March 01, 2011

Economics Group
Special Commentary

Scott A. Anderson, Senior Economist
scott.a.anderson@wellsfargo.com ● (612) 667-9281

California Economic Outlook: March 2011
Economic Performance Will Improve, but Recovery Is Still Abnormal
California’s economic recovery, for the most part, will remain painfully slow. While California’s economic performance is expected to improve by a touch in 2011, the state will continue to perform somewhat below the national average. California’s employment growth should accelerate to 1.0 percent in 2011, following a 1.5 percent decline in 2010. Private sector service employers are expected to create more jobs in 2011. Service jobs comprise about 87 percent of total nonfarm employment in the state, so this could be an important support for California’s overall job creation. Moreover, the drag from construction payroll declines will finally begin to dissipate. Not that California’s housing market is gearing up for a roaring revival, but there is little scope for further double digit construction payroll declines given how far homebuilding has already fallen across the state. California’s commercial real estate construction is already in hibernation so there will be fewer construction job losses in that sector as well. Still the legacy of the California debt/housing bubble and Great Recession remains, lurking just below the surface. The aftermath of these crises will continue to hold back economic growth in California for another year. Nowhere is this more visible than in the state’s unemployment problems. California’s unemployment rate at 12.5 percent is more than 3.0 percentage points above the U.S. average. California’s unemployment rate is expected to remain above 12.0 percent in 2011, keeping the states’ financial and housing problems very much front and center. Unfortunately, California’s housing troubles are not over. Foreclosed and distressed sales of homes will remain historically high and home values and local tax revenues continue to be at risk. Home value declines of around 7.0 to 10.0 percent are likely in many California metro areas over the coming year. According the California Association of Realtors, California median home prices have been falling for three of the past four months through December and are now down year-onyear as well for the second consecutive month after 22 months of consistent improvement. California existing home sales fell about 9.5 percent in 2010, and month’s supply of existing home inventory is on the rise for properties below $1 million. At the same time, housing inventories of higher priced properties above $1 million remain historically high. The new California governor, Jerry Brown, is facing a daunting fiscal challenge. The State of California estimates an operating deficit of $25.4 billion in FY 2011-12 without corrective action. Longer-term, if changes aren’t made to the budget, the state faces annual budget deficits of around $20 billion a year for at least the next five years. One-time budgetary maneuvers have largely been exhausted in past budget cycles, narrowing the options to fix the state’s deficits. The governor is proposing $12.5 billion in expenditure cuts for 2011-12, comprising about half of the shortfall. The bulk of the rest of the shortfall will be closed by extending four temporary tax increases adopted in February 2009. Approval of the tax extensions will require a June special election. The pace of state and local job losses in California will likely intensify again in 2011.

California’s economic recovery will be more visible in 2011 as private sector job growth improves, but by historical standards the state’s recovery remains painfully slow.

California’s housing troubles are not over.

State and local budget cuts will be a significant drag on the economic outlook for the state.

This report is available on wellsfargo.com/research and on Bloomberg WFEC

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Figure 1
California Nonfarm Employment
6% Year-over-Year Percent Change 6%

Figure 2
California Employment Growth
5% 4% Year-over-Year Percent Change 5%

Forecast

4% 3% 2% 1% 0% -1% -2% -3% -4% -5%

4%

4%

3% 2% 1%

2%

2%

0%

0%

0% -1%

-2%

-2%

-2% -3%

-4%

-4%

-4% -5% -6% California: 2010 @ -1.5% 96 98 00 02 04 06 08 10

-6%

Total CA: Dec @ 0.6% Total US: Dec @ 0.7%

-6%

-6% -7%

-8% 00 01 02 03 04 05 06 07 08 09 10

-8%

-7%

Source: U.S. Department of Labor and Wells Fargo Securities, LLC

California’s Problem: Jobs, Jobs, Jobs

California’s prominent position in the housing and construction bubble and its subsequent crash has left a deep gash in California’s job engine, leaving in its wake economic and financial hardship for many California households. If the nation’s job market has fallen into a deep economic hole, California has fallen into an abyss where little if any amount of sunshine penetrates. As we expected, California’s job growth in 2010 was spotty. Over the past twelve months only a handful of California industries have created net jobs. Professional and business services has created 66,900 net jobs since December 2009 with 47,600 jobs coming from administrative, support, and waste services, primarily employment services jobs. But job growth also resumed for higher wage professional, scientific, and technical service positions with California adding 21,400 net jobs in this important sector. Last year this sector lost 66,500 jobs. Education and healthcare has added 30,700 jobs with about half the jobs coming from education and the other half coming from healthcare. Leisure and hospitality has added 26,700 net jobs, primarily accommodation and food service jobs, as business travel and international & domestic leisure travel returned robustly in 2010. Modest job gains occurred in manufacturing, financial services, and information services. Net job losses were substantial in 2010 in construction. The industry lost another 32,900 jobs over the past twelve months, but that is only one-fifth the number of jobs lost in California construction the year before. We expect 2011 will be another year of improvement in construction payroll losses as housing and commercial construction bounces around the bottom and begins a gradual climb higher. Trade, transportation and utilities shed 4,600 jobs over the past twelve months, less than one-tenth the number of jobs lost in 2009. Stronger consumer spending over the holidays and into 2011 should allow for more jobs in this sector in 2011. State and local government job losses were a noticeable drag on California payrolls over the past twelve months. Government shed 21,700 jobs over the past twelve months, but more government jobs are at risk in 2011 and beyond as state budget cuts take a more prominent position in resolving state budget woes that will have real impacts on state payrolls. California’s unemployment rate increased a tenth to 12.5 percent in December, just one tenth of a percentage point lower than the peak 12.6 percent unemployment rate recorded in March 2010. There remains 2.27 million unemployed Californians and that number has risen modestly in five of the last six months. Further reflecting the dismal job prospects, California’s labor force has shrunk since May 2010, falling in five of the last seven months. California’s labor force participation rate fell another tenth of a percentage point in December to 63.9 percent, the lowest level of labor force participation in the state since 1977. The labor market participation often rises

California job growth will return to a broader crosssection of industries in 2011.

2

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

as job prospects improve and previous discouraged workers and marginally attached workers return to job hunting. We expect California’s unemployment rate to remain uncomfortably high at more than 12.0 percent in 2011. This will keep political pressure on the new governor to address the jobs issue. California nonfarm payrolls increased year-on-year through December 0.6 percent or 87,500 jobs, but private sector jobs have increased even more, rising 1.0 percent in 2010. Private sector job growth should strengthen in the months ahead as the drag from construction job losses subside and more retail and service businesses that rely on consumer spending for revenue growth start to see improved conditions and start adding to payrolls again. Expect to see job growth return to a broader cross-section of industries in 2011. Looking ahead, California payrolls slipped 1.5 percent in 2010, but should rebound by 1.0 percent in 2011. Figure 3
California Employment Growth
$30 X axis: Y/Y Job Growth (Ths.), Y axis: Avg. Hourly Earnings ($/Hr) December 2009 - December 2010 $25 Construction Financial $20 Trade/Trans/Ut $15 6% Leis/Hosp $10 4% $5 4% 6% Mfg. Other Svcs. 8% 8% Info. Svcs. Prof/Bus Svcs. Ed/Hlth Svcs. 10% 10% 12% 14% California: Dec @ 12.5%

California’s unemployment rate will remain uncomfortably high.

Figure 4
Unemployment Rates
Percent United States: Dec @ 9.4% 12% 14%

2%

2%

$0 -60

0% -40 -20 0 20 40 60 80 00 01 02 03 04 05 06 07 08 09 10

0%

Source: U.S. Department of Labor and Wells Fargo Securities, LLC

Searching For a State Budget That Works

California’s state budget problems have been well documented. The state is trying to close a projected $25.4 billion deficit for FY 2011-12. The trick every year is getting one that closes the state’s chronic budget gap, one that can pass through the state’s fractious legislature, and one that tries to address the state budget problems that are likely to emerge down the road. After much anticipation, Governor Jerry Brown laid his cards on the table, releasing details on how he would like to see the state’s budget problems resolved. On January 10, the governor released his budget for the state. His plan calls for further cuts in state employee pay, state social services spending and a plan to extend expiring tax increases for at least the next five years to help close the deficit. The Governor needs the legislature to agree to the plan by March for the proposed tax extensions to go to a vote of the people by June. State voters rejected some tax increase proposals in November, so it will take quite a bit of educating and selling to get the tax proposals through in one piece. The biggest selling point of the tax extensions is that without it, the state will need to pass even deeper spending cuts. The governor has already ruled out more state borrowing to address the looming imbalances, arguing that the state needs to take its fiscal medicine now. Anti-tax Republicans in the legislature are likely to take issue with the tax extension, while the Democrats in the legislature fight the steep cuts in the state’s social safety net. The fact that no one wins under the governor’s budget plan might increase the odds of passage in California’s zero-sum legislature, though getting the electorate to go along for the ride is probably the biggest wildcard. The governor proposes to cut the pay of state employees of between 8.0 and 10.0 percent in six bargaining units. These units account for more than a third of the state’s general fund payrolls.

California will try and balance its budget deficit with a combination of deep spending cuts and an extension of temporary tax hikes that will require a vote of the people.

3

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

This should bring the pay in-line with agreements reached by the Schwarzenegger administration last year and with the state’s 15 other bargaining units. These six units would also remain on three day per month furloughs through June. The governor’s plan also calls for $1.7 billion in cuts to the state’s health program and $1.5 billion in cuts for its Welfare-to-Work program. There are also large cuts to programs for the disabled, mentally disabled and autistic. The State’s colleges and universities will also see substantial cuts in funding to the tune of $1.0 billion dollars. The governor’s plan spared further cuts to public elementary and secondary schools. The tax extension includes, continuing current personal income and sales taxes as well as the vehicle license fee. More specifically, the governor’s plan calls for extending four temporary tax increases adopted in February 2009 for another five years. The voters will have to approve extending the one percent sales tax increase, the 0.5 percentage point increase in the vehicle license fee, the 0.25 percentage point personal income tax surcharge, and a reduction in the dependent exemption credit for the next five years. There is little doubt stronger economic growth and more private sector job creation will help to further repair the damage that has been visited on the state’s finances. The latest financial report from the State Controller for January shows that state revenues are recovering.1 Personal income taxes over the past seven months, the largest category of tax revenues, are running higher by 19.0 percent to $29.9 billion. More modest gains are visible in retail and sales taxes, which have increased by 3.4 percent to $14.5 billion. On the other side, corporate tax revenues remained moribund, decreasing 0.1 percent over the first seven months of the fiscal year to $4.0 billion. This lackluster performance for corporate tax revenues is partly due to a revised allocation schedule for tax payments that held down tax payments in the last quarter of the 2010, but even accounting for this change, corporate taxes are lagging past expansion cycles. Overall, the top three revenue sources still increased by 12.2 percent from the year before. Figure 5
California Tax Revenues
50% 40% 30% 20% 10% 0% -10% -20% -30% 95 98 01 04 07 10 Year-over-Year Percent Change Total: Q3 @ 3.99% 40% 30% 20% 10% 160 0% -10% -20% -30% 140 120 100 80 03 04 05 06 07 08 09 10 160 140 120 100 80 240 220 200 180 50% 260

California tax revenues are recovering, but unfortunately total spending is also on the rise.

Figure 6
California Tax Revenues
Index of 4-month moving sum, Q1 2003=100 Property: Q3 @ 161.50 Personal Income: Q3 @ 136.34 Corporate Income: Q3 @ 141.63 Sales: Q3 @ 136.91 220 200 180 240 260

Source: U.S. Census Bureau and Wells Fargo Securities, LLC

Unfortunately, total disbursements are also on the rise, increasing 4.4 percent to $61.6 billion. Local assistance increased 5.4 percent to $46.5 billion, while state operations spending increased 11.9 percent to $15.2 billion. Local K-12 education expenditures jumped 10.7 percent, and community college disbursements increased 8.8 percent. There were some categories where spending declined from the year before. Department of Corrections spending fell 7.8 percent. Legislative/Judicial/Executive dropped 2.3 percent, while debt service payments fell 8.0 percent.

1

See California State Controller’s Office Monthly statement of General Fund Cash Receipts and Disbursements Fiscal Year 2010-2011; January 2011.

4

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

California has the eighth largest economy in the world and it is the largest issuer of debt in the $2.8 trillion dollar municipal bond market, so all eyes are on the state as it tries to stabilize its government finances. The possibility of large credit losses in the state and municipal bond markets has emerged as a potential risk to the U.S. financial system and the U.S. economic recovery. Municipal bond yields have been trending higher as investors have gotten more nervous and some have run to the exits. Moody’s Investors Service gives California its lowest credit rating, a rating that is shared by only one other financially challenged state, Illinois. California’s bonds are still in relatively high demand nevertheless. California bond yields remain about 0.85 percentage points below Illinois and have fallen more than a quarter percentage point from where they were a year ago. So while California’s state and local financial problems will continue to be in the headlines, the state now appears to be on the right track toward improving the situation.

Setting Records for International Trade and Exports

Looking for a good news story on the California economy, look no further than California’s trade performance over the past year. California exports hit a new December record at $13.3 billion, a 14.8 percent increase from a year ago and the 14th consecutive month of year-on-year increases. For the year as a whole, California merchandise exports were $143.3 billion, a 19.3 percent gain from 2009 levels and the second highest total in history. Clearly, California is getting its fair share of global growth and sales abroad. Further gains will be necessary to help rebalance the state’s economy away from consumer spending and housing toward more productive drivers of economic growth going forward. California’s growth in exports is comparable to what we are seeing nationally, suggesting that California has not yet lost its competitiveness against other states when it comes to its export prowess. California held its position as the second largest exporting state in the nation behind Texas. New York and Washington State came in third and fourth. Export gains jumped in several of California’s largest trading partners. California exports to China and Mexico increased the most in 2010, both rising 21.4 percent from a year ago through December. South Korea, California’s fifth largest market, had the third largest increase up 14.6 percent. Exports to Canada, California’s second largest trading partner, increased 11.1 percent. China’s meteoric economic rise puts it neck and neck with Canada as California’s second largest trading partner, though Canada still edged out China in December. These growth rates are comparable to what we are seeing nationally. Figure 7
California Exports
$15,000 Dec @ $13,342 Millions of Dollars $15,000

California is setting records for exports and international trade.

China is neck and neck with Canada as California’s second largest trading partner.

Figure 8
California Exports by Destination Country
December 2010
Mexico 14%

$12,000

$12,000

Canada 10%

Other 53% $9,000 $9,000 China 10%

Japan 8% $6,000 Jan-09 Apr-09 $6,000 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Korea 5%

Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

5

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

California Housing – No Hollywood Ending in Sight?

Weakness in housing demand has re-emerged in the aftermath of the homebuyer tax credit expiration.

California appeared to put in a solid bottom in its housing market in 2009. California singlefamily median existing home prices hit bottom in February 2009 at $245,230, according to the California Association of Realtors. By that point, California single-family home sales were already running 77 percent above their 2008 levels. California home prices continued to rise though out the rest of 2009, peaking in December 2009 at $306,860, a full 25.1 percent or $61,630 above the February 2009 low. In our July 2010 California report, we argued that California had reached its ultimate bottom in housing, but with the expiration of the homebuyer tax credit, more signs of weakness would emerge. Home inventories would start rising again as more foreclosures and distressed sales hit the market, and we forecast some modest single digit median home price declines would once again begin to occur across much of the state. Through December of 2o1o, the latest housing data available, that is exactly what appears to have happened. Since May 2010, median existing single-family home prices have slipped by $22,580 or 7.0 percent. Seasonally adjusted single-family home sales fell for six of the first seven months of the year, but have since begun to stabilize at still historically low levels. As of December, single-family home sales were still running 6.8 percent below year ago levels. The weakness in demand that has re-emerged in the aftermath of the homebuyer tax credit has been enough to push the month’s supply of existing homes back up from the relatively low levels witnessed in 2009. California’s inventory of detached homes sat at 5.0 months in December, while attached home inventories increased to 5.8 months. Months of inventory are the highest for detached properties in Northern Wine Country at 6.1 months, Orange County at 6.0 months, and San Diego at 5.9 months. Months of inventory are below the statewide average in Sacramento at 3.4 months and San Francisco Bay at 3.8 months.

Months of inventory are higher in every price category for housing priced at $1.0 million and below.

By price level, months of inventory are higher in every price category for housing priced at $1.0 million and below. For homes valued at more than $1.0 million, months of inventory remain about the same as a year ago at 8.0 months. The largest increases in months supply have occurred in $750 to $300 thousand range. This is consistent with more supply coming on the market due to foreclosures of distressed properties in the second half of the year. As Figure 10 illustrates, California’s foreclosure rates have jumped higher once again for both prime and subprime loans. The leading indicator of foreclosures, mortgage delinquencies shown in Figure 9, appear to have peaked, but remain at very high levels, suggesting that foreclosures and distressed sales will remain a major impediment to achieving a normal housing recovery in the state of California. Housing supply will remain a pressing concern over the near-term as housing demand continues to struggle to gain momentum. Thirty year mortgage rates, which have already risen about a percentage point from their October 2010 levels, are becoming an important factor holding back a more normal recovery in housing demand. Figure 9
California Mortgage Delinquencies
10% Percent Delinquent, SA Prime Del. Rate CA: Q4 @ 6.92% (Left Axis) Subprime Del. Rate CA: Q4 @ 22.41% (Right Axis) 8% 24% 1.50% 1.25% 1.00% 4% 12% 0.75% 0.50% 2% 6% 0.25% 0% 00 01 02 03 04 05 06 07 08 09 10 0% 0.00% 00 01 02 03 04 05 06 07 08 09 10 1% 0% 6% 5% 4% 3% 2% 1.75% 30% 2.00%

Figure 10
California Foreclosures
Percent Entering Foreclosure During Quarter, SA Prime Fcls. Rate CA: Q4 @ 1.56% (Left Axis) Subprime Fcls. Rate CA: Q4 @ 3.25% (Right Axis) 8% 7%

6%

18%

Source: Mortgage Bankers Association and Wells Fargo Securities, LLC

6

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

California is slowly extricating itself from the Great Recession. Private sector job growth will be more visible across that state, even in the most troubled metro areas. More service businesses will be adding to payrolls this year as stronger consumer spending improves revenues and smaller businesses see improved top-line growth for the first time in this expansion. Manufacturing and exports will remain an important source of economic activity. Statewide job growth is being led by solid gains in some Southern California metro areas, especially in Orange County and San Diego. Net job losses continue to plague the Los Angeles metropolitan division and the Inland Empire, but even here declines are diminishing and signs of broader job growth are beginning to emerge. Northern California continues to hold back the state’s recovery as job losses linger in construction and financial services and retail sales remain moribund. Sacramento’s economy is getting hammered. Sacramento’s unemployment rate has risen further over the past year and the metro has lost 18,600 net jobs or 2.25 percent of its employment over the past twelve months. However, it is not because of state government job cuts. Sacramento job cuts are centered primarily on construction, professional & business services and financial services. Government employment in Sacramento is up 500 jobs over the past twelve months. California housing remains a considerable drag on California’s ability to grow. Weak housing demand will continue and could intensify if mortgage rates shoot higher over the coming year. The level of foreclosures and distressed sales will remain historically high, keeping housing supplies elevated. Further single-digit home price declines are likely in the months ahead. At the same time, state and local budget cuts will loom large on the economic outlook. The governor is anticipating at least $12.5 billion in additional state spending cuts, and it could be twice that amount if voters reject the extension of temporary tax hikes at the polls. This will hit Sacramento’s economy especially hard, given its already weak economic position compared to other regions of the state. Overall, California will lag the national performance over the forecast horizon, though the state’s outlook has improved due to a stronger national economy. We now expect California employment growth of 1.0 percent in 2011. Still the improved job outlook will not be enough to push the state’s average unemployment below 12.0 percent in 2011. Jobs and unemployment across the state will remain the biggest economic problem for the state’s policymakers.

Conclusion: Building a Foundation for Growth

Jobs and unemployment across the state will remain the biggest economic problem for the state’s policymakers.

7

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Los Angeles

Los Angeles Nonfarm Employment
6% Year-over-Year Percent Change Total LOS: Dec @ -0.1% 4% Total US: Dec @ 0.7% 4% 6%

The Los Angeles metro area continued to add jobs at a modest pace through December 2010. Year-on-year employment declines have moderated this year, though the pace of improvement has continued to lag the national average and the unemployment rate has continued to rise. Los Angeles nonfarm payrolls are still below year ago levels by 0.1 percent, while the nation has added 0.9 percent to payrolls over the same period. The economy appears to have regained some momentum over the past three months. The Los Angeles metro has added net jobs over the past three months. December job gains were led by retail trade, information services, and financial services. Over the past year, four industries have led the jobs recovery in Los Angles. Information added 19,900 jobs with 71 percent of the gain coming from motion pictures and sound recording. Leisure and hospitality added 11,200 jobs, almost all of them in accommodation and food service industries, and education & health services added 8,300 positions. Unemployment has been slow to recede, however. In fact, the Los Angles metro’s unemployment rate hit a new cyclical high in December at 13.0 percent more than 3.6 percentage points above the U.S. average, and well above the California average of 12.5 percent. The Los Angeles labor force continues to grow faster than new jobs are being created. Housing markets in L.A. are still quite weak. The median home price gains of around 10 percent year-on-year recorded around the expiration of the homebuyer tax credit last April are rapidly slowing. According the Case-Shiller HPI, Los Angeles home prices are 0.2 percent below year ago levels as of December and rapidly decelerating along with the nation’s. The California Realtor’s data for Los Angeles appears even dourer for attached homes. Los Angeles median home prices of attached homes at $252,358 as of December 2010 were 21.1 percent below December 2009 levels which were already 30.0 percent below 2007 levels. December attached home sales continued to trend about 18.5 percent below year ago levels, though that’s a marked improvement over October’s 25.0 percent shortfall in existing attached home sales.

2%

2%

0%

0%

-2%

-2%

-4%

-4%

-6%

-6%

-8% 00 01 02 03 04 05 06 07 08 09 10

-8%

Unemployment Rates
14% Percent United States: Dec @ 9.4% 12% Los Angeles: Dec @ 13.0% 12% 14%

10%

10%

8%

8%

6%

6%

4%

4%

2%

2%

0% 00 01 02 03 04 05 06 07 08 09 10

0%

Home Prices
40% 30% 20% 10% 0% -10% -20% -30% -40% 01 02 03 04 05 06 07 08 09 10 United States 20-City Composite: Dec @ -2.4% Los Angeles: Dec @ -0.2% -40% Case-Shiller Index: Year-over-Year Percent Change 40% 30% 20% 10% 0% -10% -20% -30%

Source: U.S. Department of Labor, Standard & Poor’s and Wells Fargo Securities, LLC

8

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

San Francisco

San Francisco Nonfarm Employment
6% 4% 2% 0% -2% -4% -6% -8% -10% 00 01 02 03 04 05 06 07 08 09 10 Year-over-Year Percent Change Total SAF: Dec @ -1.4% 6% 4% 2% 0% -2% -4% -6% -8% -10%

The San Francisco Bay Area continues to badly lag the economic growth occurring in other areas of the country and state. Moreover, the pace of job growth appears to have slowed in recent months. Nonfarm payrolls in the San Francisco metro area are still 1.4 percent below a year ago. Northern California job growth has been noticeably weaker over the past year than in Southern California. The region continues to struggle with sizable net job losses in construction and financial services. Over the past year, most industries saw net job losses, led by declines in financial services (-3,000), construction (-2,100), and trade, transportation and utilities (-1,600). Government and information, mostly publishing, shed 1,400 jobs each. There are a few standout growth drivers in the Bay Area. Computer systems design added 1,000 jobs over the past twelve months. Manufacturers added a net 100 jobs over the past year as technology and business spending grew rapidly. The promise that seemed to shine on San Francisco in the late Nineties is now a distant memory. Employment in the Bay Area jumped 15 percent between 1996 and 2000 as the dotcom and technology bubble took hold in the region, but a broader view tells a different story. Since 2000, the metro has shed all the nonfarm jobs added, leaving a legacy of squandered opportunity and no net job growth in San Francisco over the past fifteen years. Indeed, the region has actually been a serious underperformer of U.S. average job creation. The Bay Area housing market recovery is struggling, though sales appear to be stabilizing at low levels. Home price appreciation has stalled. Median home prices declined 0.4 percent from a year ago in December, according to the Case-Shiller index, after appreciating about 20.0 percent prior to the homebuyer tax credit expiration in April. The California Association of Realtors show the median home price in the San Francisco metro dropping 2.9 percent from a year ago through December. Existing home sales were running about 2.8 percent below year ago levels in December but that is a marked improvement since October when sales lagged by 21.0 percent from October 2009.

Total US: Dec @ 0.7%

Employment Growth
125 Index: 1996 = 100 United States: 2010 @ 108.5 120 San Francisco: 2010 @ 96.6 125

Forecast
120

115

115

110

110

105

105

100

100

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

95

Home Prices
40% 30% 20% 10% 0% -10% -20% -30% -40% 01 02 03 04 05 06 07 08 09 10 Case-Shiller Index: Year-over-Year Percent Change United States 20-City Composite: Dec @ -2.4% San Francisco: Dec @ -0.4% 30% 20% 10% 0% -10% -20% -30% -40% 40%

Source: U.S. Department of Labor, Standard & Poor’s and Wells Fargo Securities, LLC

9

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

San Diego

San Diego Nonfarm Employment
6% 4% 2% 0% -2% -4% -6% -8% -10% 00 01 02 03 04 05 06 07 08 09 10 Year-over-Year Percent Change Total SAN: Dec @ 0.5% Total US: Dec @ 0.7% 4% 2% 0% -2% -4% -6% -8% -10% 6%

San Diego employment has increased modestly over the past year, beating the L.A. and San Francisco metro areas. Nonfarm employment managed to rise by 6,300 jobs over the past year. Professional and business services lead job gains as employment services added 4,100 jobs. Professional, scientific and technical services added a modest 800 jobs over the past twelve months. Healthcare added 3,300 jobs, mostly from ambulatory health care service providers. Construction lost another 2,600 jobs lead by commercial construction which shed 1,100 jobs. The San Diego unemployment fell to 10.1 percent in December, down two tenths from a year ago, further illustrating the trending water nature of the jobs recovery so far. San Diego’s housing market remains far from normal and a true bottom in housing appears a ways off. According to the California Realtors Association, San Diego’s months supply of existing homes at the current sales pace remained well above the California average at 5.9 months for detached homes and 6.4 months for attached homes. Home prices appreciation is decelerating rapidly, though home prices are still 1.7 percent higher than a year ago. Further price declines are expected in the months ahead. Existing home sales in San Diego jumped 25.5 percent in December from November, but sales were still 9.5 percent below a year ago. San Diego’s defense industry is a bit of a mixed picture though there is no doubt defense will remain an important driver of San Diego’s economic future. With the Pentagon planning significant declines in procurement spending there will be some layoffs and shuffling of personnel from the major military contractors in the region, though so far at least, the downside risks appear surmountable. Helping to offset the drop in procurement spending, military spending on San Diego’s many bases is likely to grow as the Navy increases the number of ships based in San Diego and operations are streamlined in other locations. Tourism looks to be a more significant support for the local economy in 2011 as investments in a new cruise ship terminal begin to pay off. Rising hotel room rates and rising occupancy rates are already visible.

San Diego Job Growth by Industry
Thousands of Jobs, Year-over-Year Change Prof/Bus Svcs. Ed/Health Svcs. Trade/Trans/Ut Other Svcs. Financial Leis/Hosp Gov't Info. Svcs. Mfg. Constr/Mining -4 -2.6 -2 0 -0.1 -0.4 -0.8 -1.4 December 2009 - December 2010 0.2 0.1 2.1 3.5 5.7

2

4

6

8

Home Prices
40% 30% 20% 10% 0% -10% -20% -30% -40% 01 02 03 04 05 06 07 08 09 10 United States 20-City Composite: Dec @ -2.4% San Diego: Dec @ 1.7% -40% Case-Shiller Index: Year-over-Year Percent Change 40% 30% 20% 10% 0% -10% -20% -30%

Source: U.S. Department of Labor, Standard & Poor’s and Wells Fargo Securities, LLC

10

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Orange County

Orange County Job Growth by Industry
Thousands of Jobs, Year-over-Year Change Prof/Bus Svcs. 8.4 7.4 3.2 3.1 2.7 2.4 1.6 -0.9 -2.3 -4.9 -5 0 December 2009 - December 2010 5 10 15

The Orange Country metro area is recovering faster than other parts of Southern California and far quicker than Northern California. Nonfarm employment has risen 1.5 percent over the past twelve months through December. This compares to a 0.9 percent increase in nonfarm payrolls nationally and a statewide average gain of 0.6 percent. Professional and business services employment led the advance, adding 8,600 jobs from a year ago with about 60 percent coming from temporary help firms and the rest coming from high skilled and high wage professional, scientific and technical services. Year-over-year job gains also occurred in trade, financial services, manufacturing, leisure & hospitality, and education & healthcare, illustrating the broader nature of the economic expansion in Orange County. Orange County’s unemployment rate has moved below the national jobless rate as better job creation has emerged. The County’s unemployment rate at 9.3 percent is now well below the peak of 10.1 percent reached in 2009. Prior to the Great Recession, Orange County’s unemployment rate consistently hovered about a percentage point below the national average. Orange County’s home values have slid further over the past year. Orange County detached home values have fallen 7.5 percent over the past twelve months through December to a median price of $458,695. The median price in December 2008 was $442,640. A desirable location and improving economy should help to stabilize home prices though fragility remains just below the surface. Existing home inventories remain elevated compared to historical and statewide averages at 6.0 months for detached homes and 6.4 months for attached properties. The California average in December was 5.0 months for detached homes and 5.8 months for attached properties. Moreover, housing demand remains depressed as existing home sales for December remained 5.6 percent below year ago levels. Additional modest home prices declines cannot be completely ruled out for 2011, especially if mortgage rates continue to rise as we expect.

Leis/Hosp Ed/Health Svcs. Financial Mfg. Other Svcs. Trade/Trans/Ut Info. Svcs. Gov't Constr/Mining -10

Unemployment Rates
14% Orange Co.: Dec @ 9.3% Percent United States: Dec @ 9.4% 12% 12% 14%

10%

10%

8%

8%

6%

6%

4%

4%

2%

2%

0% 00 01 02 03 04 05 06 07 08 09 10

0%

Existing Single-Family Home Prices
$800 $700 $600 $500 $400 $300 $200 $100 $0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Median Prices, Thousands, Seasonally Adjusted United States: 2009 @ $172.5 Orange Co.: 2009 @ $474.1 $700 $600 $500 $400 $300 $200 $100 $0 $800

Source: U.S. Department of Labor, California Association of Realtors and Wells Fargo Securities, LLC

11

California Outlook: March 2011 March 01, 2011

WELLS FARGO SECURITIES, LLC ECONOMICS GROUP

Inland Empire
Prof/Bus Svcs.

Riverside Job Growth by Industry
Thousands of Jobs, Year-over-Year Change December 2009 - December 2010 2.3 2.0 1.5 0.4 -0.2 -0.5 -0.7 -2.0 -6.0 -6.1 -8 -6 -4 -2 0 2 4

Riverside and San Bernardino counties saw net payrolls decline yet again in 2010. The pace of job losses is decelerating, however, and there are now a handful of industries that managed to add net jobs from a year ago. Surely, the seeds of better job growth in 2011 are being sown though the aftermath of the deep declines in employment, housing and commercial real estate will continue to weigh on the region over the forecast horizon. Over the twelve months through December, nonfarm employment in the Inland Empire slipped by 9,300 jobs or 0.8 percent. Construction led the job declines shedding another 5,90o jobs. Specialty trade contractors cut 4,100 jobs, and commercial construction lost 1,300 jobs. Local government jobs losses have been severe, dropping 6,100, as property values plunge and tax revenues collapse. Job growth has been led by professional and business services, adding 2,300 positions. Leisure and hospitality added another 2,000 jobs partially offsetting the continued declines in construction. Unemployment remains the most pressing concern for the Inland Empire economy. With a seasonally unadjusted unemployment rate in December of 13.9, just two-tenths below year ago levels, the economic and financial costs of idle labor and economic slack continue to grow. Unemployment is likely to remain high, as the massive number of construction jobs eliminated over the past three years will not soon return, putting further pressure on the local housing market and local government tax revenue. Rising international trade and better consumer spending growth in the United States in 2011 should benefit the Inland Empire’s transportation industry. The Inland Empire is an important transportation hub for Southern California and an important export and import link with Asia. A true housing recovery will take longer to materialize, unfortunately. Residential housing will remain a drag on the local economy in 2011. Existing home sales in December remained 11.5 percent below a year ago, and home prices are giving up the gains made over the past year.

Leis/Hosp Trade/Trans/Ut Ed/Health Svcs. Other Svcs. Info. Svcs. Financial Mfg. Constr/Mining Gov't

Unemployment Rates
16% 14% 12% 10% 8% 6% 4% 2% 0% 00 01 02 03 04 05 06 07 08 09 10 Riverside: Dec @ 14.4% Percent United States: Dec @ 9.4% 14% 12% 10% 8% 6% 4% 2% 0% 16%

Existing Single-Family Home Prices
$450 Median Prices, Thousands, Seasonally Adjusted United States: 2009 @ $172.5 $400 Riverside: 2009 @ $169.7 $400 $450

$350

$350

$300

$300

$250

$250

$200

$200

$150

$150

$100 96 97 98 99 00 01 02 03 04 05 06 07 08 09

$100

Source: U.S. Department of Labor, California Association of Realtors and Wells Fargo Securities, LLC

12

Wells Fargo Securities, LLC Economics Group
Diane Schumaker-Krieg John E. Silvia, Ph.D. Mark Vitner Jay Bryson, Ph.D. Scott Anderson, Ph.D. Eugenio Aleman, Ph.D. Sam Bullard Anika Khan Azhar Iqbal Ed Kashmarek Tim Quinlan Michael A. Brown Tyler Kruse Joe Seydl Sarah Watt Global Head of Research (704) 715-8437 & Economics Chief Economist Senior Economist Global Economist Senior Economist Senior Economist Senior Economist Economist Econometrician Economist Economist Economist Economic Analyst Economic Analyst Economic Analyst (212) 214-5070 (704) 374-7034 (704) 383-5635 (704) 383-3518 (612) 667-9281 (704) 715-0314 (704) 383-7372 (704) 715-0575 (704) 383-6805 (612) 667-0479 (704) 374-4407 (704) 715-0569 (704) 715-1030 (704) 715-1488 (704) 374-7142 john.silvia@wellsfargo.com mark.vitner@wellsfargo.com jay.bryson@wellsfargo.com scott.a.anderson@wellsfargo.com eugenio.j.aleman@wellsfargo.com sam.bullard@wellsfargo.com anika.khan@wellsfargo.com azhar.iqbal@wellsfargo.com ed.kashmarek@wellsfargo.com tim.quinlan@wellsfargo.com michael.a.brown@wellsfargo.com tyler.kruse@wellsfargo.com joseph.seydl@wellsfargo.com sarah.watt@wellsfargo.com diane.schumaker@wellsfargo.com

Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Advisors, LLC, and Wells Fargo Securities International Limited. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company © 2011 Wells Fargo Securities, LLC.

SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE