Originally published Thursday, October 9, 2008 at 12:00 AM
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What Fed rate cut aims to do
In a rare coordinated move, the Federal Reserve and other major central banks from around the world slashed interest rates Wednesday to prevent a mushrooming financial crisis from becoming a global economic meltdown.
The Associated Press
In a rare coordinated move, the Federal Reserve and other major central banks from around the world slashed interest rates Wednesday to prevent a mushrooming financial crisis from becoming a global economic meltdown.
The Fed, desperately trying to jump-start the lending that keeps the U.S. economy moving, reduced its key rate from 2 percent to 1.5 percent. In Europe, the Bank of England and the European Central Bank sliced their rates by a half-point as well.
But will U.S. consumers benefit from the interest-rate cuts?
For most people, probably not much, at least for a while. But people with strong credit could see lower credit-card rates soon, and the move could eventually help point the economy in the right direction.
Here are some questions and answers about the interest-rate cuts.
Q. Will the rate cuts help fix the financial crisis?
A. Not in the short term, most economists say. The cuts don't directly address the main problem behind the financial meltdown: the reluctance of banks to lend money.
But the coordinated rate cuts might deliver a psychological boost to the financial markets. That's because the cuts mean that once banks do start lending again, many borrowers will be able to get loans at lower rates. That could help counter fears that the global economy is on the verge of a steep recession.
Q. Why won't the rate cuts have a more immediate effect?
A. Because in right now, banks aren't making very many loans at any rate. In today's economic climate, they're worried about borrowers' ability to pay them back. They're also hoarding cash because they lost money on bad mortgages and mortgage-linked investments.
"People who couldn't get loans yesterday ... can't get a loan today," said Carl Weinberg, chief economist for High Frequency Economics, a consulting firm.
Q. What exactly is this rate that was cut?
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A. The Fed cut the federal funds rate, which banks charge each other for overnight loans. Cutting it is the Fed's main tool for energizing a sluggish economy. In normal times, a cut in the rate is supposed to ripple through the credit markets, lowering rates for mortgages and auto and other loans. But the effect is likely to be more limited this time, because of banks' reluctance to lend money at all.
Q. So if rate cuts won't quickly turn the credit crisis around, what can?
A. Economists hope the new $700 billion bailout package will encourage banks to offer more loans by removing bad mortgage-related assets from their balance sheets and providing more capital for them to lend. The goal is to jump-start a crucial part of the credit market by making cash available to businesses for their most urgent expenses.
Q. Which consumers should benefit from the rate cut?
A. Credit-card users may see some benefit, particularly if they have good credit.
"Within one or two billing cycles, individuals ... should see their interest rates decline," said Keith Leggett, senior economist with the American Bankers Association.
Borrowing costs should also drop almost immediately for consumers with variable-rate home equity and other loans that are tied to the prime interest rate, which Bank of America Corp., Wells Fargo and other banks cut by a half point Wednesday.
Q. What about adjustable-rate mortgages?
A. That depends on how your rate is set. Adjustable-rate mortgages tied to Treasury rates are likely to drop as many Treasury yields have fallen in recent weeks, McBride said.
But those that are tied to the London Interbank Offered Rate, or LIBOR, will likely see a "big payment increase" in the next couple of months regardless of the Fed's cut, McBride said.
That's because LIBOR, which is the rate at which big international banks lend to each other, has spiked in recent weeks — those banks just aren't eager to lend each other money, so they're charging higher rates when they do.
Q. What about people preparing to take on new fixed-rate mortgages?
A. They probably won't see much benefit. Fixed mortgage rates typically track the yield on the 10-year Treasury note, which is set in the bond market. The yield on that note rose by almost a quarter point Wednesday. Fixed mortgage rates have remained above 6 percent for most of the year despite the Fed's previous rate cuts.
Associated Press reporter Eileen AJ Connelly in New York contributed to this article.
Copyright © 2008 The Seattle Times Company
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