Rate Cut Seen as Unlikely to Spark Spending Binge
The cut in the discount rate Tuesday probably will result in lower interest rates in the coming weeks but may not be enough to motivate debt-laden consumers into a new spending binge on cars, vacations and other goods and services.
The Federal Reserve Board on Tuesday dropped the key discount lending rate to 5.5% from 6% in an effort to lift the economy out of recession by stimulating consumer and business spending.
The discount rate is the amount the Fed charges commercial banks to borrow money from the central bank. It is a key and pervasive influence over the U.S. economy, affecting everything from mortgages to corporate loans.
But the little spending consumers appear to be doing these days seems to be financed by their own savings rather than from additional borrowing. The savings rate, which is savings as a percentage of after-tax income, fell to 3.7% in March from 4.1% in February as consumers balked at taking out credit cards, car loans and personal loans.
Analysts don’t expect the latest rate cut to change that trend, especially since previous rate cuts by the Fed have barely affected one of the biggest sources of consumer borrowings--credit-card loans--which continue to command double-digit interest rates.
“I don’t think we’ll see a direct or immediate effect on consumers,” said Anthony Vignola, chief economist at Kidder, Peabody & Co., a New York-based investment house. The cut by the Fed, he said, “is more of an insurance policy to stimulate a recovery.”
Earl Peattie, president of Mortgage News Co., a Santa Ana publishing firm that tracks the mortgage rates of 150 lenders, speculates that the Fed’s decision to lower the discount rate was strategically timed to encourage lower interest rates on the long-term Treasury bonds that are scheduled to be funded next week. Thirty-year fixed mortgages are closely tied to interest rates on 30-year Treasury bonds.
Separately, the 11th District cost of funds index--the index most adjustable-rate mortgages in California are tied to--continued to fall in March, reaching its lowest level since July, 1988, according to figures released Tuesday by the Federal Home Loan Bank of San Francisco.
The rate for March was 7.654%, down from 7.848% in February. Banks and thrifts typically write ARMS so that the homeowners interest rate is from 2.25% to 2.5% above the index. The current rate means that a homeowner with a $200,000, 30-year loan with a rate 2.5% above the index would pay about $90 less a month this year than a year ago. The index--which measures the average cost of money for savings institutions in California, Arizona and Nevada--moves slowly, and typically lags overall interest rate movements in the market. Therefore, the current drops actually reflect the lowering of interest rates from several months back.
Banks’ decisions to cut interest rates on loans to consumers and businesses traditionally have been based on market forces as well as the cost of money. Thus, cuts in the discount rate may not immediately be passed on in the form of cheaper loans.
Still there was some evidence that banks would soon move to lower their prime rate, the interest level typically charged to their best customers and the gauge used to set many consumer loans, including auto and home-equity loans.
Southwest Bank of St. Louis announced a one-quarter point drop in its prime rate to 8.75% effective today. While no major banks followed suit, some analysts expected many will soon.
Many businesses, however, may not benefit from the Fed’s discount rate cut because banks have been under federal regulatory pressure to tighten their credit requirements, thus, shutting off loans to even some of the best corporate borrowers.
Steve Kaplan, a principal in the Arbolado Development Corp. real estate firm, said although he is happy the discount rate was cut, he doubts that it will affect the 90-home development he is building in Torrance. The reason? Kaplan’s project is being bankrolled by Japanese interests because he, like many other builders, can’t get U.S. bank financing.
Times staff writer James Bates contributed to this report.
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Cost of Funds Index The figures show the monthly weighted average cost of funds index for Eleventh Districtsavings institutions. ‘91: 7.654% Source: Federal Home Loan Bank of San Francisco
