Low interest rates permeate economy

Call it the Alan Greenspan low-interest-rate diet. Yes, fat-free borrowing.

Low interest rates have now percolated through the entire economy: housing, retailing, corporate borrowing, auto loans, and government loans. In a nation that borrows $20.7 trillion per year, this has meant an enormous savings. Compared with only three years ago, Americans are now paying $500 billion a year less. In fact, compared with just a year ago, they are saving $300 billion a year - close to the total six-year tax cut that just passed Congress.

When the Federal Reserve meets at the end of this month, many economists expect the Fed to drop interest rates by another 1/4 of a percent. This would bring the Fed Funds rate, a short-term rate, down to 1 percent - the lowest rate since the 1950s, when the Ozzie and Harriet generation were learning about savings accounts.

"It has kept the economy afloat," says Bill Sullivan, a money-market economist at Morgan Stanley in New York.

Monday, a new round of reports painted a mixed view of the economy. In April, construction spending slowed to its lowest level in four months. But a May survey of manufacturers found that the slowdown in business was easing somewhat. The reports were in line with others last Friday, which showed consumer spending and income flat in April but confidence improving in May.

Although the stock market interpreted the economic news favorably, Bob Brusca, an economist with Native American Securities, says the data continues to show "little evidence of a building rebound or gathering of momentum."

Through these ups and downs, one bright spot for consumers has been interest rates. That's a change from the past, thanks to a major shift in the way Americans view borrowing and money. Thirty years ago, Americans were quite conservative - thinking only in terms of 30-year fixed-rate loans or five-year term loans for an automobile. But now there are scores of bank loans that are linked to short-term interest rates, such as a Treasury bill or the prime-interest rate (the rate charged to the best corporate customers).

"The household sector now has the ability to raise money, to borrow against short-term interest rates," says Mr. Sullivan.

Take adjustable-rate mortgages (ARMs), which three years ago accounted for 25 percent of all new loans, according to the Mortgage Bankers Association. As short-term rates have dropped, so have the rates on ARMs. Three years ago, the rate on a one-year ARM with a 30-year amortization was 5.84 percent. On a $200,000 loan, this was a monthly payment of $1,177. Today, the same rate has shrunk to 3.09 percent, or an $853-a-month payment. This 27.5 percent drop represents "a real opportunity for those who have taken advantage of it," says Jay Brinkman, an economist with the MBA.

Many Americans have also taken advantage of the drop in long-term interest rates, such as for 30-year fixed-rate loans. Only three years ago, mortgage rates stood at 8.52 percent. On a 30-year fixed-rate loan of $200,000, the monthly payment was $1,537.83. Today, the same loan would have a 5.5 percent interest rate, and the monthly payment is $1,135.58.

Americans have flocked to mortgage lenders. Last year, the MBA estimates refinancings totaled $1.465 trillion, compared with $530 billion in 1993, another refinance year.

In fact, many Americans are now using their mortgages as a means to borrow for other expenses. Freddie Mac, a public/private organization that seeks to provide stability in the mortgage markets, estimates that in 2001, Americans cashed out about $140 billion. This year, they are on track for about $100 billion.

Unlike mortgage rates, however, credit-card interest rates have declined modestly. Three years ago, borrowers were paying 15.83 percent, according to CardWeb.com, which follows the industry. Today, the average rates are 14.89 percent, back up from a low of 14.32 percent in December 2001.

"The rise in punitive interest rates for consumers whose creditworthiness decreases has been the main driver of the increased rates since then [December 2001]," says Robert McKinley, CardWeb.com president.

Consumers aren't the only ones benefiting from the drop in rates. Many municipalities are refinancing more expensive debt. That's the case for the Los Angeles Convention and Exhibition Authority, which is in the process of refinancing $450 million in bonds issued in 1993.

Fitch Ratings, a credit analysis service, estimates the savings to the authority will be about $53 million. "The less we have to pay, the more we have for other general-fund services," says Marla Bleavins, a finance specialist for the city.

In fact, everyone from the Flint Michigan Hospital Authority to the City of San Diego is racing to refinance. "We're seeing a lot of re- fundings," says Amy Doppelt, an analyst at Fitch.

The federal government is also benefiting from the lower rates, even though it carries debt with higher interest rates issued years ago.

About 40 percent of US debt rolls over each year. This means that over the past three years, the average interest rate paid by Uncle Sam has dropped from 6.389 percent to 4.087 percent. The net interest outlay has dropped from $206 billion in 2001 to an estimated $161.4 billion this year.