Fed's rate cut will benefit many borrowers

Wall Street may fear a recession and worry about the credit crunch, but traders still know how to throw a party when Federal Reserve board cuts interest rates.

On Tuesday, the Dow Jones Industrial average rocketed ahead more than 420 points, a 3.5 percent gain, to 12,392.66. The Standard & Poor's 500 and the Nasdaq composite each gained 4.2 percent. The S&P closed at 1,330.72, while the Nasdaq closed at 2,268.26.

What set Wall Street off was the Federal Reserve board's decision to cut its target for short-term interest rates by three-quarters of 1 percent. The immediate consumer impact of the rate cut — the third this year from the Fed — is likely to be lower interest rates on home equity lines of credit, adjustable-rate mortgages and some other loans.

While rate cuts are designed to spark economic activity, they can also ignite inflation. Federal Reserve Board Chairman Ben Bernanke has indicated he sees the weak economy as the larger threat at the moment.

"There is no reason for the Fed not to be aggressive," said Mark Zandi, chief economist at Moody's Economy.com. "The economy is in a recession, the financial system is in disarray and inflation is low."

The Fed announced the rate cut, its sixth consecutive since the start of 2007, just one day after the central bank helped to rescue Bear Stearns, one of the nation's largest investment banks, by providing a $30 billion line of credit to JP Morgan Chase to buy the firm.

The Fed is fighting not only the economy's downturn but also the credit crisis that threatens Wall Street financial firms and borrowers. Its prime strategy has been to cut rates sharply.

At the end of 2006, the federal funds rate, which is the interest rate banks charge each other on overnight loans, was at 5.25 percent. The new target announced Tuesday was 2.25 percent, the lowest point since 2004.

While Wall Street embraced the move and borrowers will get relief, the decision is bad news for those with certificates of deposit and cash holdings because they will soon see lower rates of return.

"I don't see any benefit from it. They dropped my yield," said Herbert Siegel, 88, a Deerfield Beach investor who has money market funds.

But borrowers will be clear winners.

"The biggest beneficiaries of the Fed's latest rate cut will be homeowners facing resets on adjustable rate mortgages," said Greg McBride, senior financial analyst at Bankrate.com, based in North Palm Beach.

McBride said many homeowners whose mortgages reset this year could see their payments drop. Last year, many saw payments rise. "That impact alone will be the difference between keeping a home or losing it for a lot of people," he said.

Investors may have been cheered by the idea that "we may very well have seen the worst behind us," said John Nersesian, managing director of wealth management services at Nuveen Investments in Chicago. In recessions since World War II, he said, the Standard & Poor's average decline has been 16.9 percent. The index already dropped almost 19 percent from its high last October to its low point on March 10.

Beyond borrowers with adjustable-rate mortgages and investors, a wide swath of consumers should feel the benefit of lower rates.

After the Fed lowered the federal funds rate commercial banks lowered the prime interest rate to 5.25 percent. Many consumer loans, home equity lines of credit and private student loans are pegged to the prime rate, so their rates should fall, too.

For credit cards, however, it may not work out well for those who carry a balance. Although many credit cards are pegged to the prime, McBride noted that many credit card issuers included in their credit agreements a provision that allows the card issuer to delay up to 90 days lowering their rate when the prime declines.

Another issue: Floor rates. These are rates that card issuers will not go below, as set out in their credit agreements. McBride says some cards are getting close to their floor rates.

What will happen to some long-term mortgage interest rates at this point is anybody's guess.

The interest rate on fixed-rate mortgages has actually gone up since the Fed's previous cut, which was in January. On Tuesday, longer-term rates such as on the 10-year Treasury bond, rose slightly.

Economist John Burford, senior vice president and investment portfolio manager at The International Bank of Miami, said mortgage interest rates normally are about 1.4 to 1.5 percentage points higher than the yield on a 10-year Treasury bond. But that's not the case now. Today, the average fixed-rate 30-year mortgage is set at 6.13 percent, but the yield on the 10-year Treasury Tuesday is 3.39 percent.

"Consumers are watching home prices go down and they're waiting for interest rates to go down, but banks are reluctant to lend," Burford said.

Adjustable-rate mortgages, in contrast, tend to be pegged to shorter-term rates. Many adjustable-rate mortgages today are tied to one-year Treasury bills, or the London Interbank Offered Rate, a rate banks worldwide use for dollar-denominated loans. Both those have declined, in the same fashion as the federal funds rate.

Information from the Associated Press was used in this report.

Harriet Johnson Brackey can be reached at hjbrackey@sun- sentinel.com or 954-356-4614.

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