Interest-rate cuts: a slow stimulus

Short-term loans are already cheaper, but experts say it will take time before consumers benefit fully.

Thanks to the Federal Reserve's interest-rate reductions over the past two months, consumers could save $3 a month on a $5,100 credit-card bill.

And, thanks to the Fed cutting rates, the Dow Jones Industrial Average had rallied nearly 500 points since the middle of September, adding billions to the value of portfolios. But after disappointment that the Fed might not cut rates further in December and an analyst's down grade of Citigroup, the Dow fell 362.14 points on Thursday.

These examples illustrate both the limits and the possibilities of Federal Reserve board interest-rate cuts. They can be useful to the financial markets and probably business. But, it's much harder for the Fed's moves to reach Main Street in a meaningful way. And, even though mortgage rates have come down, most economists expect the housing market will continue to struggle regardless of the Fed's actions.

"There are real consequences to the Fed's actions, such as providing liquidity to the markets and buoying the business community by showing that the Fed is engaged and will do what is necessary to help the economy," says Mark Zandi, chief economist at Moody's Economy.com.

"But, in terms of reducing debt, those impacts are small and take a long time to really matter, which is why rate cuts take a long time to filter through the banking system and for banks to pass the savings on to borrowers."

The Fed's latest interest-rate cut on Wednesday lowered the Federal Funds rate, at the rate which banks lend each other excess reserves, by one quarter of a percentage point. It follows a cut of half of a percentage point in mid-September. The rate cuts have wound their way through to what is called the London Interbank Offered Rate (LIBOR), a major interest-rate index used to set adjustable mortgages and other borrowings. According to bankrate.com, the LIBOR rate is now 4.72 percent for a one month loan, down from 5.13 percent a month ago.

"A lot of loans are based off LIBOR," says John Silvia, chief economist at Wachovia, a national bank, based in Charlotte, N.C. "The real beneficiaries of the lower rates are businesses or small businesses who borrow."

For example, immediately after the Fed dropped interest rates on Wednesday, Wachovia lowered its prime interest rate, the rate at which it loans money to its best customers, from 7.75 percent to 7.50 percent.

Some businesses that deal with consumers are fairly quick to pass through their savings. That's the case at St. Petersburg, Fla.-based Passport Marine, which sells and distributes powerboats and yachts. A Sun Sport, a thirty-five-foot family boat built by Formula, retails for $298,000. Passport, which has lined up its own financing, has dropped the interest rate on loans to buy the boat from 5.99 percent to 5.24 percent in the last two months. This has lowered the monthly payment from $1,823 a month to $1,727 a month or a savings of $24,000 over the life of the loan.

"We're not only decreasing the amount of monthly payment but we're also increasing the amount of principal you pay off," says Jim Dillon, CEO of Passport. "You are paying off a lot more of the boat when it's not appreciating in value, so that's really important."

The rate drop is a lot less significant for people carrying credit-card balances. According to the Federal Reserve, some 57 percent of cardholders have a variable rate that can rise or fall with interest-rate changes. The Fed also says the mean credit-card balance is $5,100 (the median credit-card balance is $2,200).

"For each individual it won't be a significant change," estimates Bill Hardekopf, CEO of LowCards.com, a free consumer website.

Mr. Hardekopf estimates that after the last two rate cuts the savings on a $5,100 card balance is $3 a month. "The Fed did not cut the rates so our credit-card bills will be lower," he says. "Besides, as the rates are dropping, [credit-card] issuers are finding other ways to make money, such as increasing the fee for cash advances or balance transfers [to other credit cards]."

Depending on their credit rating, the Fed rate cuts may have some favorable impact on people applying for mortgages or trying to refinance a mortgage. According to Bankrate.com, the 30-year fixed-rate mortgage has dropped from 6.25 to about 5.90 percent since August as the long-term bond markets reacted to and anticipated the rate cuts. Adjustable- rate mortgages are lower as well, falling over half of 1 percent. In September, a Mortgage Bankers Association (MBA) survey found the average application to refinance was asking for $241,300.

"If you are a prime borrower [the best credit score] and you are not asking for a jumbo loan [over $417,000], this is a really good time to borrow," says Orawin Velz, director of economic forecasting at the MBA. However, for jumbo borrowers, it can cost up to half a percent more to borrow today than earlier this summer. "It's not going to be in a normal state for a long time, people are repricing their risks," says Ms. Velz.

And, she adds, the interest-rate drop will not help people with subprime mortgages – mortgages for people with less than stellar credit. "They took out mortgages that had teaser rates that were really low," she explains. "Now there are tighter lending standards so the lower rates won't help those people."