Housing: Wall Street's No. 1 Worry

While financials appear to be the No. 1 worry, it all gets down to housing -- and that's why Fannie Mae and Freddie Mac's continuing soundness is critical. Wall Street's biggest fear right now: that housing might take another leg down.

The major factors influencing housing are still a mess:

1) No clear bottom! While sales are picking up in some hard-hit markets like California, much of those sales remain foreclosures, and prices are still generally dropping.
(See Jane Wells' blog, "Is This How to Solve the Crisis?!")

Bears have noted that sales were above-trend for so many years that they need to be below-trend for some time to get to historic norms, which would imply even lower levels than we are now seeing.

CNBC Special Feature:

- How to Play This Market: Sectors, Individual Stocks


Housing starts are at their lowest since 1991; while this is good news, the inventory level of unsold homes remains stubbornly high.

2) Rising mortgage rates has dramatically hurt refinancings, and applications for mortgages this week fell to their lowest levels since December 2000, according to the Mortgage Bankers Assn.

That's why Fannie and Freddie are so important: like it or not, they are the primary providers of liquidity in mortgages, and any pullback in this function while the rest of the mortgage market is still not functioning properly could create notably higher mortgage rates and more defaults.

In fact, this is already happening: the spread between the 10-year Treasury (at 3.79 percent) and 30-year mortgages (6.47 percent) remains unusually wide at about 270 basis points; the historical average is closer to 170 basis points, indicating that investors perceive much higher risks in holding mortgages versus Treasurys, and they are demanding higher mortgage rates to compensate for the additional risk.

The bottom line: Fannie Mae and Freddie Mac do not involve abstract intellectual discussions divorced from reality. Any seize-up in the liquidity they provide to the mortgage markets could be the major contributing factor in higher rates and another downturn in housing.

Questions? Comments? tradertalk@cnbc.com