Subprime’s Silver Lining

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Mortgage lenders in trouble. Inflated housing prices in decline with foreclosures on the rise. Capital for major deals drying up amid a broad credit squeeze and fears of a recession.


A description of summer 2007 in Los Angeles?


Try 1989, as the savings and loan debacle unfolded, and S & Ls; the major mortgage lenders of their day failed left and right after making scores of bad investments, led by Irvine-based Lincoln Savings and Loan.


It was the kind of doom-and-gloom economic news that, like today, generated worries about the region’s future, especially after sharp defense cuts caused the worst recession in 60 years.


But less than a decade later the economy roared back thanks to entrepreneurs and established business owners who seized on the growth industries of international trade, entertainment, professional services and anything Web related.


A lesson it doesn’t hurt to be reminded of.


“When there is an economic downturn, new growth sectors arise,” said Joseph Magaddino, professor and chair of the economics department at California State University Long Beach. “It’s often hard to see what those sectors will be in advance, but the region is fortunate because it has a fair amount of entrepreneurial spirit that helps when the economy is faced with difficulties.”


Even now, the stage is being set for the forces that will drive the next boom of the economic cycle. This special section of the Business Journal looks at some of these businesses and industries, how they’ve managed to dodge the bullets so far and how they are planning to seize opportunities to boost their own fortunes and drive future economic activity.


They range from entrepreneurs who buy foreclosed home properties at county courthouses, to credit unions that fund mortgages out of their own deposits, to vulture investors who see big profits from scooping up distressed debt many others avoid.


Also included are venture capitalists, who are experiencing less competition these days from private equity firms used to making leveraged deals on easy-money terms. And then there are traditional bankers who are finding that there conservative practices, such as only making mortgages to prime borrowers, are serving them well in turbulent times.


Cyclical recessions


Sometimes it’s easy to forget, but in the last 50 years, L.A. has gone through seven recessions some with barely a scratch and others, like the one in the early 1990s, nearly knocking the region’s economy out cold. Several were related to defense cutbacks, while others were driven or exacerbated by other factors, from the Arab oil embargo of the early 1970s to the rise in the prime interest rate to more than 20 percent in 1980.


However, in nearly every case, the Southern California economy adjusted eventually, with new growth engines revving up to take up the slack from the industries that sputtered. It has become almost a natural course of events. L.A. has had a long history of boom and bust cycles related to the defense industry.


Increases in defense spending had fueled a series of booms, starting with World War II, then the Vietnam era of the 1960s and again with the President Reagan’s build-up of the 1980s. Similarly, a defense drawdown in 1969-70 led to a recession that was felt particularly keenly in L.A. and a similar round of cuts contributed to a recession in 1980, when local unemployment peaked at 10 percent.


But today nothing is more seared into the consciousness of Angelenos than the defense cutbacks prompted by the end of the Cold War in the early 1990s. More than 50 percent of jobs in the sector permanently disappeared.


But even at the depths of that recession in 1992-93, the seeds were being sewn for the recovery. The rest of the nation’s growing appetite for cheap imported goods caused port traffic to grow by leaps and bounds, spurring the creation of thousands of warehousing and distribution jobs. Entertainment-related employment took off as L.A. became the center of a rapidly globalizing industry. And tens of thousands of newly unemployed aerospace workers latched on to new technologies to start new companies.


“L.A. became much more diversified, much better-positioned to withstand economic hits that might occur,” Magaddino said.


So, when the national recession that followed the dot-com bust arrived, L.A. took less of a hit than Silicon Valley, which became ground zero. That seems to give hope that L.A. is better positioned now to survive a housing and financial crisis than it was 18 years ago.


But each crisis is different. Some fear the housing and credit crisis this time around may be deeper and cause more damage to the local economy.


“We have a lot more financial instruments out there and have much larger players in the mortgage industry,” said Esmael Adibi, director of the Anderson Center for Economic Research at Chapman University. Also, the impact of the current mortgage crisis has gone global, with many of the repackaged loans being bought by banks and investors overseas.


Locally, Southern California was home to many of the mortgage lenders that have since gone bust or scaled back, from Countrywide Financial Corp., to Fremont General Corp. to Ameriquest Mortgage. Also, the region has more than its fair share of problem mortgages that could go into foreclosure.


“For years, everybody felt richer than they actually were and spent a lot more money than they should have,” said Christopher Thornberg, principal at L.A.-based Beacon Economics. “Now that wealth is going away and people are left with debt. Consumers will have to rebalance their accounts. That will have an impact.”


The key, most economists say, is whether the mortgage and housing crisis significantly impacts consumer spending, which drives two-thirds of all economic activity. Few mainstream economists are predicting a major economic disruption for Los Angeles on the scale of the early 1990s. But most also say more pain surely lies ahead.

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Howard Fine
Howard Fine is a 23-year veteran of the Los Angeles Business Journal. He covers stories pertaining to healthcare, biomedicine, energy, engineering, construction, and infrastructure. He has won several awards, including Best Body of Work for a single reporter from the Alliance of Area Business Publishers and Distinguished Journalist of the Year from the Society of Professional Journalists.

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