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ANNIE BAXTER: I'd like to bring you along on a summer road trip of an unusual variety. We're headed out in search of the first signs of the recent slowdown in Minnesota's economy. Here's why we're doing this. All the economic indicators are blinking red. Gas costs $4 a gallon. Food prices have been up 5% over last year. And US payrolls have shed more than 400,000 jobs.

As early as January, Minnesota's state economist had seen enough to say the state was already in recession. It's tough times for a lot of people. And a big question is, how and where did it all start? To find out, we're going to have to do a lot of driving around the state, throughout the metro area and suburbs. Let's get the windows down.

I've done the research in advance so I can fill you in on the details along the way. I promise you don't have to pay for gas or eat any bad road trip food. Actually, our first stop is going to be at a restaurant right here. I hope you like Japanese.

STEVE HINE: I'm going to try this Oyakodon

ANNIE BAXTER: This is Minnesota State Labor Market Analyst, Steve Hine. He works just up the street from the Saint Paul sushi joint. So we're catching him over his lunch hour. Hine's actually going to give us some tips for where to look for the first signs of the economic downturn. Hine says in other slowdowns, Minnesota held up much better than the country. But in the last recession, Minnesota's economy fared no better than the national average. And from there, things just got worse.

STEVE HINE: 2001, we were lockstep with the nation, and now we've slowed down earlier and more substantially so far than the nation has.

ANNIE BAXTER: In 2001, Hine says, it was the bursting of the dotcom bubble that triggered recession. This time, Hine says, it was the collapse of housing and a drop off in new home construction that dragged both the Minnesota and the US economies down. This is at first a bit perplexing given the housing industry's relatively small size.

If you look at Minnesota's 3 million workers, only half or 3/4 of a percent are typically employed in the homebuilding industry. And residential construction only accounts for a sliver of the overall US economy. But a lot of other industries hinge on housing like, wood products, manufacturing and mortgage brokering. So when housing stumbles, they get scraped too or worse.

Just look at the crisis of confidence that hit the mortgage giants, Fannie Mae and Freddie Mac and forced a government rescue. For now, let's focus just on the Minnesota economy. Here's a sneak preview of when trouble emerged in the state.

SPEAKER 1: Things started to unravel in early 2007.

ANNIE BAXTER: Your layoff came when?

SPEAKER 1: 06, August.

SPEAKER 2: We started feeling it kind of in the spring preview, early 2005.

ANNIE BAXTER: Perfectly unanimous answers. Well, it turns out that this is pretty complicated stuff. And in order to nail down when and where the trouble really did start showing up, we actually have to go back several years to housing's boom times. In other words, to the time when builders and others were laying the foundation for the downturn.

For that, we're heading to the Twin Cities suburbs, in the year 2003. We really get a lot of wildlife around, a lot of birds.

TODD BIERSTEDT: It's a spectacular neighborhood.

ANNIE BAXTER: We're tagging along with builder, Todd Bierstedt, as he tools around in the town of Woodbury. It's an area where his homebuilding company did a lot of business. Bierstedt is a stocky guy with a beard and glasses. He drives a white Chevy pickup and keeps it tidy.

There's a Bible and a nook near the radio. Bierstedt pulls up to a cheery, multicolored house across the street from a pond. As the wind whips around us, he says, this house is to him, a symbol of the best times in his industry. He finished it five years ago in 2003.

TODD BIERSTEDT: So it was at the years when construction activity was literally peaking right at that point in time.

ANNIE BAXTER: Bierstedt is this great person to talk to for insight about housing's heyday because of the two hats he wears. One is the hat of a guy who worked as a builder for 21 years, call it a hard hat. But he's also an expert on housing. He's been tracking industry trends with a company called Market Graphics. So with his expert hat on, Bierstedt says, at the start of the decade before the boom, builders were framing up an average of 12,000 to 13,000 new houses.

TODD BIERSTEDT: And it just kind of snowballed in the years of 2003 and 2004, building in excess of 23,000 homes per year. So we had almost-- in just those two years alone-- almost a 10,000 per year jump in new construction.

ANNIE BAXTER: The new homes were selling for several reasons. The state's population was growing. Interest rates were dropping to historic lows. And speculators were hungry for investment properties. Those were pretty good days to be a builder. Todd Bierstedt says, he didn't go on a spending spree, but he did pay down some debt and was enjoying financial stability. That was also true for a logger up in the northern part of the state. That's our next stop. Hi there. Are you Wayne?

WAYNE SCOY: Yeah.

ANNIE BAXTER: Meet Wayne Scoy. He's the owner of--

WAYNE SCOY: Scoy Lumber and Timber, which consists of a retail operation and a wholesale logging company.

ANNIE BAXTER: We're now in Northome, about 45 miles Northeast of Bemidji. This is logging country, where signs advertising log homes dot the highways. Wayne Scoy's livelihood is closely linked to the housing industry. His lumber yard supplies builders. And the timber from his logging operation feeds area mills which use the wood to make building products. So when homebuilding soared, so did his business.

WAYNE SCOY: The housing market was going. It was just an absolute crazy time.

ANNIE BAXTER: It was crazy for a lot of reasons. For one thing, there was intense pressure from mill operators. They worried that with new home construction on a tear, they might not get timber fast enough from loggers like Wayne Scoy. So the price of Scoy's timber shot up along with demand, but so did his own costs. Landowners were eager to cash in on the housing boom. And they started to charge Scoy more for the rights to cut down standing timber or stumpage, that he'd then sell off.

WAYNE SCOY: The price of stumpage went from $40 a cord to $100 a cord in the course of a few months.

ANNIE BAXTER: Scoy paid those high prices for stumpage, but he knew he'd be in trouble if the boom ended and prices for the timber he sold fell back to normal. So Scoy felt anxious about the housing boom. There was always a voice in his head saying something like this--

DIANA CARTER: This is artificial. This is not real. Is there going to be a bubble. What's going to happen?

ANNIE BAXTER: Of course, that's not Wayne Scoy. That's really Diana Carter, the CEO of WinStar Mortgage Partners. Like Wayne Scoy, Carter found the good times in her industry profitable but nerve wracking. She founded WinStar in 2001 after years in the mortgage business. We're catching up with her in Plymouth, where she based the company. Carter is a muscular little bullet of a woman, who speaks so fast. It sometimes seems like she's saying two sentences at once.

DIANA CARTER: At least we didn't-- we never did any subprime at WinStar.

ANNIE BAXTER: Carter didn't offer high risk subprime loans. But she did get tied into a kind of mortgage that's a step between subprime and more traditional loans. The in-between mortgages are called Alt-A loans. She got pressure to do those loans from the national mortgage lender, Countrywide, which was a key partner for WinStar.

Countrywide would buy some of WinStar's loans, bundle them with other loans into bonds and sell the bonds to investors. Those investors were hungry for new potentially lucrative places to put their money. So they were asking mortgage lenders to keep sending bundles of mortgage debt their way. Countrywide obliged, and pushed Carter to get on board with those risky Alt-A loans.

DIANA CARTER: Some of their top executives were saying, you need to look at expanding your product mix if you're going to increase your profit margins. I'm going, I don't think so. No, I don't think so.

ANNIE BAXTER: Carter hesitated because the home-buyers applying for Alt-A loans might have good credit scores, but they didn't have to show much proof that they could actually repay their loans. But Carter says she eventually felt like she had to do Alt-A loans to compete in the marketplace. So she started to offer them and did well initially. However, it was a move she would later regret.

DIANA CARTER: We basically put a target on our chest and said, here, hit me.

ANNIE BAXTER: Diana Carter and the other people tied to housing did well during the boom times of 2003 and 2004, but their queasiness about how long the good times would last was well-founded. We're getting to the point in our journey where some of the cracks in the economy started to emerge. Hang on tight because the ground gives way pretty fast.

We're now looking at what was happening in the spring of 2005. To jog your memory, the movie, Mr. & Mrs. Smith was coming out. During filming, stars Brad Pitt and Angelina Jolie became friends.

SPEAKER 3: Their identities are a secret, even from each other.

ANNIE BAXTER: Gas was less than $2.50 a gallon. Unemployment in Minnesota was in the low 4% range. Pope John Paul II passed away that April. And about the same time as all those other events, Twin Cities homebuilder, Todd Bierstedt, was finding himself in a bind. We're back with him and his white Chevy pickup. He's pulling up in front of a model home in Woodbury that functioned as his company's main office at the time.

TODD BIERSTEDT: I was in that modeling right when I first began to hear the incentives being tossed around out off the marketplace.

ANNIE BAXTER: The incentives Bierstedt is talking about were a sign that the new home market was starting to collapse. Other builders were offering all sorts of extras like free granite countertops and no closing costs, which essentially amounted to price cutting on homes that weren't selling.

TODD BIERSTEDT: And that's very uncommon in this market, but it happened starting in 2005.

ANNIE BAXTER: But Bierstedt couldn't afford to cut his prices to match other builders, and he fell behind the competition.

TODD BIERSTEDT: My sales went from roughly 20 homes per year down to one or two per year, almost overnight.

ANNIE BAXTER: At the time, Bierstedt was totally baffled. Builders were still pulling plenty of permits to start new homes. The housing market looked really robust.

TODD BIERSTEDT: Somebody called the timeout. I wasn't ready.

ANNIE BAXTER: Keep in mind, this is spring of 2005. It's way earlier than what most people usually associate with the housing downturn. But another builder, Hans Hagen, also saw trouble just a few months after Todd Bierstedt did. Let's hop in Hagen's car and head to where he saw the cracks appearing.

HANS HAGEN: We're going to Blaine. It's a development called The Lakes in Blaine. It's a large development, probably the largest in the state of Minnesota.

ANNIE BAXTER: Hagen is a trim, sandy-haired man with a grandfatherly manner. He's run his building company for 40-some years. And he was working at The Lakes three years ago when the market shifted.

HANS HAGEN: In August of 2005, we saw the first change for probably the preceding four years and there was slowdown in new orders.

ANNIE BAXTER: Hagen, typically builds a house only if it's pre-sold. He seldom takes the approach of, if I build it, they will come. So when his orders started to drag, he paid attention, and he built fewer houses. But other builders appeared to keep building. They were banking on a steady stream of buyers, but the stream started to dry out. And the inventory of available homes rose. Hagen says it was clear what was happening.

HANS HAGEN: The supply and demand got out of whack.

ANNIE BAXTER: You could chalk it up to a few things. One of the most important-- according to State Economist, Tom Stinson-- is that demand went down as interest rates went up.

TOM STINSON: At higher interest rates, fewer people could afford to buy that house. You could draw fewer people into the housing market.

ANNIE BAXTER: Higher interest rates made home buying costlier, and home prices kept climbing too. They didn't peak out until 2006. In the meantime, household incomes weren't growing enough to offset all the rising costs. This all spelled job cuts. Job growth in residential construction went negative in Minnesota in mid 2005. That's about a year and a half earlier than the national average.

Why Minnesota's housing industry dropped before the nation's, still has economists scratching their heads. But in any case, people working in industries tied to homebuilding felt the effects of Minnesota's housing downturn pretty quickly. And that takes us back up to Northern Minnesota. If you ask logger, Wayne Scoy, when his business suffered from housing's downturn, he in turn asks his worker, Mel.

WAYNE SCOY: Hey, Mel, when did-- it was in October or November? When did the price of that would tumble like that?

ANNIE BAXTER: And they decide it was fall of 2005. That's also when the mills that rely on Scoy's wood, saw the prices for their products start to slide. We're in a mill in Bemidji, where raw timber bumps along a conveyor belt. It's on its way to a toothy steel jaw, chewing fast. It chops the wood into strips. And eventually, the wood strips are layered and glued together in sheets.

The end product-- oriented strand board-- commonly winds up in roofs and floors. This mill is owned by the Canadian company, Ainsworth. At one point, Ainsworth employed about 500 people at its three plants in Minnesota. The company's oriented strand board started a drop in price in late 2005. The next August, Wendy and Chaz Boyer came home to a voicemail from the Bemidji plant where they both worked.

Wendy Boyers, a slender woman with shoulder-length blonde hair and blue eyes that look out anxiously, as she recalls what happened that day.

WENDY BOYERS: It was our day off. We were out running errands. And we came home and there was a message on the machine that said, there was going to be a meeting at the high school the next day. Don't worry about coming in to work nights, that next night.

ANNIE BAXTER: Boyer says they were both pretty puzzled. But they headed over to the high school auditorium the next day. They were among the last people to enter the room. Wendy Boyer says she noticed there were police present. And then an Ainsworth official addressed them, saying--

WENDY BOYERS: Those of you whose names are called, stay here. Those whose names aren't called, proceed to The Hampton Inn and you'll get your new work assignments.

ANNIE BAXTER: The people whose names were called were losing their jobs.

WENDY BOYERS: My name was called.

ANNIE BAXTER: After more than two decades at the mill, Wendy Boyer was out of a job. Her husband, however, got to keep his job, and had to leave her there at the school. What did he say to you? Do you recall?

WENDY BOYERS: He just gave me a kiss.

ANNIE BAXTER: Ainsworth closed one of its two production lines in Bemidji, and laid off 110 people that day in August of 2006. The company eventually chopped another 300 jobs by idling its mills in Grand Rapids and Cook. By that point in time, the signs of the housing market's weakness abounded.

Residential construction employment had dropped by nearly 10% or 2000 jobs since its peak two years earlier. And the wood products manufacturing industry had dropped by about 5.5% since its peak a year earlier.

TOM CRANN: You're to All Things Considered on Minnesota Public Radio news. I am Tom Crann. In this half hour, Minnesota slowdown, a special report on the origins of the state's economic downturn. In early 2005, the important housing industry started to stumble in Minnesota. And the weakness spread into the state's wood products industry. Eventually, the downturn took hold at Diana Carter's mortgage business. Here again is Minnesota Public Radio's, Annie Baxter.

ANNIE BAXTER: The boom in homebuilding got lots of fuel from easy credit, including subprime and Alt-A loans. But many of those loans went to people who couldn't afford to pay them. And by 2006, the subprime market was faltering under a crush of loan defaults and foreclosures. But the Alt-A market-- which is a step between subprime and traditional loans-- didn't look so bad yet. So Diana Carter-- who sold Alt-A loans at her mortgage lending company WinStar-- was still upbeat about her business.

DIANA CARTER: In December of 2006, I was working with my staff to really to invest in growth, to add more salespeople, to really increase what we were doing.

ANNIE BAXTER: Despite Carter's optimism in '06--

DIANA CARTER: Things started to unravel in early 2007.

ANNIE BAXTER: Investors who had been hungry for mortgage debt were now getting skittish. Given the rash of defaults among subprime borrowers, investors feared that Alt-A and traditional loans would go bad too, and that they'd lose all their money tied up in mortgages. And by the spring of 2007, the investment banks-- which had acted as intermediaries between investors and lenders like WinStar-- wanted out.

They were catching grief from investors about selling them bonds that held bad mortgages. When the investment banks pulled back, Diana Carter had a big problem.

DIANA CARTER: So it may have been 15 places I could have sold the loan on January 1st, that the end of March, they're either zero places to sell them or one place to sell them.

ANNIE BAXTER: And one day in March of 2007, one of Carter's managers came into her office and said--

DIANA CARTER: We have about $4 million of unsaleable mortgages.

ANNIE BAXTER: Now, in the past, if Carter couldn't sell a loan to one of the usual buyers, WinStar would just turn to what's called a scratch and dent company which would buy the loan at a discount. WinStar would take a haircut of maybe 1% or 2%, and it wasn't really a big deal. But now the manager told her, the scratch and dent dealers were charging about 10% to buy WinStar's bundle of loans.

DIANA CARTER: I said, well, do you understand 10% of $4 million is $400,000? He said, yeah, that's a lot of money, but yeah.

ANNIE BAXTER: But the unsaleable loans kept piling up. They went from $4 million to $8 million.

DIANA CARTER: To 10 million.

ANNIE BAXTER: To 14 million.

DIANA CARTER: To $20 million of loans that we could not sell.

ANNIE BAXTER: The result, today, Carter only sees her WinStar office from the outside looking in. She ambles over some rocks to peek through the front window of the space her company used to occupy.

DIANA CARTER: Oh yeah, now they've stripped it all.

ANNIE BAXTER: All the walls have been torn down, and the desks are long gone. Carter closed WinStar a year ago after a wave of default and foreclosure notices swamped the business. WinStar wasn't alone. By 2007, lenders nationwide had accumulated hundreds of thousands of foreclosed properties on their books, with about 38,000 of them in Minnesota, according to a report by Housing Link in Minneapolis. Sometimes lenders unloaded the homes this way.

SPEAKER 4: Here we go. And we got an opening bid at 10. Go to 20. [INAUDIBLE]

ANNIE BAXTER: At this foreclosure auction in North Minneapolis, bidders could snap up neighborhood properties for low amounts like $30,000.

SPEAKER 4: $30,000 and about 30 on the mound. 30, 30, 30 there to go.

ANNIE BAXTER: Now, it turns out that in Minneapolis, at least, more than half of those foreclosed properties belonged to investors. Maybe to a landlord who rented out apartments. And when those landlords went into foreclosure, some renters got dumped on the street. We're headed next to a place that took them in.

This is a homeless shelter for families called, People Serving People. It's in downtown Minneapolis. And we're here in the cafeteria at breakfast time. At the end of last summer, the shelter saw a big spike in clients. Eventually, the shelter's workers figured out that a surge in foreclosures against landlords was forcing renters out on the street.

YVETTE BLANTON: The landlord didn't tell me the house was under foreclosure.

ANNIE BAXTER: Yvette Blanton sits at a table in the shelter's cafeteria. Her hair is pulled back in braids and her hazel eyes are unblinking. She had been renting a home in North Minneapolis and lived there with her kids. When she eventually found out her landlord was being foreclosed upon, she thought she had some time to move.

YVETTE BLANTON: But the water and lights got shut off. So I had to hurry up and move. And I didn't have no money to get a truck to move stuff, so everything is gone.

ANNIE BAXTER: You lost all your stuff?

YVETTE BLANTON: Yeah. I'll get it again. It was just stuff. I'll get it again. As long as I got me and my kids, I don't mind.

ANNIE BAXTER: In a lot of ways, foreclosures have come to symbolize some of the worst turmoil in the housing industry. But State Economist, Tom Stinson, says, foreclosures alone don't have the power to pull the economy down. Even when you combine them with all the job losses in home construction and the rest of the housing woes, Stinson says, it's still not enough to cause a recession. He argues that the economy could have sustained all those shocks if it weren't for fuel prices skyrocketing and another even more serious issue.

TOM STINSON: The housing problems eventually triggered the credit shock, which is really the biggest part of what's going on here.

ANNIE BAXTER: The housing problem spread to the credit industry through risky mortgages like subprime and Alt-A loans. University of Minnesota Finance Professor, Andy Winton has this analogy.

ANDREW WINTON: Think of loans as being like homes. And think of subprime loans as being homes that were built out in the middle of the woods in an area that often has forest fires, and were built of somewhat more flammable materials than usual. People said, well, fire isn't an issue because we've had a bunch of rainy years the last few years. So we don't have to worry about another drought and forest fires being an issue. Then a drought came along, and those assumptions seemed to not work as well.

ANNIE BAXTER: And then, Winton says, as those homes started to catch fire, they spread to other developments.

ANDREW WINTON: And as the fire spreads, the risk of fire in other areas becomes greater. We even have a risk of fire in areas that are normally thought of as safe, because they're next to a subdivision that was in a more risky area.

ANNIE BAXTER: Last July, one of the big investment houses on Wall Street got scorched. Two Bear Stearns Hedge Funds laden with subprime mortgages had pretty much lost their value. By then, Wall Street was already fretting about the safety of mortgage debt. The Bear Stearns event stoked those worries all the more and prompted abrupt changes at our next stop, this commercial mortgage office in Bloomington.

EDUARDO PADILLA: First week of August of last year, suddenly the phone started ringing.

ANNIE BAXTER: This is Ed Padilla, the CEO of NorthMarq Capital Partners. The firm helps arrange financing for commercial real estate deals in 29 cities. Padilla says, the lenders who supplied him with funding got spooked after the Bear Stearns implosion.

EDUARDO PADILLA: Everyone calling and saying, they're canceling their applications, they are changing their commitment terms, increasing rates, lowering loan amounts. And there was not any question that something was going on in the marketplace, very dramatic and happening very rapidly.

ANNIE BAXTER: Padilla was shocked when companies like Lehman Brothers and JP Morgan Chase-- which had been reliable sources of capital-- suddenly got gun-shy just as they had with Diana Carter's residential mortgage business. The thing that really flummoxed Padilla, was that commercial real estate didn't have the high default rates the residential side was racking up. But the commercial side was still taking a beating. And despite that beating, it's clear Padilla hasn't lost his sense of humor about it. What did you go home and tell your wife that week?

EDUARDO PADILLA: I think it was there was something along the line of the party's over, the good times. It's time to change our perspective.

ANNIE BAXTER: The difficulties in the credit markets mean Padilla's customers, manufacturers, retailers and other kinds of businesses are having trouble expanding. Now, they might also be holding off on expansion plans because the economy is slowing, and they have fewer customers. But even if they want to expand their facilities, the capital isn't readily available. State Economist Tom Stinson says, tight credit is playing a big role in the downturn.

TOM STINSON: The most recent GDP numbers show that business investment fell from the fourth quarter to the first quarter. And so it is having an impact.

ANNIE BAXTER: This all hurts the economy, because when business growth slows, so does job growth. And the nation's overall output dwindles. Ed Padilla says, the glimmer of hope in this situation now is that the sources of funding haven't run dry altogether. There's still foreign money to tap. And Padilla thinks in a year from now, the markets will clear.

In the housing industry, some have a similar level of optimism. Builder Hans Hagen, started seeing more customers this spring. But builder Todd Bierstedt, doesn't have such positive news to report about his business which remains shuttered since it closed in 2006. Bierstedt is trying not to beat himself up over his losses.

TODD BIERSTEDT: It's a very humbling experience if not humiliating experience, but in the end, it is what it is.

ANNIE BAXTER: But Bierstedt is also starting a new chapter. He recently landed a job as a project manager at a remodeling company. That's a career switch a lot of builders have made while people improve their current houses instead of buying new homes. Diana Carter, the former CEO of the mortgage company, WinStar, has also moved on. Which means she's moved back to her old job. She returned to the mortgage company she used to run with her husband, and she says they're doing well, in part because of their strong staff.

DIANA CARTER: They've been good gatekeepers. They've helped to make sure that we've done good loans, that we have not allowed loans to get through that where they were more likely to be problems.

ANNIE BAXTER: Up in Bemidji, Wendy Boyer, who was laid off from the oriented strand board mill, is studying to become an administrative assistant. She thumbs through a pile of books on her kitchen table.

WENDY BOYER: It's how to run a project, this book. And how to keep costs in control and scheduling and--

ANNIE BAXTER: Boyer's husband, Chaz, is still working at the Ainsworth mill in Bemidji. The company says it'll keep the plant open for now, but it's unclear what lies ahead. According to a forest industry's trade group, Ainsworth buys about 15% of the state's timber. So more hard times at Ainsworth's mill could spell equally bad times for loggers.

AUSTIN: Hey, Wayne?

WAYNE SCOY: Hey.

AUSTIN: What are you up to?

WAYNE SCOY: Austin, we're just looking at our machinery and stuff.

AUSTIN: Oh, OK.

ANNIE BAXTER: In Northome, Wayne Scoy is pulling into the maintenance yard where he stores the heavy equipment he used for logging. Scoy is trying to sell his equipment, and will leave the logging business altogether if he can unload all his assets without taking a huge financial hit. He lost money on the business last year. The whole thing makes him pretty sad.

WAYNE SCOY: It used to be, and it was nothing more fun than to go out in the morning at zero or 10 below and get stuff running and just have everything work great. It was a lot of satisfaction in your job, but it's just now the stress and the fun has gone out of it, I guess.

ANNIE BAXTER: Scoy might sell his retail operation too, where he sells everything from docks and boat lifts to building materials. He says with fuel prices so high, the cost of all of his merchandise is going up, and consumers are buying less. And that takes us to consumer spending, one of the big questions facing the economy.

And it also takes us to our last stop, this half-empty parking lot at a Walmart in Saint Paul. The pain that started in the housing industry has spread, slowing the national economy to a crawl. Stimulus checks gave Walmart and other retailers a recent boost. But what happens as that money runs out? $4 gas, rising food prices and a steady loss of jobs have sent consumer confidence into a nosedive.

We're going to have to hold off on looking at the effects of those trends until our next tour of the Minnesota slowdown. See you next time around. I'm Annie Baxter, Minnesota Public Radio news.