Will the End of Sub Prime Cause Rates to Rise?

Is President's Bush's freeze plan on resetting mortgage ARM's the beginning to the end of the sub prime crisis? We may not like the way he has set the standards on who should get the relief. However, in the bond market there are indicators signally we could be seeing an end to sub prime problems. It is still too soon to say it is definitely happening but the short term signs are showing up and it is something to watch going forward into 2008.

One sign that I watch is the yield on the 10 year Treasury bond. It has appeared to have made a 2 year low and just a fraction of a higher than an all time low yield. What this means is the 10 year Treasury bond is tied to mortgage interest rates. The bond market's anticipation of rate cuts or hikes is what matters, not the day the Fed actually does something, unless there is a surprise from the Fed to the markets. When the yield on the 10 year Treasury bond goes down, mortgage rates go down and vice versa. On December 6th and 7th the 10 year Treasury yield reversed sharply upward by over 4 basis points. That's a big jump in these yield terms and it started on the same day President Bush laid out his plan. On a chart of the 10 year Treasury bond you can see the jump over those past two days. On the technical side, it could be signaling a bottom in interest rates for a while.

So what does this mean? It means that mortgage rates are going up at least in the short term even if you hear the Fed reduces rates next week. The bond market has already factored in a cut in rates due to the weakening of the economy that was related to sub prime. In my opinion it really doesn't make a difference whether the cut is ¼ or ½ of a point because freezing of ARMS has signaled the end of the fear of what sub prime is going to do to the economy. Our bond market knows if anything else resurfaces in sub prime we will have intervening by the President which actually helps take care of lowering rates. A precedent has been set. Interest rate cuts were happening because of the sub prime issue. Plain and simple! It's sort of like the "House that Jack Built", with one thing affecting the other. So when it comes to interest rates, those who need to refinance better get their application in this year because you might not see these low interest rates in 2008 unless we see some strong concerns that the consumer is slowing down more than they are now.

If an argument can be made regarding lowering rates due to a potential consumer recession, well, the slow down in consumer spending has been showing up. However, it's a matter of how fast the consumer slows down. If it is done in moderation, then no more interest rate cuts may be necessary to help the consumer. The consumer is still spending but just at a moderate pace. And those higher costs in fuel will determine whether or not the consumer is being pinched tightly right now in their spending. If oil continues its climb, it will be a matter of how long it stays at any new highs and how it is reflected at the gas pump. As of to date, the consumer has been resilient to these high gas problems. There are mixed signals whether we are headed for a consumer recession or not. Hence, no need to lower rates there.

The most important thing right now is unemployment. If we saw problems there, then more stimulation in growth like decreasing rates would be needed. However, unemployment is holding up well as it was shown on December 7th for the November Jobs Report. So, if the consumer is fine and the sub prime is resolving itself, then what about inflation control? That's the fundamental side of this. To control inflation the Fed would have to raise rates.

Now, getting back to if the sub prime mess is subsiding. Fed Chairman Bernanke and President Bush seem like they are going to make a good team to do whatever is necessary to make sure we see no more banking crisis for now, well at least during next year's election; even if it means the end of our free market society. Who cares if the next administration has any residual problems with a five year ARM freeze? Whether we accept this or not, to me it is saying that the sub prime crisis for now will be ending. And the end to low interest rates may follow.

Now, I'd like to play Andy Rooney here if I may. If I was given the choice to ask President Bush some questions or make comments on why we are freezing the resetting of ARMS and how it is being constructed, this is what I would ask;

If we are going to swim, shouldn't we take swimming lessons?

Why do we bail out people who made wrong choices?

Can I get bailed out on my losses I incurred during the Internet bubble? By the way, there are a lot of people who are invested in their retirement programs with these banks and these poor people barely can afford to retire prior to this problem.

Who hasn't made wrong investment decisions? Many people today who buy a home to live in consider it their main investment.

Didn't our parents always say you learn by your mistakes?

Are we supposed to rely on our government to bail out only those who cannot afford a reset? Does that mean it's not good to make too much money or you can't get bailed out for bad decisions? I guess you're saying stay poor and you will benefit more?

What about those who were given the same fate, however their timing was off because they already went into foreclosure before this freeze? I guess life isn't fair, huh?

Will the small amount of people who can benefit from the freeze really make a difference to our economy's growth? From what I have read, analysts are confused on how they are going to figure out who really can benefit.

We have the Patriot Act, why wasn't it considered by your administration to put some checks and balances in our banking system? We knew this was happening all along.

I read that withdrawls from 401k's are at a all time high due to the foreclosure problem. I'm sure the government could take away that 10% penalty for early withdrawls if they wanted to. Wouldn't that help a lot more people?

And the last one is; what happens to our free market society? I can't help but feel this is a political strategy. I sure hope not.

So, no more questions. I'd just like the answers.