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Kass: Housing Faces a Credit Event

5. Mortgage-centric banks face headwinds. Many mortgage-dependent banks (which have been operating as little more than government mortgage brokers and refinancing machines) will be put to the test. Refinancings will likely be down by over 70% in third quarter 2013. Second-half new mortgage loans will disappoint. Despite optimism surrounding bank stock net interest margin improvement, mortgage banking will produce a hole in bank profits.


  • The speedy rise in interest rates will likely interrupt the strong momentum in the U.S. housing market.
  • A deceleration in the rate of growth in residential real estate activity/turnover and in home prices lies ahead.
  • U.S. economic growth will be adversely impacted by a slowdown in the recovery in the real estate market.
  • Sell housing-related stocks.
  • Similar to housing, the U.S. stock market may sour.

The sharp climb in interest rates since early May points to some prospective weakness in the U.S. housing market (measured both by sales activity and prices) and is conspiring to reduce overall domestic economic growth to levels likely unforeseen by policymakers and by most forecasters.

The drag of fiscal austerity, tax and regulatory policy will also weigh on U.S. growth. Non-U.S. growth remains subpar. Inflation will continue to be more of a threat than deflation.

Though the global financial condition is greatly improved from four years ago and the ECB, Bank of England and Bank of Japan are on the same ZIRP page, in this slow-growth backdrop, policy risk (of premature tapering) is heightened and represents an ever-present threat to the U.S. stock market.

Housing, in particular, seems exposed to the quick climb in rates. It remains my view that prospective homebuyers -- still shaken from an unprecedented 34% drop in home prices from the peak and in the face of stagnating wages and salaries -- are far more sensitized to costs (home prices and mortgage rates) than many believe. The fence-sitter argument (i.e., that buyers will appear as rates rise) seems to have been debunked by the recent decline in purchase applications. And given the lack of opportunities available today in the creative, no-/low-documentation mortgages of yesteryear, affordability trends in 2013, though still attractive measured by history, are becoming a stronger headwind to housing.

I would avoid housing-related equities and mortgage-centric banks in the months ahead, and I would be skeptical of the consensus forecast of a meaningful acceleration in domestic economic growth (from second-quarter 2013 estimates for real GDP of less than +2% to nearly +3% in the second half of 2013).

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