxes - due to so many losing their homes and jobs - and a huge increase in spending have led to a massive $15bn shortfall.

The crisis has escalated in recent weeks, with governor Schwarzenegger putting more than 200,000 state employees on the minimum wage, firing 22,000 temporary workers and threatening to add a penny to the rate of sales tax until the budget is passed. 'We are in this position for two reasons,' says Aaron McLear, Schwarzenegger's spokesman. 'One, we have a flawed budget system but the main problem is that our expenditure far exceeds our income.'

The Californian budget process is so complex and causes such a headache every year that all banks in the state provide interest-free loans to all state employees because they know that there will always be several months in the year when state employee pay is suspended or reduced pending budget finalisation. 'It is totally ridiculous,' McLear adds.

Despite all this negativity, it is unlikely that the Californian economy will fail completely, however. Comprising about 10 per cent of entire American output, California is too big and too complex to suffer an all-out collapse.

But the state's credit rating has been cut and could come under more pressure if a budget is not passed and if foreclosures, job losses and bankruptcies continue to suck the life out of state finances.

'The California state treasury is threatening to sue us if we don't raise their credit rating but in the meantime they can't even get a budget signed. It's a mess,' says Wyss.

Schwarzenegger is doing everything he can to bring the budget crisis to a head. He is refusing to sign any more bills into law until the budget is completed. 'With a cash crisis looming and some payments from the state delayed already, the late budget takes on even a greater urgency,' the governor says.

'Until the legislature passes a budget that I can sign, I will not sign any bills that reach my desk. That means that some good bills will fail, yes.'

This kind of fiscal nightmare is nothing new in California. 'We have only had four budgets passed on time in the past 20 years,' McLear says. It has been eight weeks since the legislature missed its deadline to sign the new state budget, and if it does not act in the next couple of weeks the state will be forced to take out high-interest loans.

California is not alone. Wyss says that America's troubled states are roughly divided into three categories: 'bubble states' like California, Arizona, Nevada and Florida that are suffering declining tax revenue because of the housing crisis; auto industry states such as Michigan and Ohio that are suffering revenue declines because of an exodus of unemployed former factory workers; and 'banker states' such as New York, California again and Illinois, suffering big drops in tax revenue because of the collapse in financial services.

'All of these states will face terrible problems, just like California is facing today,' Wyss says, adding that states such as Texas, benefiting from the massive increase in the price of oil, and the farming states of the Midwest are doing well because of steep increases in food prices, and will more than likely be spared any pain. 'This is a very economically divided country today,' he adds.

And not everyone, even in California, is suffering. Since he started his 'foreclosure tours' Dias's business has been enjoying a renaissance. 'We are getting bidding wars for a lot of properties in foreclosure,' he says, giving an indication that excess housing stock is being mopped up and the market bottom is not too far off. 'And we have two TV companies that want to make a show about us,' Dias adds.

But the chances of such a gloomy programme attracting a regular audience do not seem great. People watch TV to escape everyday worries. Foreclosure, for many Americans, remains a harsh reality that cannot be avoided

http://www.guardian.co.uk/business/2008 ... arzenegger