37th Annual Economic Outlook Symposium

THOMAS WALSTRUM: OK. So I think we're off to a good start. I hope you would agree. Hopefully, we've lived up so far to Rick's forecast for this event. So now we're going to turn it over to some experts on what I'm calling key sectors. And I have up here a panel. That's what I was originally going to call it. But we've got an hour and 15 minutes total.

So I think if we did a panel, the general way to do that would be to kind of wait to hold all your questions till the end. But I want to give everyone-- I'm going to give every one of our speakers 15 minutes to give you an overview of what they're an expert on. And then instead of waiting till the end, I'm going to let you badger them with questions right away.

So the first up is Diane. Diane is a faithful participant in this event. I've gotten your forecast before. And we're very glad to have you here to talk to us about the consumer sector. It's, of course, the biggest part of the economy and definitely grateful to have you here to give us some insights on what you're seeing right now in regards to consumers. So take it away, Diane.

DIANE SWONK: There's no timer up here. And that picture of me, thank you for making me so much younger. Faithful participant in this conference means I've been doing it for a really long time, decades and decades. I never lie about my age. I'm 61. 11 surgeries during the pandemic, cancer after being in 9/11. I have a spot on my lung now and I'll be on antibiotics for a year and a half. And I'm still here and I'm happy.

[APPLAUSE]

I think I came to my first Fed meeting here, gosh, in 1988. So that's a long time. But thank you. It's an honor and privilege to be here and to be here with old friends. I see Carl right in front of me who has been around even longer than I have, although he does say I'm wearing Northern Trust colors. I wore green because I'm in the Fed and I thought it was even though we don't print money here, the Treasury prints money, I'm like, you know, kind of thematic.

So the US consumer, wow, we made a choice. COVID could have been the iceberg that took us down or instead we could have stimulated and put lifeboats in the water to reverse COVID tainted waters. Not only did we do that, some would argue that we did too much although Austin pointed out that a lot of the inflation we saw as a result of the mismatch between demand and supply was due to supply chain problems, but there was a cost of inflation. And so we can argue if we did too much. What we cannot argue is that it worked.

The US consumer, households paid down their debt. They locked into low rate mortgages, which insulated them from interest rates as they rose. And they banked the savings which are now earning interest. As a result, the US consumer that was once the beleaguered US consumer with stagnant wage gains through much of the last decade rose up and became an atlas supporting the global economy. Consumer spending accelerated over the summer.

The US economy accelerated despite my own wrong forecasts-- I own it-- despite the most aggressive credit tightening cycle by the Federal Reserve since the 1980s. It's been stunning. Why did that happen? Well, in part, inflation cooled more rapidly than wages. And we finally saw for the first time since the onset of the pandemic consumer purchasing power improved instead of deteriorate.

We saw net worth by the Fed's own triennial survey between 2019 and 2022 go up at its fastest pace, double the rate that we saw in any other three-year time period-- 37% after adjusting for inflation. And the increases were across income strata, ages, and educational attainment. All of that helped to support the economy along with what Austin noted, the labor market. at the very moment that we thought the labor market would crumble as the Fed's marathon against inflation hit its hardest mile and most people want to quit because their mind and body hits a wall, it morphed into a relay race, a relay race where sectors that had lagged earlier in the expansion picked up the baton from sectors that were driving gains out of the recovery from the pandemic.

The least interest rate sensitive sectors now dominate employment gains. Over 80% of employment gains from July to October were from three sectors alone-- leisure and hospitality, health care, and the public sector. Public education are trying to finally hire up for acute labor shortages they lost to not retirement but young people who got better opportunities working at big box discounters than they could as a teacher.

That relay race has helped to sustain the economy but more concentrated wage employment gains also make us more vulnerable to external shocks, which was obvious in October when we had the actors and the UAW strike. We saw 151,000 job gains, the lowest private sector job gains since the start of 2021 when private sector employment was still falling. That's important to remember.

A third of the job gains, over a third, 51,000 of the 150,000 in October, were in the public sector alone, mostly public education. That makes us more vulnerable to external shocks. The strikes did shave at least 45,000 officially from employment. The collateral damage showed up as almost 100,000 the household survey. We know that people over the summer-- we did see this increase in participation, which we're going to talk about, which was great. We've seen an increase in the supply of workers, which is phenomenal.

And we saw most of the increase in unemployment from 3.4% in, October in April, the low, the cyclical low to 3.8% over the summer. Most of that increase in unemployment was because more people were throwing their hat in the ring and actually looking for jobs, not a surge in layoffs. In October, that flipped.

Over the summer, it started with people taking more part time work because they wanted to. Teenagers increased their participation in the labor force. People on disabilities are working in record numbers. That is an extraordinary achievement. But on the other side of it, once we got to October, the composition of unemployment and the reasons for people taking part time jobs changed. And that's because work stoppages had collateral damage.

People had to take more part time, reduce their hours, or take up part time because of work stoppages elsewhere to make up for what they were losing due to strikes. And so I do worry about the fragility going forward but yet we still have a tailwind going into what is the fourth quarter. Spending will slow as we pivot from filling our houses and buying lots of things to relieve the monotony of pandemics and quarantines.

We now are spending on things like Taylor Swift and Beyonce concerts. A year from now-- I know this because my daughter is a Swiftie. A year from now tickets to the Taylor Swift concerts, not even the best ones are selling-- already sold out on resale sites because my daughter asked for it for a birthday. My daughter is-- she says she's communist adjacent. She told me that line.

And I'm like, does that mean you're next to a communist? And I thought about her fiance Chris, which both of which I'm supporting on the Upper East Side of Manhattan right now so I guess that would qualify. At one point in time, she charged her rent to my credit card. She's in graduate school. She was independent. I digress, but anyways, she's a Swiftie fan. A year from now, a year from now, Taylor Swift tickets, not for the best, $3,000 a piece. Now that's a powerful woman.

What's important is as we shift into more services, we also traveled a lot abroad, which is technically an import. And we were exporting a lot of that service sector inflation abroad. TSA throughput during the Thanksgiving holiday was around 10% above 2019 levels. That's pretty incredible. So we are still spending. That's the good news. The labor market has been resilient. I am worried that it is more susceptible to external shocks but I think the consumer will slow but not collapse as we go into 2024.

And I want to address one more issue that I think is important and it was one that Austin hinted at and talked about, the dissonance between consumer attitudes and between where the economy is. He's absolutely right. It's a lagging indicator. It's more reflective of where we've been and where we're going, but why?

Most consumers believe we were technically in a recession even though we were not. Why did they believe that? Because their living standards were eroding because their wage gains did not keep up with inflation. They were literally losing ground. I remember doing a panel with Charlie Cook who is one of the great political handicappers out there. And he said inflation hits everyone. Unemployment only hits a few. And that is something very detrimental to the population. And he was right.

I think one of the things we underestimate when we look at the dissonance between consumer attitudes and what we're seeing in the economy is the economy is only a snapshot. What looks good to us and what feels good to Austin, justifiably so-- bringing down inflation is great, but the level of prices is still high. And of course, consumers would love to have 2019 prices with 2023 wages.

It takes a while to catch up even though we now have had inflation cool more rapidly than wages, which is a good thing. It takes a while to regain what was lost. And it is not true, the old adage, it is better to have loved and lost than never to have loved at all when it comes to the economy. We had at the onset of the pandemic people who were considered replaceable, front line workers, become essential. Their wages leveled up and they move from the shadows of the economy into the sun only to be burned by inflation. That loss matters.

It's also important to remember what's happened to the bulk of the labor market. And that's millennials. Millennials got hit by the global financial crisis. They graduated into it and then into the subpar recovery. The 2010s were an anomaly, the subpar recovery that occurred in the wake of the global financial crisis. That damaged their lifetime earnings potential.

They graduated into the wake of the housing bust. We underbuilt. Zoning laws restricted building. Consolidation and builders cut back. The housing stock got older. And then all of a sudden when all of a sudden housing became affordable and millennials are aging into their prime home buying years, they find themselves yet again locked out by the mortgage winter, those who have locked into rates and can no longer afford to trade out of the homes they're in.

Over 40% of all mortgages are paid off in full. Over 80% are below 5% are lower. That is important. Both the increase in home values and an increase in rates have brought down-- and acute shortages have brought affordability to 1985 levels. Those millennials, not only did they not see that they could-- even though that they're more educated, women are more than 60% of current graduates, an even larger percentage of those entering into higher education, they're out attaining men in educational attainment, they have not been able to improve upon the living standards of their parents. They have not been able to achieve the American dream of home ownership. That is really important because keeping up with the Joneses is part of what we judge ourselves in the arc of how we see the economy.

And then one last thing in terms of understanding the dissonance and consumer sentiment. Even though wealth improved across every income, age, and educational attainment, the ranks of those in poverty swelled along with the ranks of the working homeless. Inequality across wealth strata intensified instead of diminished. We judge ourselves by keeping up with the Joneses.

If we're moving up and the top two quantiles of households, which now account for the majority of new home sales, which is why-- not new home sales, new vehicle sales-- that's important because they're seeing a portion of the population buy a third electric vehicle because they can afford to drive it around on their shorter run tasks. They can't afford to buy a new vehicle let alone repair the one that they have. So it's both a comparison across and also what happened before us and the generations that preceded them. They have a reason to be upset.

I joke about my daughter. My son who does stand up comedy jokes even more about her but then somehow he puts my name instead of her name in things that she did to him. And he goes, well, it just sounds much more funny if I say it was you, Mom, than her. And I'm like-- and he's like, well, you've given me a lifetime to work with, Mom.

But in all of that, there is a reality that she sees. Here she is in graduate school. She just defended her master's thesis. And she doesn't see how going forward she can do nearly as well, not just as me, it's not easy to have me as a mom, but not just as well as me but as well as those generations that preceded her. And she's not wrong about that. She's Communist adjacent for a reason. I'm hoping that will change a little with time. We have interesting political discussions at our table.

This is the same daughter who when I found out I had yet another cancer, breast cancer. I was diagnosed on December 23, 2020, and it was the height-- we didn't have vaccines yet and we weren't going to have Christmas because everyone was quarantined again. She quarantined for two weeks, took two PCR tests, drove straight through with her dog and her boyfriend from Minneapolis to Chicago, and before she walked in the door made sure she was safe and came home to be with me and support me. So I make fun of her but family is amazing.

But it is important to understand why we feel the way we do. We feel the way we do because we're still trying to catch up on what was lost. And as good as this economy looks on paper and as resilient as I believe it will remain, consumers have a reason to be discontent. The one thing that unites us all is no matter what our party affiliation, we are all equally disgusted with Congress.

And in fact, Democrats and Republicans have come together, which made for a very easy Thanksgiving for me this year. I won't say my personal party affiliations but there have been fights around the Thanksgiving table, heated debates. And this year we decided to put politics aside although when it came up, there was that commonality. But we all were unhappy about the same thing. And in that, I find a little hope because in that, our collective disgust with the divisions that we have, maybe there is a path forward, that along with the fact that inflation is now cooling more rapidly than wages, there's a path over time to restore what we lost to inflation during the pandemic.

There's a path forward that perhaps is more bright than the one in which we've been on. The last thing, it's an IQ test, isn't it, the consumer sentiment surveys? The peak of the consumer sentiment was in January 2000.

We had just gotten through the Y2K scare. Anyone remember that? The world was going to shut down on January 1. It did not. Or at midnight on December 31, 1999. Prince's song "1999" was playing like crazy. We'd just gotten through that and still had the glow of the tech bubble buoying the economy. And for a brief moment in time, labor share of the economy increased and inequality was reduced. That is the peak.

Fast forward to November, consumer sentiment was at 61.3 according to the University of Michigan index. That is the levels consistent with the global financial crisis. If you look around then versus looking around today, then was a world where inflation was cooling but wages were rising. Unemployment was low. We had yet to hit 9/11. We had yet to engage in decades-long wars. We had yet to see the fragmentation and disintegration of old trade ties. We had yet to see the world get divided.

It's an IQ test if you look around. Yes, Austin's right. The media does play a role. But it's not that the media is just looking only at the negative news. It is that the world is harder today than it was in January of 2000. And we need to get on to that as well. Thank you.

AUDIENCE: OK. I understand that. I'll get on this microphone. I'm going to ask Diane to stay up for us. We have I think five minutes or so for questions.

DIANE SWONK: I talked too long.

THOMAS WALSTRUM: Well, we started a little late too, so we can give you even a little more than five minutes if--

DIANE SWONK: I don't want to cut into my-- I want to hear what everybody else has to say.

THOMAS WALSTRUM: Anyway, so I can I have a couple questions online but I figured we can actually use these little red mics if there's anyone in the present audience who wants to talk. I see a question back there so go ahead and just hit the red button on your mic and speak out.

AUDIENCE: OK. Just comment and then a couple questions. I think that the actors strike, those 45,000 jobs, were just converted to government jobs because we have the Biden political theater and then we have the Trump political theater. So literally, I think those jobs were converted to the economy just on the government side. And you're not communist adjacent so you did give away your political leanings because that's where--

DIANE SWONK: I'm not communist adjacent. Yes.

AUDIENCE: I mean, half of America is on the communist adjacent side. Half isn't. Pretty much. You're either good or you're evil.

DIANE SWONK: No. I actually take issue with that. I don't think that's the case. Otherwise we wouldn't agree about the fact that we're all disgusted with Congress by party affiliation equally.

AUDIENCE: It kind of leads into my next question. You were saying the Treasury prints money but they haven't printed money since 2017 so if you lay out all your bills, your dollar bills, nobody's going to find any currency that was printed after 2017, so why did the Treasury stop printing currency? That's one question. And then the second question is, what's the Federal Reserve and the Treasury's interaction with the global repository?

DIANE SWONK: First of all, we've had easier money until 2018 when we started tightening rates. So your printing of money, I mean Janet Yellen signed bills so, yes, they have printed money.

AUDIENCE: Nobody will be able to find a bill that post-dates 2017. Currency has not been printed since 2017. Why is that?

DIANE SWONK: Janet Yellen has signed dollar bills since 2017. I know that for a fact. And Also there was selfies posted of the former Treasury Secretary doing that. So I'm a little confused by that. But I think what's important to understand is how tight is policy today versus what it was. The Federal Reserve was focused on stimulating the economy.

AUDIENCE: Wait. Wait. I missed that. The global repository. What's the interaction of the Treasury and the Federal Reserve with the global repository?

DIANE SWONK: I don't even-- I'm not going to go onto that. we have had stimulative monetary policy for much of the 2010S because we were in a very subdued economic environment following the global financial crisis. We actually had free money. They were paying us to take on debt.

We have now much more restrictive monetary policy and we've been insulated from it because of the fixed rate mortgages that we have. That doesn't mean that delinquencies aren't going up. They are, particularly in subprime. In the third quarter, they actually moved up into the third quintile of incomes but defaults remain low because people still have jobs.

I think the real issue is what is the ability to spend? The ability to spend is still there. We had $2.3 trillion in excess savings generated during the pandemic. It's hard to estimate exactly where we are today but with the upward revisions we saw in September, it looked like we had more than double the savings left, mostly in the top two income strata, but we still had a significant cushion of the excess savings that was generated by the stimulus, and fixed rate mortgages, and student loan deferment/forbearance.

All of that, that savings that was banked, was more than double what we thought by the end of September. And that's really important when we think about where we're going forward. So what really is important I do think the Treasury bond market is now dominated more in demand by individual investors and institutions than central banks.

They're much more skittish and more likely to expect a term premia on our debt, which means rates all else equal or higher. But we are still the reserve currency of the world. And that gives us privilege. I do worry about what does that mean in terms of the compounding of our debt and the interest expense on our debt going forward. And as far as whether or not--

AUDIENCE: Can you clarify that about the central banks?

THOMAS WALSTRUM: I'm sorry. We're running out of time for questions from one person.

AUDIENCE: Just a last point about the central banks. What comparison were you making?

DIANE SWONK: So it used to be that China and Japan were our largest buyers of our debt along with the Federal Reserve. Japan has begun buying again but they are no longer the largest buyers of our debt. And they would hold it for their own reasons and were more likely to be long term holders than individual investors and institutions, hedge funds, and things like that. And that composition of demand has changed at the same time that the supply that we're issuing has increased.

AUDIENCE: OK. Thank you. And I have one more question.

DIANE SWONK: I know Jonathan wanted to also and there was a point I wanted to make about labor force participation and that is labor force participation has increased quite dramatically. Most dramatically, we saw women's labor force participation after 20 years.

AUDIENCE: But not the 65 over 65.

DIANE SWONK: No. They have disappeared. Labor force participation among those who are prime age, which I no longer fall into, 25 to 54, has moved up to a new high in 2023. It took over 20 years to get back there. That's really important. We just barely got ahead of where we were at the end of the 1990s boom when women in the US were leading labor force participation for the world.

We now lag every other major economy in prime age women's participation even though we've exceeded that previous peak by ever so little. There's also been a demarcation between what's happened in terms of those who can work from home. Parental leave is at a record high. Men are helping women with children. We are not in a baby boom. But it is available for those with an education can participate more. We've also seen some catch up in immigration since the onset of the pandemic and the shortfall. We still have a huge fall from 2016 to 2019. Without the increase in foreign born in the labor force that we've seen since the last couple of years, we would not have had an increase in the prime age participation. Foreign born participate at a higher rate than native born. Men's participation rate got back to the peak hit before the pandemic. However, what was the peak in male participation rate in the United States? August 1958. August 1958. Every single recession we've had until this one, men have not only been hit but not recovered to their previous peak in participation. We need all hands on deck.

This is not a zero sum game. We need everyone participating. An economy that had tight labor markets, work from home, hybrid work, flexibility. That helped bring people in. I am worried that the COVID era subsidies for child care have expired and a year from now low income subsidies for child care will go away as well. We are in a child care crisis. We spend $6 of our federal government budget for every $1 on older people and retirees for every $1 we spend on children.

What do we want our future to be? The over 65-- 1995 to February of 2020, they were participating more in the labor force every single year. It turns out we live longer and more vibrant. However, COVID not only hit it, we just never came back. And we're still missing a lot of the over 65.

Teenagers peaked in their participation in 1979 when I was a teen. We've now gotten half a million more teenagers. We've also had the biggest violation in child labor laws and complaints of it that we've seen in a very, very long time. So I look at what we're doing and say we're still missing something out there. We need to sustain the participation in our labor force. And that has been key in keeping the supply of workers fed.

But think about it. We've got an aging demographic. We can only grow as fast as our labor force plus productivity growth. If our labor force particularly starts to contract, we need a lot more productivity growth. Now Gen AI may do it but it takes a while between innovation and commercialization. And those are the things that I worry about more structurally going forward.

And I think those are the nuances that we have to think about when we think about how are we going to get on a more sustainable path as we regain what we have lost to inflation. So with that, I will conclude. I know I've overdone my time. Thank you so very much.

[APPLAUSE]

OK. So definitely more questions for Diane out there. I'm very aware of that. Let's save it for the break and maybe the box lunch time. I've got to bring up our next speaker David Zin who is with the Michigan Senate Fiscal Agency. He's going to talk to us about the situation in Michigan but I've also asked him to try to talk a little bit more about the region as well and talk about the parallels between what you might be seeing in Michigan and elsewhere in our region. So with that, I'm going to turn it over to you, David. Thank you so much.

DAVID ZIN: So I'll end actually ironically on a bit of the same type of note that Diane mentioned in terms of productivity and long term constraints. A brief comment. I work for the Senate Fiscal Agency. We're a nonpartisan agency that largely works with the Michigan Senate for the budget although we do a broader array of activities than that. They pay us kind of not to have an opinion so we get to live the life we all learned about in school of positive economics. They worry about whether it's good or bad and all the normative components. And we try to just give them the data.

For Michigan, one of the things that has been a defining moment back with this peak in consumer optimism that Diane mentioned is, in May of 2000, Michigan had an employment peak. And between restructuring that was beginning in the auto industry and the lead up to the 2001 recession, we started hemorrhaging jobs. And we pretty much continued it through 2010. And in the end, we lost, as you can see on this graph, we lost about 800,000 jobs, 850,000 jobs.

And we spent much of the last decade trying to recover those and along came COVID. And while we are projecting that we will have recovered from COVID by the end of 2025, we are not expecting to recover from where we were at in 2000. Gabe Ehrlich at RSQ, he often gets asked if we're ever going to get back to there. I will admit that he and I have different answers to that. I'm much more pessimistic about whether we'll see it. And you'll see a little bit of that going on.

But if we zoom in on what's happened since COVID, you can see that Michigan took a bigger income hit, employment hit with COVID but has come back quite strongly. We've added something on the line of about 400,000 jobs in the recovery of COVID. Other states in the seventh district did not go down as far. And most of them were kind of sitting around near where they were at about the time COVID struck, the exception being Indiana. They look pretty strong there. They're actually outpacing the US average.

On Diane's point about labor force participation, we hear a lot about this in the Senate because there's this popular wisdom that the reason why job gains are falling, and inflation is happening, and wage rates are going up is because nobody wants to work. And there is a long term demographic that I'm sure most of you are aware of. I just like the graphics of where you can see the run up that Diane talked about, but you can also see the fall that's occurred since 2000. And it tends to accelerate when we've had recessions and then we kind of have a little flattening once we kind of get over the recession.

The Bureau of Labor statistics estimates that as we continue to age into baby boomer retirement years, that will actually drop off the bottom of this graph in terms of the labor force participation rates as a society. But in the short term if you look at where we're at, that kind of isn't the story as you've heard already. Labor force participation is about where it was at before COVID. Michigan has a lower than the national average but most of the rest of the seventh district has an above average participation rates. And while they're down, they're not down a lot. And if you were to compare them to the previous slide, they're not down relative to where you would have expected them to be given the long term trend.

So if labor markets are kind of flattening out as you see with those employment lines and participation's not really a factor, we can look at things like withholding and that's going to give us a measure on what's going on with both unemployment and wage growth. And while most of the states in the district don't report withholding and their public accounting monthly reports and stuff like that, I pulled Ohio because they do it.

Obviously, I have access to the Michigan data. But you can see that there has been, as the Federal Reserve has been tightening, there's been a steady downward trend in what's going on with withholding. And given that employment has been staying pretty good and unemployment, I mean, obviously the unemployment changes are driven by people not working whereas withholding is driven by the people that are working.

So we are definitely seeing slower wage gains in Michigan. And the economy appears to be slowing down. We see the same sort of story in some states for sales and use tax. Obviously, different states tax services to a different degree. Michigan is one of the lower states in terms of taxing services. So part of our downward trend that we're seeing may be driven by kind of the return of the consumer buying services as well as just maybe doing less. I don't know what to say about the Iowa line here. I don't know if everybody flees Iowa in the summer and spends money for sales taxes elsewhere or something, but there's definitely a downward trend here on sales and use tax growth.

And kind of offsetting the story on services, if you look at corporate income tax revenues, this graph is a little harder to read because Indiana has these weird spikes related to some timings on payments but there's definitely a downward trend both for Michigan and for Illinois in terms of what's going on with that. Again, I don't know what's going on with Iowa.

Maybe somebody here will have something that can illuminate it. But to us, it looks like the economy is slowing down. We were kind of forecasting that. We do a state consensus forecast where the administration, the House, and the Senate get together. And we were forecasting-- see at the end actually a decline in economic related growth in terms of the fiscal year '23. We actually look like we're probably going to hit that number pretty well in terms of our revenue forecast. And we are expecting below average growth for future years.

But we don't have a problem with just being below average growth. We've had a problem with keeping pace with inflation. And you can see the dip that job loss in the 2000s cost us but we haven't done very well since then. This is the state of Michigan's general fund revenue. And if you read about why things are strapped in Michigan, why our Senate Approps Committee has trouble making decisions, it's because the buying power of the money they have is on par with 1968. They are literally trying to finance a state with money from half a century ago.

We did a major property tax reform and school finance reform in 1995. That's why I don't go back years on on that but we have the same problem with our school aid fund, which is actually larger than our general fund. We've got about $15, $16 billion in terms of school aid fund, about $10 billion in terms of general fund. And you can see that we're essentially where we were at almost 30 years ago after the next two fiscal years of growth. So our buying power for education is similarly stressed.

And you can see some of that in terms of state government employment. Governments actually laid off a lot of employees with COVID. And particularly in Michigan, you can see we have not regained them. But in fact, all of the district states remain below the US average. So I think governments in the area have been cautious at rehiring. And they probably have some good reasons to do that because there's a lot of storm clouds kind of on the horizon for finances.

Part of the issue on state government is obviously the revenues coming in, but there's how much are you spending. And Michigan was being relatively cautious. We'd actually built up between unexpected revenues because the economy has been stronger than all of us have been forecasting. We started the last budget cycle with $9 billion extra money in terms of what we hadn't already budgeted, which is almost like being able to double the general fund. And about 2/3 of that was one time money so you'd want to use it for one time projects rather than funding ongoing projects.

And we did what a lot of states have been doing, which is carving it up into both one time things and ongoing things. So we did a bunch of major tax changes that will cost us ultimately billions. We did increase spending. We did some one time things that were called enhancement grants. We spent about $1 billion on those. And as a result going into the budget works for next year, that $9 billion is down to a little over $400 million. So we've definitely reduced spending on there.

And we've kind of piled on to the problem in terms of what we don't tax. We're not engaged with all the moving parts of the economy. I mentioned taxing services earlier. That's a big driver of the line. But we've now been going for more than a decade of exempting more of the economic activity in the state from taxation than we actually tax. And this graph does not include any of those tax breaks that were included on the previous slides.

One of the more notorious ones in Michigan is we had a tax called the Michigan business tax that became very unpopular. We repealed it in 2012, replaced it with a corporate income tax, but we had awarded during primarily during the '08-'09 recession a number of these economic development credits that were going to go on for 20-plus years. And we are still paying on those credits so we're costing ourselves about a half $1 billion a year in credits to incentivize firms and keep them from going under for a recession that's now almost 15 years old.

And we've also decided to send a whole bunch of general fund money somewhere else. And I'd only highlight really kind of the general trend here but if you look for the forecast years, we're looking at sending about 15% of our general fund revenue to something other than general fund activities. Makes budgeting a little bit difficult.

And we've got a lot of specific storm clouds. There's a lawsuit on the unemployment insurance agency. We don't know when that will hit revenues but it'll be about $150 million. We have a statutory provision that says that if general fund revenue grows by more than a multiple of inflation, you have to roll the individual income tax rate back.

There is a debate about whether that rollback has to be for one year or permanent. The attorney general has said that it's one year. She's been sued, arguing that it is permanent. If the state loses that suit, it will become an ongoing $600 million loss of general fund revenue.

The federal government's changing stuff on Temporary Assistance to Needy Families, which has the opportunity to hit us for another $400 or $500 million. The budget that we just enacted makes a bunch of promises that causes us some financial commitments that it's unclear how we're going to meet in future years regarding indigent defense and juvenile justice.

We also have an auditor general report that is looking at how we book taxpayer credit forwards. They want to change the way we've been doing it for the last two or three decades. And if they do, it will erase $1 billion from the budget on a one-time basis but it'll just vanish overnight. And we've got a whole bunch of legislation that produces, in many cases, unforecastable hiccups in revenues and/or is just simply expensive.

We could raise taxes. We have a constitutional revenue limit that says we can't collect more than 9.5% of personal income and all revenue sources-- taxes, fees, you name it. You can see that we were about at that limit at 2000. And we are forecasting it being in the vicinity of $12 billion below it over the current budget years. In other words, we could double the general fund if we went back to the same limit. I'm not saying that's politically feasible or economically or politically desirable, but from the viewpoint of the limits that we face as a state, we have some breathing room.

On the local level, they don't have a revenue limit but they definitely have a revenue problem. This looks at retirement obligations both for health care and pension plans as a share of own source or tax revenue. Obviously, you don't ever have to pay these in one year off. You do it over 20, 30 years sort of things, but the ratios here are pretty daunting at a local level.

And given that most locals get their money from property taxes, if you adjust it for inflation, property taxes are not doing a good job keeping pace with inflation, largely because of some constitutional limits that we have. And not everybody is getting the same property tax growth. Townships that have the least liabilities are doing great. Cities, and villages, and more urban areas that have the greatest liabilities are not doing well at all.

I'd like to finish up talking about some of those long term trends that Diane mentioned. I do think productivity is a big part of the issue. Your economic growth is obviously limited by how many people you have working and how productive they are. And for the seventh district, we don't rank particularly high on productivity over the 2012-2019 period. We did a little better during COVID. I didn't include that slide. But we've been sliding back to where we were at and that's why I thought this was a more relevant graph to kind of see that we've kind of got a productivity problem in the region.

We also have a population problem in the region. Michigan's finally kind of stabilized its population growth but it's growing faster than-- I mean slower than the rest of the United States. And they're old. Michigan has the 11th oldest population. The district itself doesn't do too bad spread out in terms of average age but you can see what's happening to Michigan's population.

This is just literally over the last decade. And demographically, things move very slowly. To see the average age go from 30 to 41 in 10 years is a pretty marked thing. Michigan nearly has a third of the population that is 55 or older. And we have other demographic changes. We've now moved into negative territory in terms of natural rate of population growth because of a combination of we have low fertility rates. And as the population gets older, more of them are going to die.

It's one of those things you can't escape, kind of like the drug stamp taxes that Texas has drugs and then dual arrows, death and taxes. You have to pay both. But we definitely feel like there's a problem and it's going to be here for 20-plus years. This doesn't look at working age population. This just looks at people people. And if you look at for every five year age cohort for the next 20 years, the group of people entering labor force age is smaller than the corresponding group that is entering retirement age.

And the path that we've been seeing in terms of net migration about attracting working age population has not been good. It's negative. And we don't see a lot of growth in working age population through 2050. If you look at those working age population numbers and you go back to the first graph I was giving you, we're not going to be at the 2000 level of employment in 2050. And with that, I will wrap it up. Basically, things look pretty tight at the state and local level and it's just going to get more tight because of population demographics.

[APPLAUSE]

THOMAS WALSTRUM: All right. David, this time I'm going to prioritize questions on Pigeonhole to switch things up a bit. And so I'm going to-- oh, we got one that was upvoted so I'm going to go for that one. And the question is, are there specific areas where jobs are particularly hard to fill for state and local governments? The poster suggested teachers or bus drivers noticing that, yeah, state and local government employment is still below where it was before the pandemic hit.

DAVID ZIN: Yes. Part of the issue has been governments having some reluctance to hire for budgetary reasons. But for the hiring they're trying to do, there's definitely the same kind of consistent things-- teachers, a lot of the education. And in fact, much of the growth that's occurring on that government line is occurring. Well, the line I showed you was for states so it's not going to include-- if I had put the local line up, it looks much more like the overall line, but IT is another area. Governments tend to not do well competing with private sector salaries, particularly for IT. So those are probably the two biggest areas.

THOMAS WALSTRUM: OK. And then we're pretty much out of time but I'm going to ask one more question from Pigeonhole here, which is, well, the question is about the IIJA which I believe is the Inflation Reduction Act but-- sorry. Oh, the Infrastructure and Jobs Act. That's what it is. Sorry. Got my acronym wrong. Question is-- I mean but I think we could extend it to the other kind of big fiscal stuff that came through in the last couple of years. How has that been affecting how Michigan's spending its money?

DAVID ZIN: Well, if any of you have driven in Michigan, every state likes to claim that they have legendarily bad roads. Michigan can actually rely on outside sources to say theirs are among the worst. And a lot of it relates to erosion of the funding base. Multiple times they have tried to go back and do things about that. The problem is kind of politics meets financial needs. And what's generally been adopted has been something along the lines of 50% of what was needed seven years before it actually goes into effect.

And so we phased in some funding increases and stuff like that to reach a target that was 50% of a number that we needed in 2012. And so Michigan has-- and of course, Michigan, like a number of older states, is dealing with issues with water infrastructure, sewer infrastructure, and stuff like that, not just roads. So Michigan has deployed a lot of that money. And that's one of the things that actually made it out of the legislature pretty quickly because I think the idea was, hey, we have a very long list on the Christmas list here of things and getting federal money for that was a real help. The biggest structural problem we have right now is getting enough construction workers.

THOMAS WALSTRUM: OK. Well, great. We'll stop there. All right. So we've got one last speaker for this round. It's Rhea Stephen. She is with Costar. And they do commercial real estate data. So I think everyone's been thinking about this sector a lot recently. So I'm excited to invite her up to talk. And I think we're going to have our tech come up and switch it over to the PDF. But after that, we'll have a few questions and have a break.

SPEAKER 1: Just bring it with you.

RHEA STEPHEN: Do you? Oh. You've got one right here.

THOMAS WALSTRUM: I'll just say what we're waiting here I think I'm going to stick with pigeonholes the way to go for entering questions. So please as they come up throughout the presentation, send them to me and I'll try to pick the ones that have the most votes. So thanks, everyone.

SPEAKER 1: It should still be on.

RHEA STEPHEN: I'm sorry. Look at that. It's working. Hi. I'm Rhea Stephen, a senior-- oh, you want me to use this? Oh. I'm used to walking around. Hey. How you doing? All right.

THOMAS WALSTRUM: These two aren't miced. This is the mic.

RHEA STEPHEN: Oh, that's so funny. OK. This is the best day of my life. I love it, embarrassing myself in front of the Fed. This is awesome.

THOMAS WALSTRUM: The online audience needs you to be miced.

RHEA STEPHEN: Yeah. Oh, I can see the-- look at that. OK. So commercial real estate. So when I think of commercial real estate, I think of office, industrial space, retail, and multifamily as rentals. So when we're looking at what's going on, we use similar words but we might use them differently.

Now does anybody here know the term absorption? OK. OK. Because that's kind of big with us. All right. So I was trying to think about how can I say this all in 15 minutes because usually my presentations are about a little over an hour. But if we were going to say anything about Chicago and the Midwest is that we do really strive for equilibrium between supply and demand. So as much as a lot of areas talk about population growth, we talk about almost like just in time inventory. So we're always maintaining that equilibrium.

And one thing that's really important is to learn about what structural vacancy is which is where it's kind of planned. Right. You know that you're only going to have a 15% vacancy or you know you're going to have a 5%. So it's understanding the dynamics of your market.

But there's no doubt that there's one particular sector that's been struggling in Chicago, which is office. And we're going to do not as well as tertiary markets, because our economy is really based on this CBD notion that central loop is the hub. Well, guess what, if the hive goes down, the bees are in disarray. So sorry. I didn't even mean that to be funny. But it's true, right? And so we don't really want a situation like other areas in the metro that relied on one thing.

We have a very diverse economy, as does Minneapolis. But when you're relying on one sector, that can really go down. So that's always what has preserved Chicago. But having a central business district that isn't a monoculture has really been a drain. And it's also been a drain that we had oversupplied in that particular asset type. But the other ones have always been just in time a little bit.

So we are seeing pivots. We are seeing changes happening in the economy, some really fantastic ones like Allstate campus turning into Dermody. We finally got the Sears property sold. That's going to become data centers. That was not sold on a per square foot basis. That was sold on an acreage basis because it was a land deal when the prices got that low. So we've got a lot of it's called jingle mail. Have you guys ever heard that? I just learned a couple of weeks ago. It's when you're sending in the keys in the mail. Yeah. Have a nice day. You know, jingles.

So what we have here in a situation with one of my lines, sometimes we're underdemolished, not overdeveloped. And that's really a point of like retail learned that a long time ago when e-commerce started coming in, we started seeing across Chicago massive amounts of demolitions and just starting all over. That's harder to do with office because we have beautiful gems in the central loop that we don't want to just tear down.

We've got the Robert Morris building just down the street. That's vacant. So we've got some real issues. So the eyesores don't necessarily-- they're not as obvious as the suburbs but the suburbs can actually do something about it. They can demolish. Being able to do it for a different-- having that square footage of I mean where the facilities are, it's a lot easier to repurpose than in the city.

So cap rates-- so sales, it's the lowest in 30 years. It keeps going down but I am seeing some ticking up. And why is that? Because the cap rates are going up. So cap rates are sort of like your net operating income at the one year marker. So if you have a 10 cap, that's a 10% return on your investment. If you have a four cap, it's only a 4%. Right?

So investors generally choose the four. And why? Because it's a safer bet. So when there's a 10 cap, it's like, ooh, what's wrong with it? And guess what. There usually is something wrong or, probably more importantly in today's situation, it's uncertainty because when you know where the property is going, then if you can build that into it, then, for example, the Sears thing, look, we tried to lease that out. Got it. Tear it down.

But uncertainty is what you don't know is going to happen. And so the dry powder, it's totally a thing for 2024. So in commercial real estate, by the way, we generally, full disclosure, we're not communist adjacent. I just want to put that out there. I have a son who is communist. Full stop. So we love each other but I just go, uh huh.

But anyway, so dry powder, it's the opposite situation because who can step up are the high net worth individuals or firms that they don't need to get a loan. They've got a lot of dry powder and they're just going to deploy it because now that anchor has dropped but, guess what, it is going to drag on that lake floor for a while. And this is an opportunity to buy. This is the best time to buy. The question is, how are you going to get them the loans to do that.

So uncertainty. Biggest problem in commercial real estate. And what do we have? Consumer spending. On durable goods, we're seeing people spending it on activities but they don't want things. Interest rate hikes climb and then all these other things. Right? OK. So however, we are seeing certainty in the market. We are seeing that tenants and occupiers are actually saying, this is how much space I need.

So we are seeing-- and for office space, we are seeing an uptick in leasing, but guess what, those deals are smaller. And we have a much-- we have a bloated inventory. I was covering-- in my previous role, I just did office space. And in 2018, I was going, OK, I get it that we need more, but do we really need 13 million square feet in the CBD? And not saying that I was right but I was.

And so it was going up. Like I'd just see those vacancy levels going up. It's like, yeah, because we don't need this much. And then COVID hit. Well, guess what. Shovels were already in the ground. So we just had to keep going forward. Well, now we're starting to see this kind of scaling back. And I'm very proud of my MSA that the only things that we really have under construction for office is medical lab space.

OK. Sellers even more insensitive to price because they have to sell at any price because every day you own that property is another day you're having to maintain it. So you could say, oh, I'm going to hold off because next year it will be a better year. Meanwhile, you just had to spend capital expenditures. You just had to pay broker's fees. Your elevator broke down. So all that money that you had to spend, are you really going to get it when you sell? So now we're getting-- that's why the jingle mail. OK.

So what we are seeing though across all property types, honestly, is asset management, which is intelligent. OK. I'm going to have to hold on to this. I better streamline my operations. It's not just about I'm going to just buy it and sell it. And you know, what's it called, flip it. That's the word.

OK. So what do we have in Chicago? We've got union issues, municipality red tape. It's why things are so difficult to get done here. A lot of development firms are like, I don't want to work in Chicago because I don't want to have to deal with all of this, specifically, honestly, union wages because they're not communists.

OK. So we got distribution, bottlenecks, material costs, recession, consumer spending, uncertainty. Uncertainty is the biggest thing. But it really doesn't matter if you can't get money. So interest rates up, capital lending down. Blah, blah, blah. We've got canceled, delayed projects.

So guess what. That actually could be a good thing. It's what saved us because across the country and not in the Midwest, we are seeing overdevelopment across all asset types and we really don't have that in Chicago because, OK, maybe because of other issues, but we didn't get this issue. And our developers really strongly believe in equilibrium. And I see it across the board how Chicago behaves honestly like a machine. You can almost predict the trends of development.

So then there's the function of reputation. So anywhere but Chicago, I hear that all the time. All the time. And I want to say that thing that Johnson says. You know, shut up. Get my city out of your mouth. I feel like that all the time. But then somebody said this other thing. You date Austin and you marry Chicago because it's stable. Like Austin, ooh, I'm going to chase this high rent growth. Guess what. You think that's durable? Right. And where are you getting your water, buddy?

So you got to think about these things. And we also have to think about the environment. It's like living in a place like Chicago, it's $13,000 to own a car every year. You don't need one. We have mass transit. We have a lot of-- with the density, it's better for the environment and it's better for a lot of things. And so one of them-- and I'm not going to go on a bender even though I'd love to-- is middle market missing middle housing, which Chicago does really well, which is basically having that density and different levels of affordability.

OK. So what are buyers looking for? Sale leasebacks, which is really a mechanism to get it off your balance sheet. Well, that's usually a retail ploy. And retail is not expanding the way it used to, or the players who generally own their assets and then flipped them aren't really playing this game anymore, like Walgreens and CVS. They are actually divesting. They're shrinking their footprint.

So what are they looking for? Credit tenants with long term leases and with little to no termination rights. We've seen that where, oh, we're going to buy this single tenant building and it only has, oh god, who is that firm? Oh, Caterpillar. Right. Oh, great company, and then, guess what, they decided to move to Texas and now there's this sublease on the market so it's not that great deal that it used to be.

So you look at the fine print. 10 to 15 years was good before. Now we're seeing 15 to 25, really looking for longer term leases. But we're also looking at termination rights. How easily will it be for them to get out? I forgot how much-- it was in the millions Groupon-- right? Yeah. Groupon just paid to get out of their lease. It was on the sublet market for a couple of years. So these are the things we're looking for. Creative financing. What I hear on the street is if you don't offer financing, then the deal doesn't get done.

So yes. That's kind of this whole thing about the right price, right location, redevelopment for highest and best use. So that's kind of going on with these data centers. Now what helps that is that there was this act that was passed relatively recently to-- they were taxing data centers through the roof and they decided not to do that. And so now we're seeing that come back. And that's a very strong sector I believe in because we actually have-- unlike Michigan, we have a really great infrastructure.

We're top of class one or two in the nation usually. And a lot of it has to do with the cabling going along with the train racks, train lines to get for cabling, which really helps with the infrastructure of Chicago. And there really is a lot of dry powder out there. Chicago is undervalued. And it's because getting so caught up in that we're a low growth state or even just honestly the whole metro. And it's because we're stable. And so it's like, yeah, your returns.

Let me give you a quick example. And we are exceeding rental growth across all asset types except for, well, office. But hello, office. So anyway, it's my Newman, right? So anyway, so we're seeing rental growth top of the nation. It's on the top 10 percentile. Why? Because we didn't really go so high so we don't have to get back to a new normal. So your 21% rent growth in Tampa Bay. Was that durable? No. Of course not. So the investors that would come here, they were looking for stable returns.

So what's my time like?

THOMAS WALSTRUM: Got about five minutes at the most.

RHEA STEPHEN: OK. All right. I already did that. OK. So I will not be going through my whole presentation which is fine. So US residents within a four hour drive. I like this slide because it kind of highlights what's going on, why Chicago could be really desirable, is that outside of Lehigh Valley, we have the highest-- we can reach the most people. A very close second though is Columbus.

Well, guess what. Columbus is seeing a huge growth right now because this slide must have gotten out because they get to see, wait a second, I can save money and go to Columbus or Indianapolis and get to goods to the same amount of population or not quite as quickly as Chicago but I can do it pretty well. So Lehigh Valley, which is kind of going toward-- it's hitting the East Coast.

But what's been happening-- and somebody addressed it here-- the strikes on the ports, port activity, has really helped the middle of the country because if you can't get goods in, it's like we're going to reshore and then where's a great place. Who already has the distribution network set up? Chicago does. The midwest does. So we're doing very well with industrial space.

So what I did was instead of trying to put everything separate, I put all commercial real estate property types into one chart. So when we look at a stabilized vacancy, you can see that if we go from 2020 to '13, I would say that the average vacancy rate is about 8 and a quarter. OK. So you could see that putting all the asset types together, we are below our equilibrium. So we are in a good place.

Now actually, what's really bringing this down is office, whose equilibrium beforehand was 12%. It's now at like 19%. OK. That's a big jump. And yet even that can't really bring down the market. OK. So we see this big spike of development that happened in 2023. Right. Interest rates shoop. Right. Those shovels were already in the ground. Zhoop. And this is even more dramatic when you see the construction starts. It just plummets.

All right. So I'm going to go-- I'm not going to-- I'm only going to cover multifamily because you guys addressed some things here that I want to address. So here we're looking at most markets at risk for multifamily oversupply. So Indianapolis and Columbus. These are these areas that may have grown too fast. But four and five star-- so CoStar, we have a very consistent measure of how we say a four and five star is, so it's like has a pool of certain kinds of amenities. Do they really need that Indianapolis? Right?

So Chicago, if you look at, because I look at the data all day long, our developments are actually what people want and at a price point. They're just a little bit more realistic. So we will have new construction that's a walk-up. And that's OK. It's what the market wants.

So this is my last thing I just really want to hit home because this is really important. So when we look at population, population is going down for sure, but household growth is remaining flat. This is really important concept to understand because Chicago's multifamily market is fantastic. All right. And it's because if you have a family of five that moves out of state, that's one household. And guess what. It was probably a single family home that was owned so it doesn't even affect the rental market.

Meanwhile, a different family, they get divorced, one moves out and is renting so that's actually a household gain. So where we're seeing-- so the reason why-- so Chicago actually does have household gain. And this is our slide showing my equilibrium. OK. Here we go. So this is where we're looking at construction levels. We dropped from our heights of 2018 and '19, we dropped by 57% construction. No other major market has dropped except for Los Angeles, which dropped by 15%.

OK. And they have the same issues that we do, which is politics. They have a hard time-- they have a housing crisis and they can't get new construction built. So they have their own story. So if we're looking at this, even everything across the board is going down, including three bedrooms is going down the most. But here if we look at vacancy, vacancy is actually dropping with studios, one and two bedrooms, but the three is going up. Why? Because household expansion.

So that's so much more of an indicator and the points that Diane was making about 40% of home mortgages being paid off and the millennials kind of getting the bad end of the deal, well, guess what, that's good for the multifamily market. OK. Oh, really sorry you have to rent again. Right? And so that's why you could say this four and five star demand could go up. These people are like, well, if I have to rent, I may as well live well. So that can be just a whole big thing.

And lastly, because I know you guys care about-- OK. So this is Chicago office jobs declining along with their move in. So it used to be office job creation would create absorption or positive movement, but then it just got disjointed with 2020. And this is a slide-- this is from Kastle Systems just showing the Chicago metro. We're at 52%. This is sticking-- of 2019. This is sticking. This is not going away. So what are we going to do with all this surplus?

Well, so here's this. So look at this. Yeah. OK. Fine. We're at like 16%, 17% now. But I have to say that we include owner-occupied assets whereas brokerages don't so this number is significantly higher by a good 300 basis points if we took out the owner-occupied. But we do have more office leasing. The problem is just the size. So we are seeing surety. We are one of the few markets that are actually seeing more deals getting done.

All right. So this is kind of going on to this point about structural vacancy. And just one other thing I want to teach and then I can stop is that so if you look at the historical vacancy for Fulton market, it was just below 12%. But then it went up the five-year structural vacancy shift went up to above 16%, so it kind of got really big at the right time in a way because knowing that if the writing into it that we know we're going to have-- it's going to be harder to lease it, they're going to lower their expectations. So when it goes below it, so when that vacancy actually goes below that number, that's when you're going to have some positive effects. And that's why this market is actually having positive absorption even though-- or positive move-in even though the vacancy levels are so high.

So in conclusion, the markets that-- what you need to do is you need to get your cost basis down to be able to lower your rent, or to maybe sell it for land, or you do what Houston does which just keeps building because it's the five star, it's the trophy properties that people want. They don't want the four star. They want the five. And so Houston is always building. Yes, they have a higher vacancy but they have a higher structural vacancy rate, too. And that's why that market can be kind of healthy. And I think I'm going to stop here. Is this good? Am I over?

THOMAS WALSTRUM: We're good. Thanks.

RHEA STEPHEN: I'm clapping for myself. I survived.

THOMAS WALSTRUM: All right. I'm going to ask one quick question and then we need to break because we're running a little late. So [INAUDIBLE] I wanted to ask you was someone brought up this idea of vacancy taxes in both residential and commercial real estate as a means to reach equilibrium. What are your thoughts on that and then we'll go to break?

RHEA STEPHEN: So I actually took my opinion off the slide. I'm like, you know, Rhea, don't go there.

THOMAS WALSTRUM: You don't have to answer it.

RHEA STEPHEN: You know, I mean, it's, OK, let's make up an example. Let's say, there's a town that has 30% vacancy and let's just say this town has this big eyesore and they're like, yeah, we understand we're at 30% vacancy but we're hoping somebody's going to come in and fill it because we want to tax the heck out of them. Right. That's not really very motivating. And it's like sometimes you have to kind of move on from that, that maybe commercial real estate isn't your savior.

THOMAS WALSTRUM: All right. Very good.

RHEA STEPHEN: Did I say--

THOMAS WALSTRUM: That's a great way to finish. We're going to stop here.