Financials: Why the Worst Is Yet to Come

The hammering of financial stocks was taking a reprieve early Tuesday, helped -- in part -- by the slowing pace of decline in the S&P Case-Shiller Home Price Index.

The index fell a record 15.4% in the second quarter vs. the prior year but the month-over-month decline of "just" 0.5% is providing a glimmer of hope.

"While there is no national turnaround in residential real estate prices, it is possible that we are a seeing some regions struggling to come back, which has resulted in some moderation of price declines at the national level,'' said David Blitzer, chairman of S&P's index committee.

In addition, new home sales data showed a 5.2% decline in the inventory of unsold homes, but June's sales figures were revised down to a 17-year low. Those groping for a bottom in housing can't ignore yesterday's existing home sales data, where more than 30% of sales were of "distressed homes" while inventories of unsold homes rose to 11.2 months supply, or about double normal levels.

Meanwhile, even in the unlikely event the housing market hits bottom today, optimists like Tom Brown are overlooking a series of challenges the financial sector still faces, including:

• The cost of a presumptive bailout of Fannie Mae and Freddie Mac, for which estimates range from $25 billion to as much as $500 billion. However much the government spends is money that will not be available to bailout the struggling banks and brokers, including Lehman Brothers.
• Fannie and Freddie need to refinance a combined $233 billion of short-term debt between now and Sept. 30.
• Banks, securities firms and lenders have $260 billion of short-term notes coming due by year end and a record $871 billion of bonds maturing through 2009, according to JPMorgan.

Banks are likely to struggle to get financing for those debt deals at attractive terms (assuming they can find it all). That, in turn, will make them less inclined to lend to consumers and businesses, which will crimp economic growth and keep pressure on the financial sector's profitability for some time to come.

And so the vicious unwinding of the credit bubble goes...