U.S. Sub-prime Woes: Is the Worst Over?

Fact #1: Financial risk has increased for mortgage lenders since last year.
Fact #2: U.S. consumers have been exposed to declining household wealth.
Fact #3: My Sengkang nest has not appreciated much for the last 5 years.

Truth is: I still say the current strains in the U.S. sub-prime mortgage market probably won't be the main reason to tip the U.S. into a recession in 2007. It has to be something else. But what? Nevermind now. My focus is on housing today.

Why Housing Won't Tip the U.S. into Recession This Year
The banking system. Yes, they are heavily exposed to real estate. But unlike previous real estate "bubbles" & subsequent bear markets, their balance sheets are strong & asset quality is generally high. The most leveraged mortgage lenders have already been heavily punished by the stock market since February. This has paved the way for private equity & venture capital firms to swoop in & scoop up any residual distressed assets. Plus, the Federal Reserve will probably also cut lending rates over the next several months to breathe new life into the real estate market.

If You Look Back at History These Sub-prime Woes Aren't that Bad
The good news for the economy and the banking sector overall is that loan delinquency rates are still low by historical standards. The number of bank failures in this economic cycle remains very low or benign. Most REITs have not crashed. Commercial mortgage-backed defaults sport even lower delinquency rates than residential property loans. Banks may have boosted their exposure to all segments of the real estate industry since 2000, but the overall loan quality remains good & booming earnings until recently have created a cash reserve for most lenders.

Housing is the Least of Our Worries
You have underestimated the banks. Most banks have sufficient capital reserves from years of strong earnings to cover their losses. There are actually other big risks that may weigh on U.S. & global financial markets in 2007 than the housing woes. These risks lie with Federal Reserve monetary policy, employment growth trends, consumer & corporate spending & systemic risk posed by hedge funds & other institutions laced with carry-trade loans & other synthetic derivatives. These are worthy opponents to worry about compare to the housing situations. The housing bear market is not a major risk to the U.S. economic cycle. The markets have largely discounted this event by hitting new all-time highs almost daily since mid-April.

However, investors should still expect a major stock market correction this year. I'm preparing for a correction because consumer spending, tied to a great extent to housing values, should eventually start to cool amid declining household wealth and possibly, rising unemployment.