With all the woes of subprime loans, raising rates will compound the problem, since the adjustables will rise faster and force more defaults.

WHY THE HELL ARE THEY DOING IT?

The collapse in subprime mortgages doesn't pose ``any threat to the overall economy,'' U.S. Treasury Secretary Henry Paulson said last week. He would, wouldn't he? He's hardly going to advocate we all stock up on tinned food and bottled water in our basements.

The tremors from the subprime debacle are vibrating throughout the interconnected web of modern global financial markets. Derivatives, corporate debt, loans and bank stocks are all getting trashed. Here are five reasons to expect the turmoil to worsen.

Don't Bet on Helicopter Ben . . .

A week ago, traders in the futures and options markets were pricing the chances of December interest-rate cuts from the U.S. Federal Reserve at about 21 percent. Prices now suggest a 47 percent chance that Fed Chairman Ben Bernanke will sanction lower borrowing costs to rescue the mortgage market, based on July 26 closing levels.

The rapid turnaround in interest-rate expectations shows the financial community is far from convinced that the wider economy is immune from the woes afflicting particular pockets of the bond and credit markets.....

http://www.bloomberg.com/apps/news?p...d=ageDhNv.n1A4

IndyMac Bancorp Inc. is joining rival lenders in making ``very major changes'' to loan standards and raising interest rates because of a slump in mortgage securities, an e-mail to the company's employees said.

The market for mortgage bonds has become ``very panicked and illiquid,'' Chief Executive Officer Michael Perry wrote in the Aug. 1 e-mail. National City Corp. also told companies it buys loans from that it won't accept second mortgages and some low- documentation loans, according to a notice on its Web site.

``Unlike past private secondary mortgage market disruptions, which have lasted a few weeks or so, our industry and IndyMac have to be prudent and assume that this present disruption, which appears broader and more serious, might take longer to correct itself,'' Perry wrote.

The additional credit tightening by IndyMac, the ninth largest U.S. mortgage lender, and its rivals comes at a time when it's ``difficult'' to trade even AAA rated mortgage bonds that aren't guaranteed by government-chartered Fannie Mae and Freddie Mac, or federal agency Ginnie Mae, Perry wrote.....

http://www.bloomberg.com/apps/news?p...d=aiYQzFpS01wU

BANKERS and investors might not agree, but the recent sell-off in financial markets is good news. It may, at last, have brought people to their senses. For the past few years, too much money has been lent too cheaply and too easily to too many people, whether it was speculators trying to make a fast buck in Miami condominiums or private-equity groups financing their latest multi-billion-dollar takeover. This wake-up call came too late to save the American housing market from frenzy and subsequent bust. But it may have arrived in time to stop the takeover boom getting out of control—and when the world economy is strong enough to cope with the consequences.

Watch out for the American consumer
The big question now is how serious those consequences are likely to be. The impact on debt markets themselves will be big (see article). As standards are tightened, many of the reckless practices that have become the norm in corporate lending will be abandoned. We will now hear a lot less about firms getting “covenant lite” loans, under which lenders give up their rights to monitor the behaviour of borrowers; or “payment-in-kind notes”, which allow borrowers to substitute more IOUs for interest payments. As investors steer clear of riskier debt, the takeover bids that have pumped this year's stockmarket froth will be curtailed and the most debt-laden borrowers may find it impossible to raise funds.

But most companies will be able to shrug off the credit squeeze. That is partly because creditworthy borrowers still have access to debt (albeit at a higher price), and partly because many firms don't have to borrow. Across the rich world, firms are flush with cash. Their profits have been fat for the past five years and, on average, companies have been funding their capital spending from their own resources. Credit wobbles by themselves, therefore, need not prompt an investment slump.....

http://www.economist.com/opinion/dis...src=nwlbtwfree