Correction to This Article
This column incorrectly said that Washington Mutual had its headquarters in Southern California. Although the thrift had a significant presence in California, it was based in Seattle.
California's Wipeout Economy

By Steven Pearlstein
Wednesday, March 25, 2009

LOS ANGELES The sun is shining less brightly these days in sunny Southern California.

The recession hit here earlier and harder than the rest of the country -- the statewide unemployment rate topped 10 percent last month -- and chances are it will linger here longer.

The severe downturn reflects the region's central role in the Bubble Economy.

As the headquarters for Countrywide Financial, Washington Mutual, New Century Financial and IndyMac, along with several of the nation's largest home builders, Southern California is ground zero for the mortgage crisis and the residential real estate bust.

As the capital of conspicuous consumption, its heavy reliance on auto sales, fashion, electronics and entertainment is now out of sync with the country's new frugality.

And as the gateway through which a majority of the country's imports flowed from Asia to American homes and businesses, its ports, warehouses and distribution channels, which once strained to keep up with the volume, now find themselves with large amounts of unused capacity.

More significantly, the receding economic tide has revealed serious structural problems and challenges in key sectors. The music, entertainment and electronic gaming industries are being turned upside down by the Internet. The real estate industry is bumping up against the limits of population growth and exurban sprawl. And state and local governments that have long financed themselves by pushing costs off into the future have finally met their day of reckoning.

"People here used to feel that because of the weather and the lifestyle, we were immune," said Robbin Itkin, a lawyer with a suddenly booming corporate workout and bankruptcy practice at the Los Angeles office of Steptoe & Johnson. "They don't think that now. There is a somberness I've not seen before."

Indeed, the most recent poll by the Field Research found that only about 40 percent of Southern California residents view the state as one of the best places to live. Back in the Beach Boy days, it was more than 70 percent.

I got the most vivid picture of how dramatically things have slowed at the Port of Los Angeles. Two years ago, ships lined up out to the horizon waiting to unload containers; unionized longshoreman routinely worked double shifts; and on any day there was usually work for a thousand or more nonunionized "casual" workers. But on a recent morning, the cranes on many terminals were idle, few if any casual workers were needed, and the few ships moving through the port's channel looked to be only partially loaded.

The ports of Los Angeles and Long Beach are, far and away, the biggest economic drivers in Southern California, directly employing 280,000 workers, indirectly supporting nearly 900,000 jobs in the region and handling $350 billion in goods. But last month volume at the bigger Los Angeles port was off by nearly a third, and executive director Geraldine Knatz said she and her crew were scrambling to preserve their market share. Already the port has cut fees by 10 percent on "intermodal" cargo bound for points north and east and is considering a reduction of 50 percent on new business.

It's not just the economic slowdown Knatz worries about, but also the longer-term prospect of losing business to other western ports with lower labor and environmental costs, or East Coast ports that will become her competition once the Panama Canal is widened to accommodate the biggest cargo ships.

"We're going to come back to a new normal," she predicts, with annual growth rates of less than half the average 7 percent rate of the previous decade, and a fraction of the torrid 14 percent rate in 2006.

The port's fortunes are reflected elsewhere in the region's sizable manufacturing sector -- in particular the toy, electronics and clothing companies that have long since moved the bulk of their production to Asia but retain much of their design, marketing and distribution functions in Southern California.

Last fall, Lonnie Kane had to lay off several hundred workers at the women's clothing company he and his wife have operated for decades. They import fabric from Europe and Asia, use high-tech equipment to cut the patterns and then ship the pieces out to local shops staffed by low-wage immigrant workers for the final sewing.

The small department stores that once formed the base of Kane's business are now gone, his small-store customers cannot get credit and the big department stores that buy his blouses and sweaters are constantly on the phone delaying or canceling their orders. His sales are off by more than 25 percent.

As Kane sees it, Southern California is no longer the "middle-class paradise" it fancies itself, with steady growth of good-paying manufacturing jobs. Like the rest of the country, the region is now uncomfortably divided between the haves and have-nots. Although some of that was inevitable, he also blames state and local governments whose attitude toward business has always been that if firms failed or left the area, there would always be plenty of others to take their place.

"People think that when this is all over, it will go back to the way it always was, " Kane says. "That's a fantasy."

It is hard to overstate how reliant the Southern California economy has always been on population growth to drive its economic growth -- in oversimplified terms, building houses for the next wave of home builders. In the beginning, the early developers could be pretty confident that if they built it, they would come -- from the Northeast and Midwest, and then from all corners of the globe. But in recent years, this perpetual growth machine has pretty much run out of steam as residents old and new confronted the realities of two-hour commutes, bad air, a shortage of water and a backlash against illegal immigration.

Moreover, without the steady growth in tax revenue that came with population growth, the Ponzi scheme that passes for public finance in California was suddenly and painfully revealed. Much of the blame lies with public employee unions and a handful of other special-interest groups that have essentially hijacked political control of state and local governments. Now, despite decades of high taxes and rapid growth, state and local governments find that they not only don't have the revenue to provide even basic services, but are saddled with hundreds of billions of dollars in unfunded pension liabilities and infrastructure needs.

"L.A. is becoming a Third World city," says Rick Caruso, a successful developer who has considered running for mayor.

Although Caruso's upscale new development, the Grove, has been a smashing success, he's putting most of his new projects on hold, figuring that for the moment, there's more money to be made with lower risk by buying up financially distressed properties at deeply discounted prices. There should soon be plenty for him to choose from. The shakeout in commercial real estate, which is now in full swing in suburban Orange and Riverside counties, has made its way to the tonier areas of the city. There are numerous "For Rent" signs on Melrose Avenue in West Hollywood and along Montana Avenue in Santa Monica. Lack of financing has stalled the $3 billion, Frank Gehry-designed hotel and residential project on Grand Avenue downtown and a $400 million luxury condo tower in Century City.

"It's clear to me that we will have a lot of reinventing to do here over the next few years," Jim Thomas, a prominent local developer, told me.

What's less clear is whether Southern California is ready to embrace that challenge.

Next time: Hollywood and the entertainment industry.

Steven Pearlstein will host a Web chat at 11 a.m. today at http://www.washingtonpost.com, where he is also the moderator of a new Web site, On Leadership. He can be reached at pearlsteins@washpost.com

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