Listen Minnesota Slowdown: Where it all began
Listen Ryan Jones, director of the Twin Cities division of Metrostudy, recalls the conflicting signs facing home builders in early 2006 as unsold homes started to pile up.
Here's why we're doing this. All the economic indicators are blinking red.
Gas costs $4 a gallon, food prices have been up 5 percent over last year, and U.S. payrolls have shed more than 400,000 jobs. As early as January, Minnesota's state economist had seen enough to say the state was already in recession.
It's tough times for a lot of people. And a big question is: How and where did it all start?
ROAD TRIP TO FIND THE ANSWERS
To find out, we're going to do a lot of traveling around the state, throughout the metro area and suburbs. You don't even have to pay for gas, or eat bad road trip food. In fact, our first stop is going to be at a Japanese restaurant.
We're meeting with Steve Hine, the labor market information director of Minnesota's Department of Employment and Economic Development. He works just up the street from this St. Paul sushi joint so we're catching him over his lunch hour.
Hine is going to give us some tips for where to look for the first signs of the current slowdown.
He says in other slowdowns, the state held up much better than the rest of the country. But in the last recession, Minnesota's economy fared no better than the national average, and from there things just got worse.
"In 2001, we were in lock step with the nation. And now we've slowed down earlier, and more substantially so far, than the nation has," Hine said.
Hine says the bursting of the dot-com bubble triggered the last recession. This time, he says, it was the collapse of housing and a drop-off in new home construction that dragged both the Minnesota and the U.S. economies down.
This is at first a bit perplexing, given the housing industry's relatively small size. If you look at Minnesota's three million workers, only 0.5 percent to 0.75 percent typically ply their trade in the homebuilding industry. And residential construction only accounts for a sliver of the U.S. economy.
But a lot of other industries hinge on housing, like wood products manufacturing and mortgage brokering. So when housing stumbles, they get scraped, too. Or worse.
Just look at the crisis of confidence that hit the mortgage giants Fannie Mae and Freddie Mac, and forced a government rescue.
THE BOOM BEFORE THE BUST
In order to nail down when and where the trouble really did start showing up, we actually have to go back several years to housing's boom times, when builders and others were laying the foundation for the downturn.
For that, we're heading for the Twin Cities suburbs -- and 2003.
We're tagging along with builder Todd Bjerstedt as he tools around in the city of Woodbury -- it's an area where his home building company did a lot of business.
Bjerstedt is a stocky guy with a beard and glasses. He drives a white Chevy pickup and keeps it tidy. There's a Bible in a nook near the radio. He says he considers it a kind of owner's manual that he consults when questions in life arise, and Bjerstedt has had to deal with some tough questions.
Bjerstedt pulls up to a cheery, multi-colored house nestled across the street from a pond. As the wind whips around us, he says this house is to him a symbol of the best times in his industry -- he finished it five years ago in 2003.
"It was at the years when construction activity was literally peaking, right at that point in time," Bjerstedt said.
Bjerstedt is a great person to turn to for insight about housing's hey-day because of the two hats he wears.
One is the hat of a guy who worked as a builder for 21 years -- call it a hard hat. But he's also an expert on the industry. He's been tracking housing trends with a company called MarketGraphics.
So with his expert hat on, Bjerstedt says at the start of the decade, before the boom, builders were framing up an average of 12,000-13,000 new houses per year.
"And it just kind of snowballed in the years of 2003 and 2004, building in excess of 23,000 homes per year," Bjerstedt said. "So we had in those two years alone, almost a 10,000 (homes) per year jump in new construction."
The new homes were selling for several reasons. The state's population was growing, interest rates were dropping to historic lows, and speculators were hungry for investment properties.
Those were good days to be a builder. Bjerstedt says he didn't go on a spending spree, but he did pay down some debt and was enjoying financial stability.
That was also true for a logger in the northern part of the state.
SCARY GOOD TIMES
Meet Wayne Skoe, the owner of Skoe Lumber and Timber, which consists of a retail operation and a wholesale logging company.
We're in Northome, about 45 miles northeast of Bemidji. This is logging country, where signs advertising log homes dot the highways.
Wayne Skoe's livelihood is closely linked to the housing industry. His lumberyard supplies builders, and the timber from his logging operation feeds area mills, which use the wood to make building products. So when home building soared, so did his business.
"It was just an absolutely crazy time," Skoe said.
It was crazy for a lot of reasons. For one thing, there was a lot of pressure from mill operators. They worried that with new home construction on a tear, they might not get timber fast enough from loggers like Wayne Skoe.
With rising demand, the price of Skoe's timber shot up, but so did his own costs. Landowners were eager to cash in on the housing boom. And they started charging him more for the rights to cut down standing timber -- known in the industry as stumpage -- that he'd then sell off.
"There became a point where the price of stumpage went from $40 a cord to $100 a cord in the course of a few months," Skoe said.
Skoe paid those high prices for stumpage, knowing he'd be in trouble if the boom ended and prices for the timber he cut fell back to normal.
Skoe felt anxious about the housing boom, and he wasn't the only one.
"HERE, HIT ME"
Diana Carter found the good times in her industry profitable but nerve-wracking as well. Doubts kept nagging at her.
"This is artificial, this is not real. Is there going to be a bubble? What's going to happen?"
Carter founded her company, WinStar Mortgage Partners, seven years ago, after years in the mortgage business. We're catching up with her in Plymouth, where the company was headquartered.
Carter's a muscular little bullet of a woman, who speaks so fast it sometimes seems like she's saying two sentences at once.
"We didn't ever do any subprime at WinStar," she said.
While Carter did not offer high-risk subprime loans, she did sell a kind of mortgage that's a step between subprime and more traditional loans. The in-between mortgages are called "Alt-A loans."
She got pressure to offer those loans from the national mortgage lender Countrywide, which was a key partner for WinStar.
Countrywide would buy some of WinStar's loans, bundle them with other loans into bonds, and sell the bonds to investors.
Those investors were hungry for new, potentially lucrative places to put their money. So they were asking mortgage lenders to keep sending bundles of mortgage debt their way -- even risky mortgage debt.
Countrywide obliged, and pushed Carter to get on board with those risky Alt-A loans.
"Some of their top executives were saying, 'You need to look at expanding your product mix if you're going to increase your profit margins. This is a really important part of the business. You have to look at doing this,'" Carter said. "And I'm thinking, 'I don't think so. No, I don't think so.'"
Carter hesitated. The homebuyers applying for Alt-A loans might have had good credit scores, but they didn't have to show much proof they could repay their loans.
But Carter says she eventually felt like she had to do Alt-A loans to compete in the marketplace. So she started to offer them and did well initially. It was a move she would later regret.
"We basically put a target on our chest and said, 'Here, hit me,'" Carter said.
Diana Carter and the other people tied to housing did well during the boom times of 2003 and 2004, but their queasiness about how long the good times would last was well-founded.
We're getting to the point on our journey where some of the cracks in the economy started to emerge. Hang on tight because the ground gives way pretty fast.
We're now looking at what was happening in the spring of 2005.
To jog your memory, the movie Mr. and Mrs. Smith -- starring Brad Pitt and Angelina Jolie -- was coming out. Gas was about $2 a gallon, unemployment in Minnesota was in the low 4 percent range. Pope John Paul II passed away that April.
And at about the same time as all those other events, Twin Cities home builder Todd Bjerstedt was finding himself in a bind.
We're back with Bjerstedt in his white Chevy pickup. He's pulling up in front of a model home in Woodbury that functioned as his company's main office at the time.
"I was in that model here on your right when I first started to hear about the incentives being tossed around in the marketplace," Bjerstedt said.
The incentives he mentions were a sign the market for new homes was starting to collapse. Other builders were offering all sorts of extras like free granite counter tops and no closing costs -- which essentially amounted to price-cutting on homes that weren't selling.
"It's, I suppose, sort of like retail. You have your shelves stocked with goods, and a certain amount of time goes by. What do you do? You have a sale, you get rid of stuff," Bjerstedt said. "That's very uncommon in this market, but it happened, starting in 2005."
But Bjerstedt couldn't afford to cut his prices to match other builders. He fell behind the competition.
"My sales went from roughly 20 homes a year to one or two a year, almost overnight," he said.
At the time, Bjerstedt was totally baffled. Builders were still pulling plenty of permits to start new homes. The housing market looked really robust.
"Somebody called a timeout, and I wasn't ready," Bjerstedt said.
Keep in mind: This is spring of 2005 -- way earlier than when most people usually associate with the housing downturn.
Another builder, Hans Hagen, also saw trouble, just a few months after Todd Bjerstedt did. Let's head to where he saw the cracks appearing.
"We're going to Blaine, a development called The Lakes," Hagen said. "It's a large development, probably the largest in the state of Minnesota."
Hagen is a trim, sandy-haired man with a grandfatherly manner. He's run his building company for some 40 years.
He was working at the Lakes three years ago when he noticed the market was shifting.
"In August of 2005 we saw the first change in probably the preceding four years. And that was a slowdown in new orders," Hagen said.
Hagen typically builds a house only if it's pre-sold. He seldom takes the approach of, "if you build it, they will come." So when his orders started to drag, he built fewer houses.
But other builders appeared to keep building -- they were banking on a steady stream of buyers. But the stream started to dry out, and the inventory of available homes started to rise.
Hagen has a straightforward explanation for what was going on.
"The supply and demand got out of whack," he said.
State economist Tom Stinson makes the same call.
"It is a supply and demand story," Stinson said.
You could chalk it up to a few things. One of the most important, Stinson notes, is that demand went down as interest rates went up.
"At higher interest rates, fewer people could afford to buy that house. You could draw fewer people into the housing market at that time," Stinson said.
Higher interest rates made home buying costlier, and home prices kept climbing as well. They didn't peak out until 2006. In the meantime, household incomes weren't growing enough to offset the rising cost of a home.
That spelled job cuts.
Job growth in residential construction went negative in Minnesota in mid-2005. That's about a year and half earlier than the national average.
Why Minnesota's housing industry dropped before the nation's still has economists scratching their heads.
But people working in industries tied to homebuilding felt the effects of Minnesota's housing downturn pretty quickly. And that takes us back up to northern Minnesota.
If you ask logger Wayne Skoe when his business suffered from the housing downturn, he turns to his employee, Mel.
"Hey Mel, it was in October or November, what year was it? When did the price of wood tumble like that?"
They decide it was fall of 2005, about when the mills that rely on Skoe's wood saw the prices for their products start to slide.
That brings us to a mill in Bemidji, where raw timber bumps along a clanking conveyor belt. The logs are headed to a toothy steel jaw, chewing fast. It chops the wood into strips.
Eventually, the wood strips are layered and glued together in sheets. The end product, oriented strand board, commonly winds up in roofs and floors.
This mill is owned by the Canadian company Ainsworth. At one point, Ainsworth employed about 500 people at its three plants in Minnesota.
The company's oriented strand board started to drop in price in late 2005. The next August, Wendy and Chas Boyer came home to a voice mail from the Bemidji plant where they both worked.
Wendy Boyer is a slender woman with shoulder-length blond hair, and blue eyes that look out anxiously as she recalls what happened that day.
"It was our day off, we were out running errands. And we came home and there was a message on the machine that said there was going to be a meeting at the high school the next day. Don't worry about coming in to work the next night," Wendy Boyer recalled.
Boyer says they were both puzzled, but they headed over to the high school auditorium the next day. They were among the last people to enter the room.
Wendy Boyer says she noticed there were police present. And then an Ainsworth official addressed them.
"'Those of you whose names are called, stay here,'" Boyer recalled. "Those whose names aren't called, proceed to the Hampton Inn and you'll get your new work assignment.'"
Boyer says the people whose names were called were losing their jobs.
"My name was called."
After more than two decades at the mill, Wendy Boyer was out of a job that paid about $22 an hour. Her husband, however, got to keep his job, and had to leave her there in the school.
"He just gave me a kiss," Boyer said.
Ainsworth closed one of its two production lines in Bemidji, and laid off 110 people that day in August 2006. The company eventually chopped another 300 jobs by idling its mills in Grand Rapids and Cook.
By that point in time, the signs of the housing market's weakness abounded. Employment in the residential construction industry had dropped by nearly 10 percent -- approximately 2,000 jobs -- since its peak two years earlier, and the wood products manufacturing industry had dropped by about 5.5 percent since its peak a year earlier.
THE MORTGAGE BUSINESS
The slowdown that started early in 2005 in the important housing industry spread to Minnesota's wood products industry. Eventually, the downturn took hold at Diana Carter's mortgage business.
The boom in home building got lots of fuel from easy credit, including subprime and Alt-A loans. But many of those loans went to people who couldn't afford to pay them.
By 2006, the subprime market was faltering under a crush of loan defaults and foreclosures. But the Alt-A market, a step between subprime and traditional loans, didn't look so bad yet.
So Diana Carter, who sold Alt-A loans at her mortgage lending company WinStar, was upbeat about her business.
"Even in December of 2006, I was working with my staff to invest in growth, to add more sales people to really increase what we were doing," she said.
Despite that optimism in 2006, Carter says things started to unravel in early 2007.
Investors who had been hungry for mortgage debt were getting skittish. Given the rash of defaults among subprime borrowers, investors feared that even less risky loans would go bad and that they'd lose all their money tied up in mortgages.
By the spring of 2007, the investment banks -- which had acted as intermediaries between investors and lenders like WinStar -- wanted out. They were catching grief from investors about selling bonds that held bad mortgages. And when the investment banks pulled back, Diana Carter had a big problem.
"There may have been 15 places I could sell the loan on January 1. At the end of March, there was either zero places to sell them or one place to sell them," Carter said. "It seemed like Lehman Brothers was one of the last holdouts to buy these loans."
The withdrawal of the investment banks suddenly made a few things clear to Carter. Her company had loosened its lending standards more than she said she was aware of. She had stepped away from the business for a while to do some philanthropy. And she said, during her absence, the company's lower lending standards had facilitated fraud.
It turned out that some of the buyers had lied when saying they'd occupy their new home. Some had bought multiple properties in a week, with the intention of flipping them.
When those loans were dispersed among multiple investment banks, no one noticed the fraud. Then, when they all showed up at WinStar's last holdout, Lehman Brothers, that bank also balked at buying the loans.
One day in March 2007, one of Carter's managers came into her office. Carter recalls him telling her, "We have $4 million of unsalable mortgages."
In the past, Carter said, if she couldn't sell a loan to one of the usual buyers, WinStar would just turn to what's called a "scratch and dent" company, which would buy the loan at a discount. WinStar would take a haircut of maybe 1 percent or 2 percent. It wasn't a big deal.
But now, the manager told Carter, the scratch and dent dealers were charging about 10 percent to buy WinStar's bundle of loans.
"And I said, 'Do you understand 10 percent of $4 million, that's $400,000.' He said, 'Yeah, that's a lot of money,'" Carter recalled.
But the unsalable loans kept piling up. They went from "$8 million, to $10 million, to $14 million to $20 million of loans that we could not sell," Carter said.
Today, Carter only sees her WinStar office from the outside looking in. All the walls have been torn down, and the desks are long gone.
Carter closed WinStar a year ago, after a wave of default and foreclosure notices swamped the business. WinStar wasn't alone.
FORECLOSURES CLOSE IN
By 2007, lenders nationwide had accumulated hundreds of thousands of foreclosed properties on their books -- with about 38,000 of them in Minnesota, according to a report prepared by HousingLink in Minneapolis. Sometimes lenders unloaded the homes at auctions.
At a recent foreclosure auction in north Minneapolis, bidders could snap up neighborhood properties for prices as low as $30,000.
It turns out that in Minneapolis at least, more than half of those foreclosed properties belonged to investors -- maybe to a landlord who rented out apartments.
When those landlords went into foreclosure, some renters got dumped on the street.
We're headed next to a homeless shelter for families called People Serving People in downtown Minneapolis.
At the end of last summer, this shelter saw a big spike in new clients. Eventually, the shelter's workers figured out that a surge in foreclosures against real estate speculators was forcing renters out on the street.
"The landlord didn't tell me the house was under foreclosure," said Yvette Blanton.
She's sitting at a table in the shelter's cafeteria, her hair pulled back in braids, her hazel eyes unblinking.
She had been renting a home in north Minneapolis and lived there with her kids. When she eventually found out her landlord was being foreclosed upon, she thought she had some time to move.
"But the water and the lights got shut off, so I had to hurry up and move, and I didn't have money to get a truck to move stuff. So everything is gone," Blantin said. "I'll get it again, it was just stuff. As long as I'm with my kids, and we got somewhere to have a roof over our heads, in the shelter if it has to be, I don't mind."
In a lot of ways, foreclosures have come to symbolize some of the worst turmoil of the housing industry. But State economist Tom Stinson says foreclosures alone don't have the power to pull the economy down.
Even when you combine them with all the job losses in home construction and the rest of the housing woes, Stinson says it's still not enough to cause a recession.
He argues that the economy could've sustained all those shocks, if it weren't for fuel prices skyrocketing, and another, even more serious issue.
"The housing problems eventually triggered the credit shock, which is really the biggest part of what's going on here," Stinson said.
The housing problems spread to the credit industry through risky mortgages like subprime and Alt-A loans.
University of Minnesota finance professor Andy Winton has this analogy.
"Think of loans as being like homes. The question of where you build the home and how you build the home has a big effect on whether it will catch fire later on," said Winton. "Think of subprime loans as being homes that were built out in the middle of the woods, in an area that often has forest fires, and were built of somewhat more flammable materials than usual."
"People said, 'Fire isn't an issue because we've had a bunch of rainy years, and drought and forest fires aren't an issue.' Then a drought came along and those assumptions seemed to not work as well," Winton continued.
Then, Winton says, as those homes started to catch fire, they spread to other developments.
"And as the fire spreads, the risk of fire in other areas becomes greater," said Winton. "We even have a risk of fire in areas that are normally thought of as safe, because they're next to a subdivision that was in a more risky area. And that subdivision goes up in flames, and the fire starts spreading to safer homes."
Last July, one of the big investment houses on Wall Street got scorched. Two Bear Stearns hedge funds laden with subprime mortgages had pretty much lost their value.
By then, Wall Street was already fretting about the safety of mortgage debt. The Bear Stearns event stoked those worries all the more, and prompted abrupt changes at our next stop, a commercial mortgage office in Bloomington.
"The first week of August last year, suddenly the phone started ringing," recalled Ed Padilla, the CEO of Northmarq Capital Partners.
The firm helps arrange financing for commercial real estate deals in 29 cities. Padilla says the lenders who supplied him with funding got spooked after the Bear Stearns implosion.
"Everyone was calling and saying they're canceling their applications, they are changing their commitment terms, increasing rates, lowering loan amounts," Padilla said.
"It was one of the days where the phone was ringing; it was just one call after another. And there was not any question that something was going on in the marketplace, very dramatic, and happening very rapidly," he continued.
Padilla was shocked when companies like Lehman Brothers and JPMorgan Chase, which had been reliable sources of capital, suddenly got gun-shy, just as they had with Diana Carter's residential mortgage business.
The thing that really flummoxed Padilla was that commercial real estate didn't have the kind of high default rates of 5 percent and 10 percent that the residential side was racking up.
Those numbers might seem small, but before the housing bubble burst, default rates mostly hovered below 1 percent. So far, commercial default rates have only hit about 1 percent, says economist Mark Zandi at Moody's Economy.com. But Zandi does expect the commercial default rates to rise.
Despite that beating, it's clear Padilla hasn't lost his sense of humor about it. He laughs when asked what he told his wife that week.
"I think it was something along the line of, 'The party's over. It's time to change our perspective,'" Padilla remembered.
The difficulties in the credit markets mean his customers -- manufacturers, retailers, and other kinds of businesses -- are having trouble expanding. They might also be holding off on expansion plans because the economy is slowing and they have fewer customers.
But even if they want to expand their facilities, the capital isn't readily available. State economist Tom Stinson says tight credit is playing a big role in the downturn.
"The most recent GDP numbers show that business investment fell from the fourth quarter to the first quarter. So it is having an impact," Stinson said.
This all hurts the economy because when business growth slows, so does job growth, and the nation's overall output dwindles.
Ed Padilla says the glimmer of hope in the situation now is that the sources of funding haven't run dry altogether. There's still foreign money to tap. Padilla thinks in a year from now, the markets will clear.
AFTER THE TROUBLE
In the housing industry, some have a similar level of optimism. Builder Hans Hagen started seeing more customers this spring.
But builder Todd Bjerstedt doesn't have such positive news to report about his business, which remains shuttered since it closed in 2006. Bjerstedt's trying not to beat himself up over his losses.
"It's a very humbling, if not humiliating, experience," he said. "But in the end, it is what it is."
But Bjerstedt is also starting a new chapter. He recently landed a job as a project manager at a remodeling company. That's a career switch a lot of builders have made, while people improve their current houses instead of buying new homes.
Diana Carter, the former CEO of WinStar mortgage company, has also moved on, which means back to her old job. She returned to the mortgage company she used to run with her husband, and she says they're doing well, in part because of their strong staff.
"They've been good gatekeepers. They've helped to make sure that we've done good loans, that we've not allowed loans to get through where there was fraud, or more likely to be problems," Carter said.
In Bemidji, Wendy Boyer, who was laid off from the Ainsworth oriented strand board mill, is studying to become an administrative assistant. She thumbs through a book on her kitchen table.
"It's how to run a project ... and how to keep costs in control and scheduling," she said.
Boyer's husband Chas is still working at the Ainsworth plant in Bemidji. The company will keep the mill open for now, but it's unclear what lies ahead.
According to a forest industries trade group, Ainsworth buys about 15 percent of Minnesota's timber. So more hard times at Ainsworth's mill could spell equally bad times for loggers like Wayne Skoe.
Back in Northome, Skoe is pulling into the maintenance yard where he stores the heavy equipment he used for logging.
Skoe is trying to sell his equipment, and will leave the logging business altogether if he can unload all his assets without taking a huge financial hit. He lost money on the business last year. The whole thing makes him pretty sad.
"It used to be, there was nothing more fun than going out in the morning at zero or 10 below, and get stuff running, and just have everything work great. It was a lot of satisfaction in your job," Skoe said. "But now it's just the stress and the ... the fun has gone out of it, I guess."
Skoe might dump his retail operation, too, where he sells everything from docks and boatlifts to building materials.
He says with fuel prices so high, the cost of all his merchandise is going up, and consumers are buying less.
That takes us to our last stop, a half-empty parking lot at a Wal-Mart in St. Paul, and to consumer spending, one of the big questions facing the economy.
The pain that started in the housing industry has spread, slowing the national economy to a crawl. Stimulus checks gave Wal-Mart and other retailers a boost, but what happens as that money runs out?
Four-dollar gas, rising food prices and a steady loss of jobs have sent consumer confidence into a dive.
We'll look at the effects of those trends as part of our next tour of the Minnesota slowdown.