Fed Cut a Mixed Bag for Borrowers, Savers
The Fed gave debt-laden consumers a gift in the form of lower borrowing costs that should trim billions of dollars off the burden of credit card debt, home equity lines of credit and other variable-rate debt.
But questions remain about whether the cut will spark enough additional spending to help the economy, whether leery banks will make borrowing more difficult and whether consumers should be adding to their already-considerable debt, even if they can.
Meanwhile, the rate cut will mean more pain for savers, who almost certainly will see rates on certificates of deposit and money market accounts continue to fall.
Economists will closely watch how consumers borrow and save in coming months, because their spending accounts for two-thirds of the American economy and is seen as the best hope for keeping the nation out of recession.
Yet consumers already are struggling with near-record debt levels, with more of them missing payments as the economy has slowed.
“We have a household sector that is already burdened with debt and we are tempting it to take on more debt” with lower rates, said Paul Kasriel, chief economist at Northern Trust Corp. in Chicago, who has described rising consumer debt levels as a “ticking time bomb.”
Currently, consumers overall are dedicating roughly 14.3% of their monthly disposable personal income to making payments on houses, cars and credit card loans, according to the Federal Reserve. The last time household debt service reached those proportions was in the final quarter of 1986.
The Fed figure is an average. For many Americans, the monthly payment burden is much higher.
The strain of making payments is starting to show. Mortgage loan delinquencies--loans that are at least 30 days past due--jumped to 4.5% of loans outstanding in the fourth quarter of last year, which was the highest delinquency level since 1992. Meanwhile, the credit card delinquency rate rose to 3.34% of accounts, up from 3.22% a year earlier.
Banks have countered by tightening their lending standards, economists note. “Banks are responding as they normally do in the late stages of any expansion by pulling back,” said Gary Schlossberg, economist at Wells Capital Management. Even though rates on credit cards, car loans, personal loans and home equity loans probably will drop, some consumers could find themselves facing a tougher time winning approval from lenders, he said.
People with marginal credit histories probably will bear the brunt of this credit-tightening, said Doug Duncan, economist at the Mortgage Bankers Assn. of America. Lending to consumers with poor or nonexistent credit soared in the 1990s.
“It’s like the level of unemployment--the people with [marginal employment skills] are the last hired and the first ones to be laid off. The first out in terms of lending are the people on the margin of credit quality,” Duncan said.
But for many Americans, the latest rate cut will provide some breathing room. Americans with variable-rate credit cards are expected to save $1.2 billion over the next year, and the savings could mount to $2 billion if fixed-rate cards also cut rates to be more competitive, said Robert McKinley, head of CardWeb.com.
Many credit card rates move in tandem with the prime lending rate, which was cut to 7.5% from 8% by major banks on Wednesday.
Likewise, many home equity credit line rates are tied directly to the prime rate, producing instant savings for borrowers.
Also, this may be a particularly good time to buy a new car, as lower loan rates combine with aggressive rebate and incentive deals from auto makers desperate to lower their inventories, said David Littmann, economist at Comerica Bank.
Still, the lure of lower rates could prove devastating both to some consumers’ personal finances and to the nation’s economy, if consumers suddenly must cut back because of continued layoffs or other financial trouble, economists said.
“Lowering interest rates defuses the bomb [of consumer debt] a bit,” Kasriel said. But by inducing more people to borrow, the Fed is “just adding to the explosive power of that bomb. When it’s triggered, it could be all the more devastating.”
Others believe worries about consumer debt levels are overblown.
Sung Won Sohn, chief economist for Wells Fargo Bank, said his research shows that it’s largely people with lower incomes who are running into trouble, while middle- and upper-income borrowers are easily making their debt payments. More affluent consumers are thus in a good position to help boost the economy with further borrowing, he said. “They’re the ones in the position to spend, and they’ve got the money,” Sohn said.
The Fed cut certainly reduces the incentive to save: Bank CD rates are now at two-year lows and are likely to continue to fall as the Fed’s cut translates into lower yields, said Greg McBride, analyst for rate-tracker Bankrate.com.
The average seven-day compound yield on taxable money market funds is 4.66% now, and could fall close to 4% in coming weeks given the Fed’s move Wednesday.
The only good news for savers is that inflation has been tame, McBride said. “Nominal rates are lower, but [savers’] purchasing power is not being significantly eroded,” he said.
