The economy is cooling in a non-cataclysmic way [FXStreet]. As a result (or as the cause), the housing market has been posting weaker numbers lately [MW] which exposes the vulnerability of one of the strongest business sectors today: Banking.

Why do banks continue to show rosy returns? It has been said that banks will be able to weather the proverbial soft landing. History (selectively) shows this, but why is that not a sound basis for analysis of current conditions?

Banks were able to survive the last downturn in the early 1990s, except smaller local banks. The FDIC said the mid to large sized banks did just fine back then.

This time its different. Exotic and adjustable mortgages are a relatively new market force with little history to rely on. According to Northern Trust, 60% of current bank earnings are based on housing and housing comprises more than 16% of GDP.

In other words, its important. Banks need to reel in their underwriting standards again.

The reduced issuance of mortgage securities [WSJ] will also hurt Wall Street.

Among the reasons: weakening trends in stock and bond underwriting and trading, and even a cutback in risk among hedge funds, leading them to reduce their borrowings through Wall Street brokers. Issuance of mortgage securities, one analyst warns, may wane as the housing bubble deflates.

_But its too soon to tell_
One of the reasons banks looks so good these days as they relate to mortgages is exotic products like option-ARMs. Mortgages are just starting to reset, so the full impact of borrowers unable to refinance their adjustable rate mortgages is not yet apparent. Also, banks can book the full amount of the mortgage payment, even if the rising number of borrowers choose to only make the interest payment. This quirk in bookkeeping rules does not do investors any favors.

Source: Businessweek


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