Slowdown in the valley: What's ahead?
BY DAVID A. SYLVESTER
Posted Sunday, Aug. 5, 2001
Mercury News
Silicon Valley, get ready for life in the slow lane.
After five years of turbocharged growth, the tech-dominated economy here is still plunging toward a bottom. When it starts to turn around, economic growth could well look positively ordinary over the next four years. Economists warn that the valley may show signs of lagging -- or performing only marginally better than -- the national economy: flat or declining real estate prices, slower personal income, higher unemployment and meager job growth.
The good news is that the tech bust isn't expected to be as bad as the long recession that hit Southern California after the defense industry shrank permanently in the early 1990s. Sooner or later, corporations and small businesses are going to need to replace their PCs, buy more powerful databases, update their servers hooked to the Internet. It just won't happen until after some wrenching adjustments for the tech producers.
``Northern California is in a big hurt right now,'' says Edward Leamer, professor of economics and director of the UCLA Anderson Forecast. ``But it will experience a bounce-back in the tech business.''
Among those in a big hurt are Michelle and Dennis Montgomery of Santa Clara. Their own personal bubble burst last year, and the consequences are spreading to those around them. Last year, Michelle's stock options, worth $1.5 million, suddenly plunged in value 98 percent. Not only had the Montgomerys increased their spending on big-ticket items, expecting the options to hold their value, but they also found they owed more than $150,000 in federal taxes for the phantom gain on the nearly worthless paper.
Other lives affected
Their own tech wreck is changing at least seven other lives.
The Montgomerys' niece won't be attending De Anza College this fall, because they can't help pay her bills.
Their son won't be buying a house this year, because the Montgomerys can't help with a down payment.
Their granddaughter in San Diego will see her grandparents less, because they can't afford the air fare to visit her.
A house cleaner, a hairdresser, a waiter and a restaurant owner at a favorite restaurant are all seeing the Montgomerys less.
Two people, however, have seen an economic boost from the Montgomerys. A real estate agent should earn a commission on selling a second home where they had hoped to retire, even though the price is dropping. And a tax attorney is helping them deal with their back taxes.
Now, they are scaling back wherever they can.
``I was just saying to my husband, where else can we cut?'' says Michelle, now worried about layoffs at her company. ``I think people are scared to spend money because they don't know if that's what they are going to have to live on if they are laid off.''
Aftershocks expected
Already the largest tech companies in Silicon Valley -- Hewlett-Packard, Cisco Systems, JDS Uniphase -- have cut somewhere in the neighborhood of 15,000 jobs locally, and more could come. Economy.com's forecast shows that Santa Clara County will feel the repercussions of the burst bubble until 2005:
Economic growth will come crashing back to earth. The county's total output of goods and services soared 32 percent last year -- and now is growing at a 3.5 percent annual rate. Next year, it will be worse, then grow barely faster than the U.S. economy through 2005.
The job boom is over. The prediction: virtually flat growth in jobs this year and next, then jobs will grow here at the same rate as everywhere else in the United States.
The unemployment miracle is over. After hitting a record low of 2 percent last year, it will now exceed the national average, peaking in 2005 at 5.9 percent.
The average worker isn't going to get rich working here. Personal income grew nearly 23 percent last year, and now will lag behind 4.7 percent annual growth of 1994. Annual incomes will grow faster elsewhere in the U.S. economy starting next year.
Steve Cochrane, regional economist at Economy.com in West Chester, Pa., expects the worst of the downturn to hit at the end of this year or early next year. ``We've got another six to nine months to go before we see a real sign of a turnaround,'' he says.
Such a long recovery puts Silicon Valley squarely within the pattern outlined by the dean of bubble economics, the late MIT Professor Charles Kindleberger, in his landmark book ``Manias, Panics and Crashes.'' He reviewed nearly 40 bubbles recorded over the past 400 years to show how they rise and fall in phases.
So far, the tech bubble is following the first phase closely. A bubble starts with a rush to new investments based on some economic change, in this case the Internet. The surge is financed by an expansion of the credit system, draws in speculators and the naive, then bursts when the new investments fail to deliver the expected profits.
A Ponzi scheme
In this way, the dot-com boom became ``the biggest Ponzi scheme in the postwar era,'' says Kenneth Rosen, professor of economics at UC-Berkeley and a former student of Kindleberger's. ``And we were in the center of it, right in Silicon Valley.''
The second phase of the classic bubble -- which may not happen in Silicon Valley -- hits the financial system. The decline in stock prices hurts real estate and reduces the value of collateral for bank loans. In response, the banking system tightens credit, and businesses are unable to expand or start failing.
``Financial innovation is often at the heart of bubbles,'' says Doug Wood, professor of banking and finance at the Manchester Business School in Manchester, England.
In Silicon Valley, a real estate decline in some form is widely expected over the coming months. Rosen estimates the county could lose 25,000 to 50,000 jobs, driving down the median price of a single-family home in Santa Clara County 5 to 15 percent by next year. Among the most expensive homes, the decline will be steeper, around 25 percent.
And a real estate decline could hurt the banking system.
``We haven't got there yet,'' says Jim Paulsen, chief investment officer at Wells Capital Management. ``If we do, you'll see the traditional signs of a bust. You'll find the banks have a lot of consumer-debt problems.''
It may not come to that. Rosen does not believe bank lending became excessive during the tech bubble. ``No one got carried away with this,'' he says. ``Everybody knew it was a bubble.''
That reduces the chances of too much debt, which can become an economic killer after a bubble pops. If there's anything favorable in the post-tech bubble era, it's that most of the bubble, outside of the bonds issued by telecom companies, was financed by stock, not debt.
``The other booms you think about -- the oil boom, the railroads of the 1880s, the real estate boom of the late 1980s -- those were all financed by debt,'' Paulsen says.
In Japan, a mountain of bank debt has dragged down the economy ever since its economic bubble popped in 1989. Since then, the country has faced a decadelong period of deflation, recession and sluggish growth.
A more recent example of a U.S. bubble was the irrational exuberance for oil in the late 1970s.
In 1973, the Organization for Petroleum Exporting Countries sharply raised oil prices, triggering a U.S. recession but sparking a boom in Texas oil fields. The entire state's fortunes soared. Developers rushed to build homes, apartments and office towers. Banks and savings institutions eagerly lent money to finance the growth. But the state fell into a deep recession when the boom turned to a bust.
No bank debt
During the bubble, energy stocks soared, increasing 83 percent in 1980, according to the calculations of Ken Fisher, chairman of Fisher Investments in Woodside. But since then, energy stocks underperformed the overall market for 20 years, he says. From a strict economic point of view, that could happen to tech stocks now, he says.
However, one thing in Silicon Valley's favor: The tech boom was not financed by bank debt, as the Texas oil boom was.
Yet, debt does haunt some people, including the Montgomerys. They borrowed against their home to pay for big purchases during the bubble: a rural home for retirement, a new car for her brother. They planned to pay off the loan with the stock options.
``The biggest thing about having the money was being able to be there for my family,'' Michelle says. ``I could have taken the stock and cashed it and put it in the bank. But that's not what you do when you get stock. We went to a professional and he said, `Don't panic. This is a long-term thing.' We did what we were told.''
The long term may look cloudy, but economists, including Federal Reserve Chairman Alan Greenspan, still believe technology holds the key to economic growth. And as long as companies here innovate, that will benefit Silicon Valley.
``It's going to be the center of the New Economy for the foreseeable future,'' says UCLA's Leamer.
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Contact David A. Sylvester at dsylvester@sjmercury.com |
