By Steven Pearlstein
Friday, January 4, 2008
Next Friday in Tysons Corner, Steve Fuller and his colleagues from George Mason University will release their annual outlook for the Washington area economy. The title of this year's confab:
"Will Housing Recovery Drive Growth?"
That's right, folks, housing recovery. As Fuller sees it, with the local economy likely to add another 40,000 jobs this year -- just slightly below last year's 44,000 -- and unemployment at historic lows, the only way to fill those jobs will be to recruit people from somewhere else. Obviously, those workers and their families will need somewhere to live. And with new-home construction at recession levels, it will be only a matter of months before the existing inventory is sold off and builders start breaking ground on new houses and condos.
And there you have it: a rebound in residential construction, a big new spurt of public construction and a steady flow of federal procurement contracts, all conspiring to keep the Washington economy growing at the modest annual rate of 2.8 percent in 2008.
It's just what the local business community desperately wants to believe. And it's all part of the larger story of how Washington has the strongest regional economy in the nation and is basically recession-proof.
Too bad it's also a fantasy.
For a more realistic assessment, let's begin with the stock market, which, for all its faults, is a pretty reliable leading indicator. Last year, the overall market, as measured by the Standard & Poor's 500-stock index, managed to eke out a 3.5 percent gain. But during the same period, an index of Washington area stocks showed a decline of nearly 18 percent.
Let's consider some of the bigger companies -- and some of the bigger local employers -- that are part of that index.
Among the biggest losers, of course, were Fannie Mae and Freddie Mac, the mortgage finance giants, and NVR, the big home builder. Investors and executives are not anticipating any rebound for those companies in 2008, nor should you.
Also hurting are other financial services companies such as credit card giant Capital One and Friedman Billings Ramsey, Washington's home-grown investment bank. They, too, have beaten-down share prices.
Marriott International is not only a big local employer, it's also a pretty good proxy for the local tourism industry, which posted record numbers during the first half of 2007. But the travel business is notoriously cyclical, and by the summer it was pretty clear to everyone that the cycle had peaked. Not surprisingly, Marriott shares fell 28 percent on the year.
Ah, but what about the tech and telecom sectors, which are booming in some parts of the country? Alas, in the Washington region, it is more of a mixed bag.
On the plus side, there are a handful of small Web 2.0 companies that have gained some traction, along with satellite companies like Orbital Sciences and Hughes that are on a roll, while telecom equipment maker Ciena has recovered from its near-death experience.
But at the same time, it's not been a particularly heady period for other tech companies like MicroStrategy or AOL, which continued to shrink locally and move more of its top executives to Time Warner headquarters in New York. Then there's Nextel, which has never recovered from its ill-fated merger with Sprint and may soon disappear from the local scene if the new chief executive moves the corporate headquarters back to Sprint's home town of Overland Park, Kan.
Government contracting, of course, has been a key driver of economic growth here, and big defense companies Lockheed Martin, General Dynamics and Northrop Grumman are still riding high on the Bush military buildup. But among the midsize contractors, the outlook is more mixed: DynCorp's shares soared nearly 70 percent last year, while CACI's fell 21 percent.
Indeed, even Fuller acknowledges that federal procurement spending in the Washington region will barely keep up with inflation this year.
Meanwhile, every state and local government in the region has begun to confront budget shortfalls as property values drop and corporate profits shrink. What will inevitably follow will be higher taxes, shrunken payrolls and reduced spending, hardly the ingredients for economic growth.
There are, of course, many key sectors in the local economy that are privately owned and aren't reflected in the stock market averages.
In 2007, for example, law firms had their best year ever, thanks in large part to all the work generated by mergers and acquisitions, stock offerings and bond syndications. As the Washington partner of a big national firm put it to me, he could not recall another time when every specialty practice in every one of the firm's offices around the world had posted significant gains. Things were so good, in fact, that Williams & Connolly recently announced that it would raise pay for first-year associates to $180,000 from $160,000.
But does anyone honestly think this kind of explosive growth will continue? After all, the market for asset-backed securities has virtually melted down, deal flow has turned from a flood to a trickle and the window for stock offerings has been effectively closed. And with a presidential election coming up and power divided between a weak Democratic Congress and a weak Republican president, 2008 is likely to be a slow year for the lobbying and regulatory work that are the bread and butter of many Washington firms.
Which brings us, finally, to real estate -- commercial as well as residential -- which over the past several years has been a major source of jobs, wealth, profits, tax revenue and economic growth for the Washington region. We now know that this was a bubble, fueled by cheap and abundant credit. Now the bubble has burst, and the only question is how long it will take for supply and demand to come back into balance at a price people can afford.
In terms of commercial construction, there are 20.6 million square feet of office space under construction in the metropolitan area, according to Delta Associates, a local research firm. That's not only a record for this region, it's also more than any other region in the country can claim.
That wouldn't be a problem, of course, if there were tenants already lined up for those buildings at rents high enough to cover the land and construction costs. But that's not the case. According to Delta, the percentage of buildings pre-leased at the time of completion fell from 73 percent in 2004 to 36 percent in 2007. And Delta's Greg Leisch predicts that for 2008, the figure is likely to be around 30 percent.
What that means is that, at the current lease rate, it will take until the end of 2010 for the Washington economy to fill up all the office space that is under construction and not spoken for. And between now and then, there will be a steady decline in the jobs associated with this once-booming sector.
It would be lovely if housing construction could pick up just as office construction abates, as Fuller predicts. But don't count on it.
The latest data from Metrostudy, a housing research firm, show that there are 4,000 new single-family homes and 17,000 new condos and townhouses available in the Washington region, at a time when sales are running at the combined rate of about 1,500 per month. By my calculation, that means it will take at least a year to completely work off the inventory. More significantly, unless demand for new housing picks up, there will be no need for builders to increase production beyond current levels to satisfy future demand.
Builders seem to agree. The latest data on building permits issued in the Washington region -- a leading indicator of local construction -- shows a decline of 26 percent from a year ago. And Mark Zandi, chief economist with Moody's Economy.com, predicts that it will be at least 2010 before residential construction begins to contribute to the regional economic growth.
As I see it, it comes down to a simple observation:
If the majority of big companies in the region are expecting a decline in profits, if the flow of capital has slowed, and employment in nearly every key sector is likely to be either flat or declining, 2008 is shaping up as the worst year for the Washington economy since the downturn of the early '90s.
Steven Pearlstein can be reached firstname.lastname@example.org.