Inland Empire Outlook Fall 2013 Issue

INLAND Clouds on the Horizon EMPIRE W OUTLOOK

Photo Credit: Phil Roeder

e begin this issue of the Inland Empire Outlook by examining the looming crisis of unfunded pension liabilities (p. 2). Recent reports indicate that at least 34 states failed to contribute the necessary amounts to fund promised pensions in the past year. We examine the factors contributing to this situation and note that recent changes in accounting rules may add more cities and states to the list.

Economic and Political Analysis Volume IV | Issue 2 | Fall 2013

Pension Liabilities Loom Large pg. 2-7 Raising Minimum Wages Means More Teens Out of Work pg. 8-13 Stuck in Second Gear pg. 14-19 Colton Crossing: A Model for PublicPrivate Partnerships pg. 20-23

CLAREMONT MCKENNA COLLEGE Claremont, California INLANDEMPIRECENTER.COM

Governor Jerry Brown recently signed legislation that will raise the minimum wage in California to $9/hour in July 2014 and to $10/hour in January 2016. We survey the research on minimum wage increases, analyze data on the relationship between minimum wage increases and teenage unemployment, and conclude that the California increase is likely to result in higher teenage unemployment (p. 8).

Our analysis of the latest economic data shows a recovery that is limping along (p.

14). Although the U.S. unemployment rate dropped slightly from 7.4% to 7.3% in July 2013, it is not because people found jobs. The main reason the unemployment rate dropped is because people stopped looking for them. Locally, the Inland Empire housing market is also stuck in second gear, with total home sales virtually unchanged from 2011 to 2012.

Finally, we examine the successful use of a public-private partnership to build a railway overpass at Colton Crossing, relieving congestion at a busy rail intersection (p.

20).

On October 9, 2013, the Inland Empire Center, in partnership with the UCLA Anderson Forecast, will hold the eighth CMC-UCLA Inland Empire Forecast Conference at the Citizens Bank Arena in Ontario. Jerry Nickelsburg of UCLA Anderson Forecast will present the national and state national forecast, Professor Manfred Keil of CMC will present the Inland Empire forecast. The conference will also feature panels on Healthcare and the Affordable Care Act in the Inland Empire and Industry Reactions to the Forecast. Major sponsors of the conference include Citizens Business Bank, Oremor Automotive Group, the Lewis Group of Companies, the Redevelopment Agency for the County of Riverside, and the City of Ontario.

We at the CMC Inland Empire Center hope you find this edition of Inland Empire Outlook a useful guide. Please visit our website, www.inlandempirecenter.org, for updates to these stories and other Inland Empire news. -The Editors

Pension Liabilities Loom Large

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Photo Credit: FiddleFlix

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he declaration of bankruptcy by cities like Detroit and San Bernardino has brought renewed attention to the issue of unfunded pension liabilities and the role they play in the fate of local governments. CNBC reports that at least 34 states failed to contribute the necessary amounts to fulfill promised pensions in the past year. The New York Times reports that state and local government pensions are collectively underfunded by at least $1 trillion, likely more. The Times reports that Detroit has nearly $18 billion in liabilities and the state of Illinois has around $133 billion in net pension liabilities. Estimates indicate that Illinois’ net public-employee pension liabilities amount to 241 percent of the state’s annual revenue. In Connecticut it is 190 percent, 137 percent in New Jersey and 17 percent in New York. The growing wave of unfunded pension liabilities must be addressed. There are a number of potential solutions, but first, it is important to examine the initial causes and effects of this crisis.

A pension liability consists of the financial liability incurred through the promise of future pension payments. Specifically, it is the difference between the amount of money due via pensions and the amount of cash the government entity has on hand. Pension liabilities are often labeled as ‘unfunded,’ meaning that the financial resources necessary to fund pension obligations are not sufficient. This usually happens for one or two reasons: either the entity which promised the pension is not able to set aside the necessary funds in the first place or it has diverted funds previously allocated to fund pension liabilities to fulfill another short-term purpose. The problem with the former is apparent, while the

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problem with the latter is that an entity that today takes a loan from its pension fund, is not likely to be able to repay, plus interest, years down the road when it needs to write pension checks to retiring employees.

The financial crisis and economic downturn in 2008 amplified the adverse effects on the amount of unfunded pension liabilities in municipalities across the country. Many entities, both public and private, invest pension funds in the hope of gaining large returns or, at a minimum, interest. Much like private investments, pension funds suffered significant losses in the financial crisis of 2008. This meant that even municipalities, which had until then adequate financial resources to fulfill promised pensions, were suddenly left short of necessary funds. Although certainly not the only cause, the economic downturn was one key factor in brewing the perfect storm.

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AT LEAST 34 STATES FAILED TO CONTRIBUTE THE NECESSARY AMOUNTS TO FULFILL PROMISED PENSIONS IN THE PAST YEAR.

In addition to the extraordinary circumstance of the largest financial downturn since the Great Depression, other, more controllable circumstances also played an essential role in leveraging governments across the country. First, public employees were promised very large pensions that required very little personal contribution.

According to the New York Times, there are 20,000 public employees in California who receive annual pensions greater than $100,000. Similarly, Chicago pays $1 billion per year solely to retired teachers, and New York City’s pension costs grew from $1.8 billion to $8 billion in a little over a decade. Public officials simply failed to consider the long-term ramifications of offering such large, one-sided pension programs.

Second, a number of government entities spent funds designated for pensions payments on other projects or risky investments with the promise of replacing the spent funds at a later date with new revenue or returns from their investments. Most often, the funds were not replenished, leaving less money to pay out costly pension benefits. For example, The Dallas Morning News reported that the Dallas police-fire pension fund has over $400 million tied up in luxury real estate, from vineyards in Napa to 42-story skyscrapers in Downtown Dallas.

Cities and states across the country are now left speeding down a path toward bankruptcy. There are, however, some potential solutions, including increases in taxes and transition to defined contribution plans. Almost all of these are more difficult than bankruptcy, which so far seems to be the best bad option for municipalities dealing with a collection of budgetary woes. A number of notable cities like San Bernardino and Detroit have already filed for bankruptcy protection under Chapter 9, while even more are likely to follow suit.

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Detroit is the most recent and, perhaps, most well-known case of municipal bankruptcy. At between $18 and $20 billion, its July 2013 filing for bankruptcy is by far the largest municipal bankruptcy filing in history. The first signs of Detroit’s fate appeared in 2012 when the state of Michigan was granted greater financial oversight of municipal finances, including the opportunity to appoint a committee to review the city’s finances. Governor Rick Snyder appointed Kevyn Orr as the emergency financial manager of Detroit in March 2013, but it was by then too late. The inevitability of Detroit’s bankruptcy had been solidified over the course of many years. The city has long felt the drastic effects of this unfortunate situation. The Wall Street Journal cites a decrease in population by more than 50% from its peak of 2 million, a tripling of unemployment since 2000, a 100% increase in homicide rate, and average police response times of 58 minutes. Furthermore, only 8.7% of police cases are solved.

Recent changes from the Government Accounting Standards Board may result in an even more troubled picture for cities and states. The new accounting rules will require better disclosure on pension costs and also require governments to use more realistic, lower expected rates of returns on their pension assets.

Similarly, Moody’s Investor Services recently announced that it is considering increasing the role that pensions play in the calculation of credit ratings for municipalities. A heavier weight on pensions and related Funded Ratio for Aggregate Pension Data By State

Source: The State of State Pension Plans, Morningstar, Inc., November, 2012 4 | INLAND EMPIRE OUTLOOK

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debt would adversely impact the ratings of hundreds of cities. It may lead to more pessimistic forecasts as Moody’s reminds pension and debt holders that they have, “enforceable claims on the resources of local governments.” Moody’s has already placed 30 California cities on review for possible ratings downgrades. The cities on the Moody’s list are Azusa, Berkeley, Colma, Downey, Danville, Santa Monica, Sacramento, Fresno, Glendale, Huntington Beach, Inglewood, Long Beach, Los Gatos, Martinez, Monterey, Oakland, Oceanside, Palmdale, Petaluma, Rancho Mirage, Redondo Beach, San Leandro, Santa Ana, Santa Barbara, Santa Clara, Santa Maria, Santa Rosa, Sunnyvale, Torrance, and Woodland.

The city of San Bernardino declared bankruptcy in the summer of 2012. Officials claimed they no longer had the funds necessary for daily city operations, noting that outstanding pension obligations were a primary cause. Most recent reports cite a $46 million deficit in the city. The U.S. Bankruptcy Court for the Central District of California ruled on August 28, 2013 that San Bernardino is eligible for bankruptcy protection. The California Public Employees’ Retirement System, or Calpers, is the city’s biggest creditor. Calpers staunchly opposed the bankruptcy ruling, arguing that it should not be treated like other creditors and instead should be paid in full. Calpers further argues that this ruling sets a bad precedent for municipalities across the country. The fund is contemplating options for appeal.

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MOODY’S INVESTOR SERVICES HAS PLACED 30 CALIFORNIA CITIES ON REVIEW FOR POSSIBLE RATINGS DOWNGRADES.

Riverside County, on the other hand, has a relatively positive position in terms of pension liabilities. Prior to 2012, Riverside was heading down a similar path, but recent reforms to percentage contributions by employees resulted in roughly $100 million per year in savings. Riverside County CEO, Jay Orr, confirmed a total liability of approximately $5 billion, roughly $1 billion of which is unfunded.

This means about 80% of pension liabilities in Riverside County are covered. And, although $1 billion is still a large sum of money, in comparison to local governments across the country, Riverside County’s pension system is considered “well-funded.”

When asked how the county was able to accomplish such reforms, CEO Jay Orr remarked, “It was [a] painful [process]…we have six unions whose contracts were staggered, we were not able to reach agreements with them, so we had to impose on all of them.” He explained that these external pressures, including among others pressure from elected officials, made the negotiations particularly difficult. “We ended up having to give [affected] employees an 8% pay raise [to account for the increase in employee pension contributions].” Although the 8% pay raise cost the county more money up front, the long-term savings will amount to about $100 million per year.

“In the beginning it cost us a lot of money, but in the long term it will pay off…we were able to keep most people employed, I have about the same number of people now as I did back then, roughly 18,000 [employees],” said Orr.

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On the local level, a number of activists and unions are challenging the legality of bankruptcy, and instead, suggesting alternatives. For instance, in Cincinnati, an organization called Cincinnati for Pension Reform is working to place an initiative on the 2013 ballot, which would transition to a defined contribution pension system. Such a system places responsibility for retirement funding on employees rather than employers.

In response, labor unions continue to fight back against such attempts at change. They want to ensure access to promised benefits and ensure the accessibility of such benefits for future employees as well. In the case of Cincinnati, the Ohio Civil Service Employees Association is encouraging public workers not to settle for any sacrifice of employee benefits. Such campaigns leave reforms unlikely to pass via ballot initiative, unless a sudden shift in public opinion occurs.

The United States federal government engaged in a similar transition in the 1980’s in an attempt to make pension liabilities more manageable. At the onset of the 1980’s defined benefit pension plans were most popular amongst federal employees. Since then, defined contribution plans have become an integral part of the Federal Employees Retirement System. The transition occurred in 1986 due to rising costs associated with defined benefit plans and a growing number of government employees who had been granted access to such pension programs. The plan now consists of three parts: a defined benefit plan known as the FERS annuity, mandatory Social Security participation, and a defined contribution plan known as the Thrift Savings Plan.

There are, however, other potential solutions to the municipal pension crisis, namely a number of combinations of tax increases across the board and changes in the nature of current and/or future pension plans.

The first broad alternative is to increase taxes. There are three different potential tiers for increased taxation. The first involves maintenance of the status quo from the standpoint of pension benefits and an increase in household taxes sufficient to cover those costs. Such an option, however, seems unattractive due to the fact that, according to a study done by Robert Novy-Marx of the University of Rochester and Joshua Rauh of Stanford University, it would require an increase in taxation across the board of $1,385 per household per year to pay for the massive amounts of both state and municipal government pension liabilities.

Another slightly more attractive option has municipalities engage in a “soft freeze,” meaning that newly hired employees are enrolled in a defined contribution (as opposed to a defined benefit) system. In a defined contribution retirement plan, employees, not employers, pay into retirement funds. Even with such changes, the same study indicates that an increase in taxation by $1,210 per household per year is necessary.

Finally, the least conservative option from the standpoint of both municipalities and their employees, is a “hard freeze” combined with an increase in taxation across the board. A “hard

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freeze” would entail the halting of employer benefit contributions for all employees, regardless of tenure, in addition to the enrollment of newly hired employees in a defined contribution system. Novy-Marx and Rauh indicate that such measures would still require annual tax increases of $700-$800, per household. Although effective, such plans face an uphill battle given the political cost from public employees and taxpayers. This leaves municipal governments with just one more option: the status quo (and likely bankruptcy), bringing us back to square one.

Bankruptcy offers local governments a process – albeit lengthy and complicated – to deal with creditors and discharge financial obligations. It offers little solace, however, to the public employee who will likely lose some or all of her promised pension or to the taxpayer who will pay for the government’s mistakes over the course of many decades.

Photo Credit: James Walker

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Page 8 Raising Minimum Wage Means More Teens Out of Work

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he minimum wage in California will increase to $9/hour in July 2014, before rising further to $10/hour in January 2016. Until Governor Jerry Brown signed this legislation on September 25, 2013, a minimum wage increase was not on most people’s radar. State minimum wages prevail if they are above the national wage. California is currently one of 19 states that have the state minimum wage set above the federal level. The current California minimum wage is $8.00/hour, $0.75 above the national minimum wage, making it the eighth-highest state minimum wage in the country.

The expected minimum wage increases would put California at the top (assuming no other states make similar changes). The original version of the legislation, AB10, introduced by Assemblyman Luis Alejo (D-Watsonville) and initially passed by the California Assembly on May 30 of this year, only called for an increase to $9.25 by January 1, 2016. The final, more sweeping version was approved by a two-thirds majority in both the State Senate and Assembly on September 12. Is this cause for celebration for the working class, or should they be more concerned about their incomes and employment in the future?

Evidence suggests that the increase should be cause for concern.

Nobel Prize winning economist Milton Friedman once remarked: “There is nothing that does so much harm as good intentions.� Obviously, neither California politicians nor supporters of minimum wage increases in general, intend to hurt the poor. The general motivation behind the increase is that minimum wages have remained constant in California for the last five years while price inflation has simultaneously slowly eroded purchasing power. Additionally, supporters of the minimum wage increase assume that

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there will be negligible employment losses, if any at all. Assemblyman Alejo has also repeatedly stressed that teenagers are not the only ones who receive minimum wages -- 60% of recipients are at least 26 years old. This means that the minimum wage affects not only teenagers, but also many ordinary working class adults, many of whom are supporting dependents. Altogether, 2.4 million work in minimum wage jobs in California. Minimum wage increases are widely popular if not “a moral imperative” (Senator Bill Monning, D-Carmel). So what is the downside?

Minimum wage empirical research hardly ever finds unemployment effects in older age groups.

For teenagers in the labor force, however, there does tend to be a significant and measurable aggregate unemployment rate increase as a result of an increase in the minimum wage. Until the early ‘90s, the consensus view held by economists was that a 10% minimum wage increase would lead to declines in teenage employment of between 1% and 2%. This is the benign but misguided effect of the desire to help the poor. It is misguided because those who have jobs and remain employed are made better-off at the expense of those losing jobs. The most affected group is teenagers, with a quarter earning minimum wages only, and most of their jobs are in the leisure and hospitality industry, more specifically in fast food outlets.

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RAISING THE

MINIMUM WAGE BY 25% DURING THE NOT-SO-GREAT RECOVERY MEANS MORE TEENS WILL BE OUT OF WORK.

The consensus view was eroded by the so-called New Minimum Wage Research literature starting in the early ‘90s.

Looking at fast food restaurants and event studies, such as a minimum wage increase in one state without a coinciding minimum wage increase in an adjacent state, these researchers found no negative employment effects. One of the principle authors was Alan Krueger, who was the Chief Economist at the U.S. Department of Labor under President Clinton and the former Chairman of President Obama’s Council of Economic Advisers. This research won the hearts and minds of politicians, and federal minimum wages were increased in late 1996, albeit remaining constant for the next 10 years until 2006.

Furthermore, given that many of the minimum wage jobs involve repetitive tasks, both for teens and others, we expect to see labor saving technology taking away these positions over time.

Considering the recent trends in automation and the coinciding productivity increases, there is particular concern since the proposed hike would reduce teenage employment by 2.5% to 5%.

California teenagers have already experienced extremely high unemployment rates. For 2012, the teenage unemployment rate in California stood at 34.6%, the highest state unemployment rate in the nation. Although data for teenage unemployment rates at the MSA level are not available, it is likely that the Inland Empire values are even higher, just as the overall unemployment rate is currently higher in the Inland Empire (10.4%) than statewide (8.9%; both figures are seasonally

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adjusted). Moreover, the Inland Empire has experienced severe job losses in manufacturing and construction during the Great Recession. These jobs have not yet returned; it is the leisure and hospitality sector that has seen increases in employment since the end of the recession. Further employment losses would be disastrous in terms of depreciating human capital, especially for teenagers. Most would agree that teenagers should not sit around idly; instead they should develop work skills. There is much empirical evidence that spells of unemployment increase the probability of subsequent unemployment episodes.

During the last full year of the pre-Great Recession economic expansion, there was considerable pressure to increase federal minimum wages. This included a letter signed by over 650 economists, five Economic Nobel Laureates, and six past Presidents of the American Economic Association, all supporting a “modest� increase in the federal minimum wage. The timing of the 2007-2009 federal minimum wage increase of 41% could not have been worse: it coincided with the onset of the Great Recession. Subsequently teenage unemployment rate levels reached post-WWII record highs and teenage employment to population ratios reached record lows (see Figure 1).

Figure 1. Employment-Population Ratio and Unemployment Rate, 16-19 year olds, United States, 1948-2013.

Unemployment Rate

25.0

50.0

45.0

20.0 40.0 15.0 35.0 10.0

5.0

0.0

Employment-Population Ratio

30.0

30.0

25.0

Source: Bureau of Labor Statistics

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Difference between Teenage and Total Unemployment Rate

Figure 2: Effect of 2007-2009 Minimum Wage Increases on Teenage Unemployment Rates Relative to Overall Unemployment Rates, 1948:1 – 2013:2.

17

15

13

11

9

7

5

3 3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5

U.S. Unemployment Rate

1948-2007

2007-2013

Source: Bureau of Labor Statistics

Clearly minimum wages cannot be blamed for most of the increase in teenage unemployment or decrease in the teenage employment-population ratio. However, we can analyze to what extent the minimum wage increase caused teenage unemployment rate increases above and beyond what we would have expected from the cyclical downturn. Figure 2 attempts to do so by plotting the difference between the teenage unemployment rate against the overall U.S. unemployment rate.

The blue crosses indicate all observations prior to the 2007-2009 minimum wage increases and the fitted line gives us a benchmark of how much higher we would expect the teenage unemployment rate to be due to the downturn. The red dots represent the observations for the 2007-2009 minimum wage increase period: note that all post July 2007 observations lie above the line, meaning that the difference between teenage unemployment rates and the U.S. aggregate unemployment rate was higher than expected. While not a formal test for the effect of minimum wage increases generating higher unemployment rates for teenagers, it is strongly suggestive. In August 2012, for example, we find that the U.S. teenage unemployment rate was 5.5 percentage points higher than what we would have expected from historical trends.

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The other fact that stands out regarding the proposed minimum wage rate hike is its timing.

Previously, in California and elsewhere, minimum wage increases typically where voted on by the legislature when the economy was expanding strongly. Yet today, even without considering a growing population, California and Inland Empire employment levels have still not reached their pre-recession levels. In 2006, the previous minimum wage increases in California were voted on, and California and the Inland Empire were in the final stages of a strong economic expansion: California’s GDP grew by 6.5% in 2004, and 5.8% in 2005 (note that the 2006 numbers were not available by the time the decision to raise the minimum wage was made). For the Inland Empire, the respective numbers were 4.6% (2004) and 4.2% (2005). The end of the boom was also not in sight, although warning flags should have gone up by early 2006 when employment in the construction industry in the Inland Empire had peaked. Housing prices continued to rise, at least in the coastal regions, and there was a general sentiment that all members of society should be participating in the increased wealth creation. Contrast this to the most recent economic data for California and the Inland Empire: California’s GDP expanded at a rate of 0.3% (2010), 1.2% (2011), and 3.5% (2012).

The corresponding numbers for the Inland Empire are 2.0%, 0.2%, and 1.7%. There are serious questions about the wisdom of increasing minimum wages at this point of the business cycle. Businesses will be increasingly hesitant to hire more expensive workers in times of uncertainty like these.

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THERE ARE SERIOUS QUESTIONS ABOUT THE WISDOM OF INCREASING MINIMUM WAGES AT THIS POINT OF THE BUSINESS CYCLE.

It is possible that much of the motivation for increasing the California minimum wage came from President Obama’s State of the Union speech, where he suggested an increase in the federal minimum wage from $7.25 to $9.00. Not many had expected the president to contemplate such an increase in the current economic climate. What was even more surprising was his justification, namely that such an increase “would mean customers with more money in their pockets.” This relies on the flawed assumption that these customers would keep their jobs despite wage increases. In what followed, Senator Harkin (D-IA) and Representative Miller (D-CA) introduced Bill H.R. 1010 which would have increased the Federal Minimum Wage to $10.10 by 2016 and then tie it to the Consumer Price Index thereafter. Such a 39% hike would have been even bigger than the current California minimum wage increase. The bill was defeated in the House on March 15, 2013. Those who are concerned about negative employment effects of minimum wage increases had hoped for the same to happen in California. If the motivation is compassion for low income earners, then there are other, more efficient, tools to help the poor such as Earned Income Tax Credits (EITC).Minimum wage increases, however, are politically more popular with the electorate.

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We forecast that the minimum wage increase will lead to employment decreases for teenagers in the Inland Empire and in California. The timing of this increase -- during the current phase of the business cycle where employment growth has been uncharacteristically slow when compared to previous recoveries – is particularly damaging. Even if the pace of job creation picks up, employment for teenagers will not recover quickly as a result of the hikes. Labor saving technologies will threaten many of the jobs that teenagers currently occupy, further depressing teenage employment.

Photo Credit: NAS Oceana

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Stuck in Second Gear

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Photo Credit: Jay Crihfield Photography

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ive years after the housing-market collapse, the U.S. economy is on the mend but still remains far from normal by historical standards. Financial companies have been recovering slowly. After the crisis, many of them became more conservative in terms of borrowing and lending. Housing prices are rising, but millions of homes still remain underwater. The unemployment rate has fallen steadily, in part because millions of Americans have given up looking for work. Economists and analysts are not sure how long it will take before the U.S. economy will be able stand on its own without a multi-billion dollar injection from the Federal Reserve. But for now, to prevent financial disruptions, the Fed will continue pumping a full $85 billion a month into bond markets perhaps until its next meeting in late October.

According to the National Bureau of Economic Research, the U.S. economy experienced 10 recessions between 1946 and 2011. The severity of a recession is generally determined by its length and by the magnitude of the decline in economic activity. The 10 previous post-WWII recessions ranged in length from 6 to 16 months, averaging about 10.5 months. The most recent 2007-2009 recession, which began in December 2007 and ended in June 2009, was the longest recession in the postwar period, and lasted 18 months. Figure 1 shows changes in U.S. output for the 1981, 2001 and 2007 recessions, provided by the Federal Reserve Bank of Minneapolis. The decline in real GDP, from the peak in December 2007 to the trough in the second quarter of 2009, was $553 billion, or 4.1 percent. That was the largest relative decline in real GDP from peak to trough in any of the nation’s previous 10 postwar recessions.

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Figure 1. Change in U.S. Output during Past Recessions

Source: Federal Reserve Bank of Minneapolis

The steep decline in output led to a sharp decrease in employment that almost doubled the official unemployment rate during the two-year period. In December 2007, the U.S. unemployment rate was for 4.8 percent, in June 2009 it was 9.5 percent, reaching a peak of 10.0 percent in October 2009, according to the Bureau of Labor Statistics.

The U.S. unemployment rate slightly dropped to 7.3 percent this August from 7.4 percent in July 2013. It is possible that the Obama’s economic stimulus package helped to some extent to revitalize the economy and create new jobs. However, the main reason the unemployment rate went down was not because people found jobs, but because they stopped looking for them. For instance, in August alone 312,000 people dropped out of the labor force. Each month, the Hamilton Project estimates the number of jobs that the economy needs to create to return to its pre-recession employment level. For example, if the economy adds 208,000 jobs each month, then it will take until August 2018 to close a the job gap. According to the Bureau of Labor Statistics, in August the economy added 169,000 new jobs. That number is almost nothing compared to what the economy needs. With the average of 169,000 new jobs per month, it will take at least seven more years, until August 2020, to reach the pre-recession employment level.

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Nationwide, the housing market continues to recover. Mortgage lending reached its highest level in five years, according to the Federal Reserve’s data. The number of borrowers has significantly increased due to historically low interest rates and new refinancing options, which allowed eligible borrowers to refinance their homes at today’s low rates. The 2012 Home Mortgage Disclosure Act data showed that the total number of originated loans of all types (such as conventional, Federal Housing Administration, or Veterans Administration) and all purposes (such as home purchase, home improvement, or refinancing) increased by about 2.7 million mortgages, or 38.0 percent, from 2011. Nearly 6.6 million loans were issued to refinance existing mortgages, which accounted for nearly 54.0 percent increase from 2011. Home purchase lending also increased by about 13.0 percent. Already, banks have been competing to make loans to the most responsible and trustworthy customers. According to Inside Mortgage Finance, during the second quarter of 2013 banks made nearly $59 billion in jumbo mortgages with loan limits ranged from $625,500 and higher, which was a 20.0 percent increase from the previous year.

Since the housing market collapse, housing prices have rebounded nationwide partly due to low interest rates and strong competition for houses. According to the real estate firm DataQuick, the median home prices have been steadily increasing over the last year, including in California’s Inland Empire, “a region of desert scrub an hour east from Los Angeles.” In the second quarter of 2013 the median home price in the Inland Empire stood at nearly $238,000, a 10.2 percent Figure 2. Median Home Price in the Inland Empire

Source: DataQuick

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increase from last quarter and a 28.6 percent increase from a year earlier (See Figure 2).

It might seem as if things are looking brighter these days, but a full housing recovery requires not only a rebound in prices, but also an increase in new home contruction. Despite the fact that median home prices in the Inland Empire increased by 28.6 percent over the last year, construction activity is still not back to normal. Yes, it is true that earlier this month KB Home launched four new developments in Chino, Ontario, Temecula and Perris, but, nevertheless, rising labor costs, high prices on materials and land, a short supply of ready-to-build lots make other new-home developers more cautious about taking on new projects.

Overall, home-sales volume is not nearly where it was in 2005. As shown in Figure 4, sales of new homes in the Inland Empire still remain low. In 2012, there were only 5,090 new units sold, compared to 39,663 new home sales in 2005. Among them, 3,660 new homes were sold in Riverside County and 1,430 in San Bernardino County. Sales of previously owned homes in the Inland Empire continue to rise but at a slower rate as buyers adjust to higher rates and prices. In 2012, there were 64,801 properties sold, compared to 64,784 in 2011. In Riverside County sales of existing homes rose from 37,209 to 37,396 homes since 2011, while in San Bernardino County they dropped from 27,575 to 27,405 homes over the last year.

Figure 3. Home Sales (All) in the Inland Empire and Counties

Source: DataQuick

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Because quarter-to-quarter comparisons without seasonal variances might distort the overall picture, we analyze seasonally adjusted home sales data for the Inland Empire. As shown in Figure 4, home sales between 2011 and 2012 look similar. New home sales fell by a seasonally adjusted annual rate of 0.39 percent from the beginning of the year due to high mortgage rates and unaffordability of desired properties, which forced buyers to step back. In contrast, sales of previously occupied homes rose at a seasonally adjusted annual rate of 0.66 percent from the first quarter of 2013. An increase in sales of previously owned homes in the second quarter of 2013 are likely to be a result of buyers rushing to lock in deals before mortgage rates started to increase. “This is partly due to the rise in interest rates, which again hurries some of the people into making the decision,” said Lawrence Yun, chief economist for the Realtors’ group, to the Wall Street Journal.

Figure 4. Home Sales in the Inland Empire

Source: DataQuick

Distressed sales —comprised of short sales and REOs— as a percentage of total existing sales for the second quarter of 2013 dropped to 32.0 percent, compared to 40.0 percent in the first quarter (See Figure 5). As the economy continues to improve, the number of borrowers behind on mortgage payments has fallen.

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Figure 5. Distressed Sales as a % of Existing Home Sales in the Inland Empire

Source: DataQuick

The housing market continues to recover, but slowly. Recently tightening inventory, rising mortgage interest rates, and restrictive mortgage lending requirements, slowed the pace of economic improvement. An increase in housing prices affected home affordability and held back some otherwise qualified buyers from making a purchase. “Here we are in the middle of the year, but, the economy has shifted down to second gear,� said Robert Kleinhenz, chief economist at Los Angeles County Economic Development Corporation.

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Colton Crossing: A Model for Public-Private Partnerships

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No More delays at the new Colton Crossing Overpass Photo Credit: Gary Friedman

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irst built in 1883, Colton Crossing historically is known as the site of one of the most heated railway construction conflicts of the 19th century, resulting in a personal confrontation between then California Governor Robert Waterman and the famed lawman Virgil Earp, an event that was later dubbed as “The Battle of the Crossing.” Located in the city of Colton in San Bernardino County, Colton Crossing is recognized in modern times as one of the busiest railway junctions in the United States, controlling most of the rail traffic into and out of Southern California. Used by BNSF Railway (BNSF) and Union Pacific Railroad, as well as for commuter services by Metrolink and Amtrak, Colton Crossing serviced more than 110 trains daily in 2008. However, the crossing’s facilities were not built to handle that volume of traffic. As one of the main shipment corridors for the regional transportation of goods from the Ports of Los Angeles and Long Beach, the Colton Crossing was responsible for cargo from the largest combined harbor in the United States. The volume of cargo anticipated to move through the Ports of Los Angeles and Long Beach is expected to double by 2020, drawing serious concerns about Colton Crossing’s load capacity. Due to heavy usage, trains were already forced to idle at the point where the existing lines cross, causing severe delays—at times up to four hours. Such delays also impacted the efficiency and reliability of passenger train operations, and affected local communities due to the blockage of local arterials, noise, and air quality emissions associated with idling trains.

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BNSF and Union Pacific selected the Alameda Corridor Transportation Authority to evaluate the cost, design, and construction of a new east-west or north-south structure to alleviate rail congestion and resolve affiliated issues with the Colton Crossing. The final study was then delivered to the San Bernardino Associated Governments (SANBAG) on December 15, 2006 on behalf of the railroads. By 2008, SANBAG formalized its position as the neutral party in discussions between the private railroads, the City of Colton and Caltrans on the financing and design of the new Colton Crossing construction. Parties from the public and private sector were involved from the beginning as a Project Development Team was formed under the direction of SANBAG’s Director of Project Delivery, Garry Cohoe. As various proposals were evaluated, an outside firm, HDR Engineering, was hired by the team to lead the environmental studies and assess six proposed solutions. Cost estimates for the six proposals ranged from $200 million to $2 billion, allowing for some to be eliminated based on cost alone. Ultimately, HDR and the Project Development Team determined that the most practical and cost effective solution was to bring the Union Pacific tracks that run east to west up over the north-south BNSF lines. The 1.4 mile concrete flyover was estimated to cost $202 million and to take up to three years to complete. Construction began in November 8, 2011 and the original projected completion date was in early 2014.

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BOTH THE RAILROADS AND SANBAG WORKED TOGETHER TO ADDRESS SOME OF THE CONCERNS FROM THE LOCAL COMMUNITY.

Though the Union Pacific flyover proposal was one of the more economical of the proposed designs, procuring all the necessary funding for the project was still a major challenge. The project received funding from federal grants, taxpayer-approved state funding, and private financing from BNSF and Union Pacific. More specifically, in 2010, the Colton Crossing Project received $34 million from a Federal Tiger Grant through the American Recovery and Reinvestment Act federal stimulus fund. With cooperation from Caltrans, the project was also eligible to receive $41 million from State Proposition 1B funds from the Transportation Corridor Improvement Fund after the necessary environmental documentation was completed within the year. The railroads contributed the remaining $18 million in construction costs.

Both the railroads and SANBAG worked together to address some of the concerns from the local community. In particular, Colton residents were concerned with noise pollution from trains, as well as air quality and safety. Though outside the scope of the Colton Crossing Project, the three entities jointly funded the creation of two “Quiet Zones” during the flyover’s construction, which eliminated nighttime train soundings (except in the event of emergencies). Furthermore, SANBAG and Union Pacific collaborated to finance a rerouting of the 9th Street rail tracks, which previously ran through a residential neighborhood in South Colton.

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With shared resources from all parties, the Colton Crossing Project is a model for the efficiency and success of infrastructure projects using the public-private partnership structure. The fundamental collaborating principle behind a public-private partnership is not new. A publicprivate partnership is a contractual agreement between a public agency (federal, state or local) and a private sector entity. Through this agreement, the skills and assets of each sector (public and private) are shared to deliver a service or facility for public use or public improvement.

According to the National Council for Public-Private Partnerships, they have been in use in the United States for over 200 years and thousands are operating today. These partnerships take a variety of forms and are used for a wide range of services including water/wastewater delivery, transportation, urban development, and delivery of social services. The council estimates that the average American city works with private partners to perform 23 out of 65 basic municipal services.

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THE NATIONAL COUNCIL FOR PUBLICPRIVATE PARTNERSHIPS ESTIMATES THAT THE AVERAGE AMERICAN CITY WORKS WITH PRIVATE PARTNERS TO PERFORM 23 OUT OF 65 BASIC MUNICIPAL SERVICES.

Though the public-private partnership model is not a panacea, in cases such as the Colton Crossing Project, it proved to be an ideal solution to what otherwise may be a daunting task. Open communication from the railroads, government entities, and the local community from the beginning was an essential factor in its success and is a critical aspect when evaluating any effective, sustainable partnership model. Given this early collaboration, the Colton Crossing Project is a prime example of the benefits of a well-structured public-private partnership. By establishing a consensus goal and consistently receiving input to reach that goal from members of all invested parties, the public and private sectors were able not only to address their own concerns, but also those of the local community. The Colton Crossing Project was completed on August 16, 2013, eight months ahead of schedule and at a cost of $93 million, more than $100 million under budget.

Caltrans’ cooperation in granting some excess freeway right-of-way allowed for a design that greatly reduced both construction time as well as the overall cost of the project. Furthermore, collaboration from Caltrans and the railroads allowed for applications for both federal grant funding and state funding to run smoothly. Caltrans Director Malcolm Dougherty projects that the new construction will produce “travel time savings valued at $241 million and reduce greenhouse gas emissions by 31,000 tons annually.”

In a time when California is still plagued by the impacts of the 2008 recession and severe budget cuts, public-private partnerships represent a feasible and sustainable model of financing critical

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infrastructure. The Colton Crossing Project represents a gold standard for such cooperation and members from both the private and public sector attribute the project’s success to its collaborative component. With the release of the American Society of Civil Engineers’ most recent infrastructure grade report, it’s anticipated that the U.S. will need an investment of $3.6 trillion by 2020 in order to meet the nation’s current infrastructure needs. Publicprivate partnerships represent a sustainable and effective method of financing these essential projects.

Photo Credit: CHJ Consultants

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Editorial Board Andrew Busch Director, Rose Institute Marc D. Weidenmier Director, Lowe Institute David Huntoon Manfred Keil Kenneth P. Miller Bipasa Nadon

INLAND EMPIRE OUTLOOK

Yelena Tuzova

Student Editor Kathryn Yao

Staff Nicole Appleton Hye Won Chung Ryan Driscoll Jessica Jin Richard Mancuso Tenzin Tseky Mengyue Wang

INLANDEMPIREOUTLOOK.COM INLANDEMPIRECENTER.COM

The Inland Empire Outlook is a publication of the Inland Empire Center at Claremont McKenna College.

The Inland Empire Center The Inland Empire Center for Economics and Public Policy is based at Claremont McKenna College. It was founded as a joint venture between the Rose Institute of State and Local Government and the Lowe Institute of Political Economy to provide business and government leaders with timely and sophisticated analysis of political and economic developments in the Inland Empire.

The IEC brings together experts from both founding institutes. Marc Weidenmier, Ph.D., director of the Lowe Institute, is a Research Associate of the National Bureau of Economic Research and a member of the Editorial Board of the Journal of Economic History. Andrew Busch, Ph.D., director of the Rose Institute, has authored or co-authored eleven books on American politics and currently teaches courses on American government and politics. Manfred Keil, Ph.D., an expert in comparative economics, has extensive knowledge of economic conditions in the Inland Empire.

Kenneth P. Miller, J.D., Ph.D., is an expert in California politics and policy who studies political developments in the Inland Empire. Bipasa Nadon, J.D., has worked in municipal government and specializes in local government policy. David Huntoon, MBA, specializes in economic development, survey research, and tribal governments issues.

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