The real estate blog.

The subprime meltdown, high energy prices and higher food costs have been dominating economic news lately. It was easier to dismiss when other indicators like the stock market and employment were doing well. Since last week when the Dow shed over 600 points, the negative news is starting to gain more traction.

While there are problems out there, the catalyst to a 1970’s style economic catastrophe, is interest rates. Do you know what they’re doing? They’re going down significantly. The benchmark 10 year bond market which is most closely tied to long term mortgage rates has shed over 30 basis points since last week. Like a golf score, the lower the bond rate, the better it is for borrowers. For investors, a lower yield equals lower returns.

Short term interest rates are

bound by the overnight lending rate set by the Federal Reserve Board. The Fed meets tomorrow to decide this rate. After 17 straight rate increases to fend off inflation, the Fed has held the rate steady since last August. Citing contained inflation in the face of a housing downturn, the Fed has been slow to make any changes. Economic bulls have called this the “Goldilocks” economy with everything being “just right” with interest rates.

Today’s gains on Wall Street certainly give some credibility to things being OK, even though employment increases in July fell short of expectations and unemployment ticked up one tenth of a percent. Economic pessimists have been calling for the Fed to lower interest rates since the end of last year and now seems to be the point where this actually may happen. CNNMoney reports -

In fact, according to federal funds future contracts listed on the Chicago Board of Trade, the market is pricing in about a 7 percent chance of a quarter-point rate cut on Tuesday. According to these futures, investors are betting that it is all but certain the Fed will lower rates at least once by the beginning of next year.

Problems in subprime lending have spread to the lenders and financiers behind those loans and now a phase of credit tightening has begun.

The Fed is in a tough spot. The financial markets have been rocked in recent weeks on credit concerns, namely that the problems in the mortgage market may not be isolated to subprime borrowers. Several hedge funds and large banks have run into trouble because of exposure to subprime loans.

The fear now is that this could be just the tip of the iceberg in terms of loan problems. As a result, tightened credit standards could cause not just a pullback in consumer borrowing and spending but also could spell an end to the private equity buyout boom that has helped lift stock prices for the past year.

These worries might cause the Fed to rethink its stance on the economy and cause it to start lowering rates in order to prevent a notable economic slump, or even a recession.

Is this the beginning of a tremendous economic downturn, or is it simply a rough spot in an otherwise healthy and expanding economy? I’ll leave those decisions to Bernanke and crew, but I will take a guess. The Fed will hold rates steady on Tuesday and await more data.

Meanwhile, long term mortgage rates are dropping. Pay attention.