Housing and Banking Signaling Double Dip

We're seeing record-breaking mortgage delinquencies and foreclosures, and the FDIC Quarterly Banking Profile still shows stress in the banking system.

(Editor's Note: This article was written by Richard Suttmeier, chief market strategist at ValuEngine.com, which is a fundamentally-based quant research firm in Princeton, New Jersey, that covers more than 5,000 stocks every day.

The Federal Reserve was worried about the fragile recovery in the housing market with the homebuyer tax credits expiring April 30. We saw mortgage applications drop 27.1% for purchases last week, which is a clear sign of this dilemma.

More than 10% of homeowners have missed at least one mortgage payment in the first quarter of 2010, which is a record high and up from 9.1% from a year earlier. Of these, about 8% of all homeowners with a mortgage, estimated to be 4.3 million homes, have missed at least three months of mortgage payments or are in foreclosure.

Mortgage modifications have put many homeowners in “mortgage limbo” waiting for help -- and then they don't get any. And since they don't make monthly payments while they negotiate, when trail modifications aren't offered, the homes go into foreclosure or the short-sale status. This is why I forecast another wave down for home prices in the second half of 2010.

What prompted my prediction in March 2007 that we would be in recession in 2008/2009 with a bear market for stocks being confirmed for stocks by the end of 2007? Weak housing and problems in the banking system! Back then I stated that you cannot have a bull market in stocks with a bear market in financials.
Housing stocks had peaked in July 2005, community banks peaked at the end of 2006, and regional banks peaked in February 2007. The broader market didn't peak until October 2007, as that’s when the contagion finally hit home.

This year the pattern is slightly different, as all markets peaked around the same time. The Regional Banking Index (BKX) peaked first on April 21 given the uncertainty of financial regulations.
The ABA NASDAQ Community Bank Index (ABAQ) and the Housing Sector Index (HGX) peaked with the broader markets on April 26. The major averages fell into the red year to date, but housing and financials remain in the green.

The US ban on short-selling of bank stocks was a total ban set in the week of September 20, 2008. This graph is the ABAQ. Our ban was on all shorting, not just naked short selling.
Note that one week spike higher as shorts were forced to cover. I favor a ban on naked shorting of all stocks, and the elimination of CDOs and credit default swaps --those that Warren Buffet called “financial weapons of mass destruction."

favor a ban on naked shorting of all stocks, and the elimination of CDOs and credit default swaps --those that Warren Buffet called “financial weapons of mass destruction."

You don't need a ban on those. You just need a simple regulation that you must own the security covered by the CDO/CDS, and cannot purchase coverage in excess of what you own.

Then they revert back to being insurance instead of a novel way of shorting the market. Allowing someone who doesn't own a security to purchase a CDO/CDS for it would be akin to me being allowed to take out homeowner's insurance on my neighbor's home - and if that happens, note that I have a vested interest in it burning down.

My business which is very sensitive to the economy is in the tank after having had the best month ever in February, this is already a double dip for me.

http://en.wikipedia.org/wiki/Credit_default_swap

A holder of a bond may “buy protection” to hedge its risk of default. In this way, a CDS is similar to credit insurance, although CDS are not similar to or subject to regulations governing casualty or life insurance. Also, investors can buy and sell protection without owning any debt of the reference entity. These “naked credit default swaps” allow traders to speculate on debt issues and the creditworthiness of reference entities. Credit default swaps can be used to create synthetic long and short positions in the reference entity.[4] Naked CDS constitute most of the market in CDS. In addition, credit default swaps can also be used in capital structure arbitrage.

And for those who claim Republican policies played little or no role in the financial meltdown, I present post 5 - Phil Gramm's Commodities Futures Modernization Act exempted Credit Default Swaps from regulation - and eventually, most CDS's were the equivalent of naked short selling - trillions of dollars worth - and it was INSANE for any bailout money to go to persons who held such an instrument - they were not losing money on the underlying security, but instead the government was making good their short positions.

The needed regulation is quite simple - you must own the security in question to purchase a CDS for it. No massive bureaucracy needed to enforce such.

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