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Stocks Fiddle as Subprime Burns

January same-store sales show why most economists see no big spillover from housing's slump.

The familiar and sad story of the subprime mortgage business weighed down the stock market Thursday after

HSBC Holdings


reported that it miscalculated the risk of its subprime lending program.

But the subprime mortgage market's woes are not new, and the spillover from bad loans into consumer spending has been and is expected to be small. Indeed, Thursday's reports of strong January retail sales were the perfect foil for the bears' hackneyed argument that the subprime mortgage market could tank the broad economy.

"There is a perception in the market that maybe housing isn't turning as much as we'd hoped, but two weeks from now, it'll probably be the opposite," says Michael Driscoll, director of listed trading at Bear Stearns. "Today, housing is a wet blanket."

Stocks ended well off of their lows for the day but still in the red. The

Dow Jones Industrial Average

fell 0.2% to close at 12,637.63. The

S&P 500

and the

Nasdaq Composite

slipped only a fraction to close at 1448.31 and 2488.67, respectively.

Given the gravity of losing a family home, or defaulting on debt, one might have thought the market would have fallen farther on HSBC's warning. It may sound cruel, but the subprime segment of the borrowing population just doesn't carry much weight on many trading floors. It is the classic story of Main Street vs. Wall Street, which has found a way to ignore the carnage.

"The spillover from the subprime segment of the mortgage market has a marginal impact on consumption and credit, and it poses no systemic risk at this time," says Torsten Slok, senior economist at Deutsche Bank.

In a research piece in November, Slok cited a quote from former

Federal Reserve

chairman Alan Greenspan from October 2006: "A lot of people are going to lose their homes. ... It's a family tragedy. It's not an economic -- or macroeconomic -- tragedy."

How different is his tone from that of our new Fed leader, Ben Bernanke? In a speech last week Bernanke said: "If we did not place some limits on the downside risks to individuals ... the public at large might become less willing to accept the dynamism that is so essential to economic progress."

So while it is clear that the subprime mortgage market is only a small part of the economic haystack, the current Fed chairman is probably unlikely to ratchet up the pressure with rate hikes, unless absolutely forced to. Indeed, such calamity on Main Street is part of why the Fed seems so committed to remaining in the pause position, despite higher-than-desirable inflation and evidence of loose liquidity in the system.

Slok notes that adjustable-rate mortgages, or ARMS, make up only 20% of the total outstanding single-family mortgages, and ARM resets add up to about $18 billion in 2007. He adds that this is a small amount compared with annual consumer spending of around $9 trillion. The impact of the resets will account for less than 0.2% of total consumer spending, says Slok.

"Low-income households account for a smaller share of total consumer spending than they used to," he writes. The poorest 20% of the U.S. took in 3.4% of total income in 2005, down from 4.1% in 1970.

For the institutions that made these loans, some pain may be in the cards, but this is not the 1980s, says Joe Brusuelas, chief economist at IDEAglobal. He adds that most institutions are properly hedged against the credit risk in their portfolios.

"The key is securitization," says Slok. Mortgage lenders securitize and sell off the loans they make immediately, so the risk is distributed globally, he says. No individual institution is as exposed as if they had all the loans on their own books. "The explosion of securitization and derivatives has helped make the economy more resilient to these setbacks," says Slok.

Banks across the nation have started to rein in their lending standards as well, according to the Federal Reserve's quarterly survey of senior loan officers, which came out earlier this week. Their caution indicates that they are concerned about credit quality, but also that they are attempting to protect against further real estate market weakness.

"The results indicate that banks substantially tightened their credit standards for mortgages to individuals, with the percentage of banks that tightened standards reaching the most since 1991," writes Tony Crescenzi, chief fixed-income strategist at Miller Tabak and

contributor. "Banks are primarily concerned with the real estate market and not the overall economy."

The catalyst for the day's debate on housing was London-based HSBC's announcement late Wednesday that it misjudged the creditworthiness of some of its subprime mortgage loans, and that it would have to increase by 20% the amount of capital it sets aside to cover loans that go sour. HSBC fell 2.6% on the day. The bigger loser Thursday was

New Century Financial

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, which fell 35.4% after saying it expects to tighten its lending standards and make fewer loans in 2007.

Washington Mutual

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Countrywide Financial


both slid over 2% as well.

The homebuilders were also hurting Thursday as

Toll Brothers

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announced a 19% drop in revenue and ballooning cancellations and write-downs. Toll fell 3%, while competitors




D.R. Horton

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Pulte Homes

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slid over 2% on the day.

However, the housing slump didn't hit the retailers in January. According to Thomson Financial, 63% of retailers beat Wall Street's expectations for same-store sales growth.

Companies such as




Limited Brands




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surpassed expectations. Investors sold the news in many cases, as only Federated finished up 3.7%. Limited and Nordstrom fell 0.9% and 0.25%, respectively.

For now, the consumer is holding up even amid the subprime market's deterioration. But there is still a way to go before investors can feel assured that the question of spillover is behind them. The spring home selling season lies ahead, and exogenous factors such as oil prices and interest rates could suddenly stop cooperating. But one thing is for sure: Bernanke is paying attention to Main Street, and that means rate hikes are unlikely as long as the housing market continues to suffer.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.