Say bye to that castle of sand?

While U.S. stock markets are closed today in observance of Martin Luther King Jr.'s birthday, European stocks got slammed harder than at anytime since 9/11.

The European equivalent of the Dow Jones Industrial Average was down 5.4 percent for the day with stocks in banks and insurance firms leading the way.

While you can't trade U.S. stocks today, futures traders on the Chicago Mercantile Exchange are betting the Dow will drop more than 500 points when it opens tomorrow morning. If that sentiment holds, we could be headed for the fourth-biggest one-day drop in U.S. stock prices in history (see Reuters story).

As investors pull billions out of the stock market, that will push long-term interest rates on bonds and mortgages down. But with an increasing likelihood that the Fed will slash its target for the federal funds overnight rate by 50 basis points on or before its Jan. 29 meeting, the benefits of falling long-term interest rates may be fleeting. Experts say worries about inflation (yes, even in the face of recession) and the weak dollar could push investors away from bonds, sending long-term rates in the opposite direction of short term rates. 

As mortgage broker Lou Barnes put it Friday, "this is a bird-in-hand moment for refinancing."

But let's take Federal Reserve Board member Frederic Mishkin's advice and stop obsessing about what the Open Market Committee will do about short-term rates at its next meeting. Whether we've got a 25- or a 50-basis point reduction coming, isn't the Fed just throwing a last, desperate shovel on the sand castle as that big wave comes rushing up the beach at us?

While big losses in the stock market don't have to spell doom for housing markets (the dot com bust kicked off the housing boom, although nobody is too eager to go down that road again), this latest wave of panic (the third since the credit markets were disrupted in August) is not going to help the credit crunch and could mean a recession is all the more likely.

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