Big Banks Cut Prime Rate for 2nd Time Since Oct. 19

Major banks across the nation Thursday cut their prime lending rates to 8.75% from 9% in the second quarter-point reduction of the key rate since the Oct. 19 stock market collapse.

The cuts reflected the Federal Reserve Board’s efforts to stabilize the economy with easier credit after the market debacle and came on a day when the central banks of West Germany and Switzerland also reduced key lending rates. “If there could be a silver lining from the crash, this is it,” said Gary Schlossberg, vice president and senior economist at Wells Fargo Bank in San Francisco.

The latest round of interest rate cuts here and abroad roused the stock market after two days of losses, carrying the Dow Jones industrial average to 1,985.41, up 40.12 points.

The market rebound came despite the fact that the dollar fell to new lows on world markets Thursday after Treasury Secretary James A. Baker III was quoted as saying that the Reagan Administration would rather let the dollar fall than risk recession by propping it up with high interest rates.

On the currency market in New York, the dollar fell 1.2% against the Japanese yen, 1.6% against the West German mark and 2.1% against the British pound.

First to drop the prime rate were New York’s Chase Manhattan and Citibank, soon followed by major lenders across the nation. Security Pacific, First Interstate, Union Bank and Bank of America were among those in the California market to follow suit.

The two-week easing of rates reverses a climb that began last March, when the prime stood at 7.75%. The rate “spike”--which had reached 9.75% at some banks--had already begun to slow housing and auto sales and had spread alarm in the markets and other sectors of the economy as well.

The prime rate is the basis for many loans to small- and medium-sized businesses and to consumers. Changes in the prime rate are roughly paralleled in mortgage rates, although mortgage rates generally are not directly tied to the prime.

Many economists contend that rates may come down by another quarter point or more before the end of the year.

“This is really sort of an intermediate step,” said Paul Getman, economist with WEF Group in Bala Cynwyd, Pa. “If you look at the way other rates have come down, this drop is overdue.”

The Deutsch Bundesbank, the German central bank, announced Thursday morning that it would lower the so-called Lombard rate to 4.5% from 5%, thus acceding to pressure from the United States and its European neighbors. The Swiss national bank cut its Lombard rate from 5% to 4.5% and its discount rate to 3% from 3.5%. The British and Dutch have also lowered key rates.

Urged to Lower Rates

U.S. officials have urged the West Germans to drop their rates to take pressure off the dollar, which U.S. officials have sought to lower over the past two years to stimulate the American economy.

The West Germans did not reduce their discount rate, however.

The difference between the two rates is that when private banks borrow at the Lombard rate from the central bank, they put up stocks and bonds as collateral; when they borrow at the discount rate, which is lower, they pledge cash.

The Federal Reserve Board moved quickly after Black Monday, Oct. 19, when the stock market plunged 508 points, to inject the economy with enough money to cushion the effects of the panic. The Fed’s stimulus has already showed up in the fall of other key rates, such as the so-called federal funds rate and rates on Treasury bonds and Eurodollars.

Reservoir Has Grown

Interest rates on three-month Treasury bonds, for example, have fallen about 1.25 percentage points since the stock market collapse, noted David Resler, economist with Nomura Securities International in New York.

The pool of funds that banks can use for loans has also been swollen recently as investors have moved money out of stocks into other financial instruments, such as money-market mutual funds and certificates of deposit, economists noted.

This increase in funds was reflected in the Fed’s announcement Thursday that the nation’s basic money supply had grown $9.1 billion to an adjusted $769 billion, during the week that ended Oct. 26. The figure includes cash in circulation, deposits in checking accounts and non-bank travelers checks.

Among the most direct beneficiaries of the prime rate cut will be the millions of Americans who have taken out home equity loans since the beginning of the year to take advantage of changes in the federal tax code. The interest they pay on their loans rises and falls with the prime rate charged by their bank.

The widespread enthusiasm for home-equity loans was cooled as the year progressed by the upward drift of the prime rate, which added 2 percentage points of interest expense between April and October. “This is a very lucky break for all those people,” economist Getman said. “It should serve as a lesson about what can happen.”

Mortgage Rates Falling

The value of home equity loans in the United States has swollen to about $100 billion from $35 billion in the past year. The loans became attractive under the new tax law because interest on them remains deductible from federal taxes, unlike interest on other consumer loans, which is being phased out.

The decline in interest rates has also begun to lower home mortgage rates, although firm figures on the extent of the dip are not yet available. James Christian, economist with the U.S. League of Savings Institutions, estimated Thursday that the drop may soon average about 1 percentage point on 30-year fixed-rate mortgages, and 0.25 to 0.50 percentage point on adjustable-rate mortgages.

Adjustable mortgage rates have been far below those of fixed-payment rates in recent months and will probably be slower to reflect the changes, he added.

Economists are generally agreed that interest rates are headed down for the remainder of this year, but opinions vary widely on how long the decline will continue. Many believe that the stock market fall does not reflect any underlying weakness in the economy and argue that rates will turn up next year.

But others contend that the market shock portends darker developments, including a loss of consumer confidence, and argue that the nation is headed for a recession and a prolonged period of lower rates. In telephone interviews, several economists cited the results of a Los Angeles Times poll that found many consumers planning to defer major purchases because of the current economic uncertainty.

“We’re really in uncharted waters here,” Resler of Nomura Securities said.