Trickle Down Effect

The threat of the U.S. economy slowing continues to be real. The trend for Housing Starts and Building Permits has been on the decline for six consecutive months since January. Recently, we saw further evidence the real estate market was on the blink of a potential crash. New home sales for July was weaker than expected at 1.072 million versus the estimate of 1.105 million and down from 1.12 million in June. Existing home sales for July was also soft at 6.33 million versus the estimate of 6.55 million and down from 6.60 million in June.

 The declining sales are placing pressure on the sell side as sellers struggle to sell properties. The days of price wars in the residential market driven by multiple bids and euphoric buying are over. We are beginning to see the negative impact of higher rates on the real estate market. Foreclosures are rapidly rising as homebuyers and investors find themselves facing higher monthly payments as variable mortgage rates rise.

 Recently, H&R Block Inc. (NYSE/HRB) said it would need to record a $102.1 million provision in the first quarter in order to cover the higher mortgage loan defaults that its Option One Mortgage Corp division is seeing. I expect to see the same from other mortgage lenders as the housing market softens.

 The reality is many homeowners are already leveraged to the max and facing higher payments. But there is also a trickle down effect: Higher mortgage payments translate into lower disposable income after housing expenses. This means less money available for other purchases, especially big-ticket items such as appliances, cars, furniture, and travel. The end result would be declining consumer spending and since this represents about two-thirds of the U.S. economy, we could see a softening of GDP growth going forward and the potential of another recession.