Maybe Thomas Wolfe is right, and you can't go home again. But it's an opportune time to revisit the always-controversial housing market and its related shares.

Recent words and deeds by the Federal Reserve seem designed to engender further strength in the already robust housing market, although some economists worry about it being too much of a good thing.

Another round of refinancing and/or home-purchase activity should aid homebuilders, but even once-staunch bulls say it may prove to be a last hurrah for the sector.

On Friday, the government reported that housing starts fell 6.8% in April to 1.63 million seasonally adjusted units. That was below consensus estimates and the lowest level since August 2002, but still very strong by historic standards. Also, mortgage applications for purchase are again at record levels, housing affordability remains high, and new-home sales moved sharply higher in March, noted Peter Kretzmer, senior economist at Banc of America Securities. "All of these factors point to a rebound in the starts data."

Earlier in the week, the Mortgage Bankers Association index of mortgage loan applications -- which includes purchases and refinancings -- rose to 1417.8 for the week ended May 9, up 13.7% from the prior week. Refinancings accounted for 72.4% of total applications in the latest survey, up from 68.7% the prior week.

Since May 9, yields on the benchmark 10-year Treasury note have fallen further and were below 3.50% early Friday following another round of disappointing economic data. Such low levels are very likely to spur another round of refinancing activity, perhaps challenging the record levels set in March.

Furthermore, "if we get stabilization in the labor market, we're probably going to observe another surge in home sales," said John Lonksi, senior economist at Moody's Investors Service, who noted that 30-year fixed-rate mortgages have fallen to 5.45%, a new low for the cycle. "That's probably good for the economy, as it will provide another boost to consumer spending on appliances, furniture and other items bought following the purchase of a home."

Having said that, the Fed "runs the risk of an unwarranted, perilous rise in home prices later this year," Lonski warned. "Eventually there's a price for overstimulating certain aspects of economic activity."

The economist recalled how Fed easing in 1998 to offset the unraveling of Long Term Capital Management "further inflated the equity market bubble," and he suggested a repeat in housing could be in the offing. That is, the housing bubble some have warned about since early 2002 may be coming to fruition.

Paul Kasriel, director of economic research at Northern Trust in Chicago, is less focused on the potential short-term positives of housing. He believes the sector's problems already are compounding.

Mortgage foreclosures hit a 30-year high in the fourth quarter, and personal bankruptcies hit an all-time high of nearly 1.6 million for the 12 months ended March 31, Kasriel noted, indicating that even higher foreclosure rates are likely in the first quarter.

This could pose "major problems" for the financial sector as "direct and indirect" exposure to mortgage debt among U.S. commercial banks was 57.2% of total bank credit in 2002's fourth quarter, he continued. That figure includes mortgages, mortgage-backed securities, collateralized mortgage obligations and direct obligations of Fannie Mae and Freddie Mac.

"So, if more problems were to arise with regard to the creditworthiness of mortgages or mortgage-related debt, U.S. commercial banks would not be able to dodge this bullet," Kasriel warned.

But however you feel about the housing market -- pillar of the economy, boom, expanding bubble -- it seems unlikely the sector's momentum is about to come to a screeching halt.

"I have no doubt Greenspan will do all in his power to keep interest rates in general, and mortgage rates in particular, low," Kasriel quipped.

Homebuilding Bulls Bow Out

Naturally, continued momentum in the housing market should benefit related stocks, most notably the seemingly unstoppable homebuilders. Since the Nasdaq Composite peaked on March 10, 2000, the Homebuilding Index is up 255%, and it has more than doubled since the market's September 2001 lows. Since mid-March, the index is up nearly 30%, about double the S&P 500's gains and well in excess of even the Comp's advance.

In sum, those who've tried to short the homebuilders have been burned, and folks who've stayed the course have been richly rewarded (at least on paper). The question is whether it's time to book those profits. It is (already was, actually), according to Brad Ruderman, managing partner at Ruderman Capital Management, a Los Angeles-based hedge fund with $145 million under management.

"The thesis why I bought them is still intact," Ruderman said, ticking off a list of positives, including ongoing pessimism and high short interest in the group, low relative valuations, strong industry management, stock buybacks and relatively limited insider selling, "plus the added stimulus from this rally in the bond market."

But Ruderman, cited here on Feb. 27 as being very bullish -- a stance he reiterated a week later during a sharp selloff sparked by weak first-quarter order growth at Lennar ( LEN) -- recently sold his entire homebuilding holdings. These included Toll Brothers ( TOL), Centex ( CTX) and D.R. Horton ( DHI).

Each of those were up about 30% since they were cited here in late February, and the hedge fund manager didn't want to risk those heady gains. "The luster of the trade is somewhat clouded by the bond market," he said. "I don't want to be a casualty of a major bond market selloff and have half my gains removed. That doesn't mean I don't like homebuilders , but we're in uncharted waters" in the fixed-income sea.

At this point, there doesn't seem to be much that will send bond prices lower and yields higher, a development that would undermine interest rate-sensitive stocks such as homebuilders. Then again, Wall Street was convinced rates could only go higher earlier this year. The opposite occurred.

For those curious, Seabreeze Partners' Doug Kass took a very similar stance as Ruderman. On May 7, Kass announced on Street Insight.com that he had sold all his homebuilding shares. (After having been a strident short on the sector, Kass reversed course late in 2002, and homebuilders had become his "favorite sector bet" earlier this year.)

Citing his rationale for selling, Kass wrote: "With the last ratchet down in yields, I can't see investors' perceptions of homebuilders getting any better for now."

Notably, that was before the most recent ratcheting down of yields, which has spurred further strength in the group, prior to Friday's setback.

The message from Ruderman and Kass seems to be that pigs get slaughtered, whether they live in homes of straw or stick. Even if the sector's strength currently seems as thick as a brick.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to Aaron L. Task.