Economist Crossfire:
How Much Longer for the Slump?

By John Salustri

The old saying dictates that if you ask two people their opinions you'll get three answers. And nothing is more unclear than when this never-ending economic slump will end. But two economists stuck their necks out recently and offered their opinions on the state and future of the economic standstill. The venue for their opinions was RealShare Philadelphia, sponsored by Real Estate Media, the parent firm of GlobeSt.com in February. And while many of their comments were directed at the Philadelphia market, you can hear truths resonate throughout real estate regions nationwide. The Economist Crossfire, moderated by Media president and CEO Jonathan Schein, featured William C. Dunkelberg, professor of economics at Temple University, and Joel L. Naroff, Ph.D. & chief economist at Commerce Bancorp. Following is an edited transcript of that conversation.

(RealShare Philadelphia took place prior to the start of the Iraqi conflict.)


Dunkelberg, Schein and Naroff at RealShare Philadelphia

Schein: Give us your take on the state of the economy.

Dunkelberg: The best way to think about the economy is to remember your youth, the days of heavy partying and how you felt a day or two after. That's what's happened in this economy; there was a huge growth spurt from 1995 to 2000, led by heavy investment-spending. Suddenly, in mid 2000, we crashed, and now we're trying to recover from the hangover. The main problem is that there is too much stuff. There were a lot of good investments, but now we have too much office space, almost too many new houses, too much equipment. Until we use a lot of that up, economic growth will be slow. That thing we call CapX--capital expenditures--will lag and in the meantime we're happy to have consumer and government spending carrying the economy.

Schein: Joel, do you disagree?

Naroff: Yes, to some extent. Capital expenditures, which make up 6% to 7% of the economy, did hit a wall in mid 2000. But even if we had minimal capital investments, we'd still have decent growth between government and consumer spending. But there are other hurdles that have affected decision-making, not just "too many things." Beyond the aftermath of Sept. 11, we've had the accounting scandals and reports of mismanagement that led to a further deterioration of the equity markets, and now there are the uncertainties brought about by the Iraq war. We may have excess supplies, but each time we try to get over the hurdles, something else gets in the way.

Dunkelberg: Look at the stock market versus what's going on in the real economy--Main Street vs. Wall Street. We've lost some $7 trillion in market cap since the peak, but we made up a little more than $5 trillion in home appreciation for consumer portfolios. And of course consumers are much more confident about wealth accumulation through their homes than they are through Enron stock. So they're spending, and government spending has been increasing at almost double-digit rates. So while uncertainty over the war impacts the stock market and there is some leakage into the real economy, it doesn't seem to be that large.

Schein: But consumer confidence was reported by the Conference Board at a nine-year low. If so, what are the ramifications of a potential housing bubble?

Dunkelberg: We do see some decline, but you have to get perspective. The Michigan Index puts consumer confidence at around 80. But in the '90-'91 recession, it fell to 65. We're a long way off recessionary levels in terms of consumer sentiment.

Naroff: I agree. You have to watch what consumers do, not what they say. But is there a housing
bubble? We think of housing as one market, but it's not; there are thousands of housing markets.
You have to ask yourself, when mortgage rates move from 5% to 7%--and they will--how many people will pay the same price for a house that they would pay when that mortgage rate was 1.5% lower? Very few. Demand for those very expensive homes will have to fall. Will it happen everywhere? No. Will there be areas where there are significant declines? Absolutely.

Schein: Let's turn to the Bush stimulus package, which proposes the elimination of double taxation of dividends. How do you think that will impact equities and specifically REITs?

Dunkelberg: It's hard to say. It's obviously a good idea. In simple terms, if you own a share of stock and the company earns a dollar, that's your dollar and you've already paid tax on it, so it's unfortunate that you have to pay tax again. It's possible that there will be some change in preference in terms of the composition of asset portfolios. But many economists feel it's a good long-term change to make. At the same time, it won't have much short-run impact on stocks or valuations.

Naroff: Right. This is no short-term stimulus package. It's a long-term fundamental change in the nature of taxation. But when you're running huge budget deficits as we are now, the real question is: if you are going to add to the deficit, is this the best way to do it.

Schein: Speaking of deficits, Joel, some states and local municipalities are headed for real fiscal crises. How will that play out now and in a few years?

Naroff: So many towns are dependent on job and wage growth, and since the President didn't propose any assistance, you may see tremendous pressures that result in cuts in services or increases in taxes. Over the next year, the cuts that have to be made will be significant.

Dunkelberg: Ninety percent of state and local budget problems reside in about six states, and the rest are not really that bad off, but they all did the same thing that politicians tend to do. They saw revenue grow and made commitments to spending. And even though revenue died, the commitments didn't. Deficits appeared and now we have a scramble to balance the budget.

Naroff: Let's talk about the job market, which clearly affects occupancy rates. This area of the country has always been a slow-growth region. Engines of employment growth don't seem to exist. Even when the economy turns, and it will--barring any sort of dangers surrounding the war with Iraq--don't expect employment growth to surge. It will be a while before we get back to normal levels.

Dunkelberg: Suburban growth here is a lot better; there's a lot of business development in our suburban areas. So the issues today are the same we faced when I came here in '87. Is Philadelphia the Danish or the doughnut? How do we make the city of Philadelphia the nice creamy center of the region?

Schein: What's the best real estate sector to invest in? And what's the worst?

Dunkelberg: In the old days, with inflation, you could buy any piece of property and be assured that inflation would raise the price. But for 20 years we fought inflation, and we won, so you can't count on that anymore. You now have to be very careful about
where you go. In general, we clearly have too much commercial real estate from the hangover in
the '95-to-2000 boom when we built too much stuff. So not much is going to happen in the office sector. Residential real estate will continue to do well. Other than that, you really have to be very opportunistic.

Naroff: The theme over the next five or 10 years will be the idea that this metropolitan area has left a lot of older, small cities and towns behind as it decentralizes. This is a typical development process. Over the next decade, you'll see the infill process take over, whereby we revitalize the older communities that are closer in to the city itself. And the state will come out with incentives to do that. Clearly, the need is there.