By: Dr. Lynn Reaser

On February 13, S&P completed its review of 16 European nations and announced several downgrades.  Does anyone care?

The answer is ‘yes.’  Although credit-rating agencies lost much credibility during the 2008 financial crisis, downgrades (or upgrades) can still impact markets and politics.

The S&P latest downgrades were not unexpected, but they validated Europe’s ongoing struggle to solve its debt problems.  Europe needs a fiscal pact to enforce budget discipline, a larger funding backstop to bolster credit markets, and polices that promote economic growth rather than just austerity.  A lower credit rating typically raises borrowing costs.  Forced selling by funds requiring certain ratings could add additional pressure on European banks, companies, and country borrowers.

Bond purchases by the European Central Bank (ECB) could cushion the impact on interest rates, as done in the U.S., but debt issues must ultimately be addressed.

The answer is generally no. Construction dollars are pledged for infrastructure and other long-term investments necessary to support both current and future students. Construction bonds submitted to the public for approval in fact specify allowable uses of the funds. Due to the lengthy 25-30 year bonds, the projects supported are long-term in nature. Funds for short-term spending, such as computers, would more appropriately come from operating budgets   Equipment necessary to infrastructure such as fiber optic cables, computer labs, or data processing centers could be an appropriate use of construction dollars.

When putting bond requests before the electorate, school districts need to carefully prioritize their needs. In this economy, tight budgets are going to be a persistent reality for quite some time. Ultimately, a more efficient use of resources will be necessary to address these budget constraints.

Q:  Will San Diego County median home prices rise in 2012? Where will the median stand by year’s end?

By: Dr. Lynn Reaser

 Yes.  Several forces should drive a modest price in home prices this year.  Job growth has picked up and the unemployment rate is slowly subsiding.  Mortgage rates should remain near historic lows.  Affordability has improved markedly thanks to the drop in both home prices and interest rates.  The rise in apartment rents has also made ownership a more attractive option.  The overhang of foreclosed homes, particularly in the inland areas, and high standards for loan qualification will still limit the overall rise to about 3%, taking the median price to $325,000 by year-end.

Although hopes were high that Europe would make progress at its summit last week, fears are again rising in financial markets that the plan to impose greater fiscal discipline on Eurozone members may not win approval and that the fund to provide financial assistance will be inadequate.

The solution to Europe’s problems demands two major actions:  (1) a fiscal “pact” imposing rules and discipline on member countries to keep their deficits in check and (2) a commitment by the European Central Bank (ECB) to stand as “lender of last resort” to purchase bonds of its members states in need.

Any fiscal pact must demand transparency in the reporting of economic and budget numbers.  The threat of real sanctions must also be credible.  The primary political objection will be the loss of sovereignty of individual countries as they surrender some control of their governments to a European entity.

The ECB has resisted to this point a policy that would require it to emulate the quantitative easing programs of the U.K. and U.S. (“QE2” most recently in the United States).  It has questioned its legal authority and is also concerned about the loss of its political independence.  The ECB needs to see clear signs of fiscal discipline before it would consider providing massive assistance on the monetary side.

Europe faces some extremely difficult decisions in the period ahead.  The outcome and market’s confidence in the negotiations and actions taken during coming days and weeks will be critical.  The world will be watching.

Much of the focus recently, and habitually, has centered on the risk globalization poses for the national and local economies.  Yet, exports are a key factor supporting companies, incomes, and jobs.

Here in San Diego, exports have soared during the past two years.  Shipments of goods produced in this region and sent to other countries will likely exceed $600 million in 2011.  Following last year’s 77% surge, San Diego’s exports have climbed another 48% so far this year.  Growth during the past two years has been about triple the rise seen nationally.

Exports generate many different types of jobs, including manufacturing, warehousing, distribution, financing, logistics, insurance, legal, and accounting.  A wide range of skills are involved, including low, medium, and high skilled professions.

Europe represents four of San Diego’s top ten export destinations (Switzerland, the United Kingdom, France, and Germany).  With Europe headed for recession in 2012, some slowing in our export potential is therefore likely for the year ahead, offset in part by significant further gains to emerging markets such as Malaysia and China.

Crazy talk, right? I was meeting with a Portuguese friend a few days ago, and this is what she asked me. Well, actually, it was more of a statement. This was the second time on this trip that I heard this phrase from two different people. I don’t think we have heard much along these lines back in the U.S., but then again prior to coming to Europe I had not heard serious conversation of the end of the Euro as common currency. That is now being openly discussed in many areas of public and ordinary life.

Most of you know I have been in Europe for November and for a few days into December. I have had the opportunity with a group of PLNU MBA’s and colleagues to visit Portugal, France and Germany, and discuss the current Euro zone (and world) crisis in great detail with both experts and ordinary people. The news here that we accumulated this past month has been far more sobering than I expected and understood from my perspective in San Diego.

Rather than attempt to provide you with some great economic and business details and projections (I think we all know someone who can do this far better than me!), I thought I would share some snippets of conversations which I have recorded below. These may give you some idea of what is happening here. I hope you enjoy them and find them interesting

“The contagion is here and spreading.” – OECD Chief Economist to the MBA group, 11/21/11

“I object to the German and French Dictatorship.” – Portuguese political leader, morning news, 11/29/11

“People here have long concluded that a single Euro for the Euro Zone cannot continue.” – Portuguese man, 11/7/11

“The Italians are being bailed out. What is next?” – Overheard from two elderly Portuguese women on a street corner, 11/28/11 (It is somewhate shocking to be seeing economics being talked about by elderly people normally thinking about the fresh fish at the market.)

“You Americans get what you pay for. You are an untaxed country.” – Economist from the University of Paris II, 11/21/11

“The primary reason the EU and the Euro was created was to stop wars in Europe. If we lose the Euro where do we go?” – Said by a Parisian economist to us, 11/21/11

“The Germans took nearly 100 years to repay their debts from WWI to the Allies. And then they corrupt us with easy money that they want repaid in three to five years. How is that fair?” – Said to me in private conversation by a Portuguese woman on 11/28/11.

“The future is the relationship between the United States, Germany and India. This is the only power that can stand against the Chinese.” – Said by a German University leader in Stuttgart to me, 11/8/11

“Brazil? Wait two more years until the World Cup and Olympics passes. Then you will see the bubble deflate there and wreak havoc on the high-flying Brazilians.” – Said to me by a Lanaguage Instructor, 11/29/11

“Yes, we have fine roads and bridges, but there are no businesses and commerce to support them. We are like a child given a pair of oversized basketball shoes to grow into but we have no ball to play with. ” – Lisbon CEO comment to me over lunch, 11/29/11

“The EU provided us much but the price we paid was abandoning our industries such as fishing, clothing and cork. Now what do we do?” – Said to me by a Portuguese man, 11/25/11.

“It is feeling very much like the 1930’s in Southern Europe. We see the rise of the German power in the North and it concerns us. The future is so unknown.” – Two Portuguese men, said to me on 11/5/11.

By: Dr. Lynn Reaser

Q: Are the early positive signs of increased holiday spending signs for an upswing in the economy for 2012?

 Yes.  Consumers do appear to be more willing to spend as many households have reduced their debt burdens and interest rates have dropped.  Still, many headwinds face the economy.  Europe’s sovereign debt problems persist and the region faces a recession or exceedingly slow growth next year.  The U.S. could see a significant drag if unemployment benefits and payroll tax cuts are not extended, while the long-term deficit issue has not yet been solved.  Businesses remain uncertain, which will likely keep a lid on job growth.  On balance, more U.S. consumer spending points to a better 2012 but growth is likely to be only moderate.

Q: Are San Diego consumers in a better buying mood this coming holiday season than they were in 2010?

                                                                                                                                                                A:  No.  While San Diego County has added 15,000 jobs so far this year, triple the gain for all of 2010, the jobless rate is still close to 10%.  Wages have not kept pace with prices as food and energy costs have jumped.  Home prices are somewhat lower than a year ago.  Stock prices remain volatile and have struggled to even match last year’s closing values.  Meanwhile, a major cloud of uncertainty looms regarding both the European debt situation and our own budget problems.  San Diego consumers will still spend for the holiday season but they will remain cautious as in 2010.

Q: Is a federal flat tax a good alternative to the current progressive income tax system?

A:  No.  Most Americans are not willing to accept a system where higher and lower income earners would pay the same rate.  They do support a major simplification of the current 3.4 million-word tax code.  Broadening the tax base by eliminating the labyrinth of deductions and exemptions could both reduce all tax rates and raise revenues.  The corporate tax rate should be reduced from the present 35%, which is the highest in the world.  The double taxation of capital gains and dividends (currently taxed as profits at the company level and as income when distributed to shareholders) should also be ended.

The Administration this week announced a new program aimed at assisting “underwater” homeowners (whose homes are worth less than their mortgages) to refinance.  It will be voluntary for lenders, mortgage insurers, and other industry participants to sign up.

Although operational details may not be released until November 15, lenders may find it worthwhile to refinance loans where loan-to-value ratios have climbed above 125%.  This could especially be true where borrowers might otherwise “strategically default” or abandon their houses even if they are able to make the required payments.  Lenders may target the provision of the new program waiving risked-based fees if the borrower shortens the term of his mortgage.  Hence, lenders could receive almost the same monthly payments although for a shorter time span.

About 900,000 borrowers have refinanced through the first refinancing program, called the Home Affordable Refinance Program (HARP).  Another 900,000 participants in this amended HARP would amount to only about one-thirtieth of the mortgages owned or guaranteed by Fannie Mae and Freddie Mac.  Moreover, the new program will do little to absorb the excess of foreclosed properties still weighing on the housing market.

In sum, this program might provide some assist to beleaguered homeowners but is hardly a panacea.