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Rate drop isn't likely to benefit consumers

The Baltimore Sun

The Federal Reserve lowered its benchmark interest rates yesterday by one-half percent, a larger-than-expected reduction that gave an immediate lift to the stock market and is expected to boost an economy rattled by rising mortgage defaults and foreclosures.

But don't expect the first rate cut in four years to help you instantly refinance your mortgage more easily or finance a shopping spree on plastic. Experts warned that consumers will not feel, and should not expect, a drastic change in their pockets anytime soon.

"It isn't going to make a hill-of-beans difference to consumers today, tomorrow or even a month from now," said David A. Stepherson, senior portfolio manager at Hardesty Capital Management, an investment advisory firm in Baltimore. "The Fed move is much more important to the stock market and the bond market than it will mean for the average consumer."

The Fed controls two important rates: first, the discount rate, which is the rate that Federal Reserve banks charge commercial banks for loans, and second, the more closely watched federal funds rate, which is the rate that banks charge each other for overnight loans. The latter can affect rates on some types of consumer loans. The Fed cut both rates yesterday.

But many other rates are influenced by the bond and other markets rather than by the Fed.

That's not to say yesterday's cut in the federal funds rate, to 4.75 percent, is irrelevant to consumers. It is expected to help bolster consumer confidence, which could give the economy a boost, which, in turn, would reassure jittery lenders. A number of large banks quickly followed the Fed's lead by cutting their prime rate, which they charge their best borrowers, from 8.25 percent to 7.75 percent.

"It's all tied together, and it'll take a while to sort out," Stepherson said. "We think a half-a-percentage-point cut will be better at getting the economy, particularly the consumer, spending again."

Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business and former chief economist at the U.S. International Trade Commission, went further. He said, "My bet is that this move, along with other rate cuts later, as needed, will avert a recession."

What the cut does not do, however, is create an instant change of fortune for consumers, experts cautioned.

"All this does is make it easier for you to borrow money," said Steven Isberg, associate professor of finance at the University of Baltimore and senior research fellow at the Columbia-based Credit Research Foundation. "You should not wake up tomorrow and suddenly decide that everything is more affordable now."

Credit card interest rates will barely be affected. Once a credit card company has your business, experts say, it generally won't lower your rate on an existing card unless you ask for it.

Even if there is movement in concert with the Fed cuts, consider that it could cause your credit card interest rate to go from 19 percent to 18.5 percent. "Gee, yea. That's great. Go spend," Stepherson said with a heavy dose of sarcasm. "That helps a lot."

Also, savings rates on certificates of deposit are expected to decline.

So, do consumers have anything to like about yesterday's Fed move?

"It's going to lead to lower interest rates on consumers' loans, because they follow the federal funds rate down," Morici said.

One change that consumers might see quickly is lower rates and better financing options on car purchases.

"It will depend on how badly they want to sell you a car," Isberg said. "Most dealers want to sell cars pretty badly, so you could see an immediate affect there."

Consumers will likely see more mixed results in housing and mortgages, experts said.

Homeowners with very-low-rate adjustable-rate mortgages (ARMs) will still see their monthly payments increase after the rates reset, but the increases won't be as large, because ARM rates are sensitive to Fed moves.

"It could mean a little less pain for the homeowner who is facing a reset on their adjustable mortgage rates," said Greg McBride, senior financial analyst at

ARM rates are usually tied to the one-year U.S. Treasury bill, which usually stays in proximity to the federal funds rate. Fixed mortgages, however, are tied to the 10-year Treasury bill, which hasn't moved much from a year ago.

"Mortgage rates are already low," Stepherson said. "The Fed cut isn't going to do much for fixed-rate mortgages."

And the Fed cut won't increase the value of your home, Morici said.

"If your home is worth less than your mortgage, it won't matter if you're going from one fixed-rate loan to another fixed-rate loan or from a flex to a fixed," Morici said. "Historically, mortgage rates have followed Fed cuts, but that link has been broken in recent years. What's happened in the industry lately will further weaken that link."

With home prices flat or falling after a five-year boom, a spike in late payments and a record number of loan defaults, one cut will do little to lessen the current pain.

"This is not a panacea to cure all ills in the housing and mortgage markets," McBride said. "Nor is it designed to be. This is a step to make sure that the downturn in housing doesn't drag the rest of the economy down with it."

In other words, only time and the possibility of more Fed cuts down the road will really give consumers real money to bank on down the road.

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