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Fed Leaves Interest Rate Stable ... For Now

Consumers Already Overburdened by Debt and Energy Prices?

By Martin H. Bosworth
ConsumerAffairs.com

August 9, 2006

Living in a Bubble? Mortgage Crisis? Act Now to Avoid Foreclosure • Avoiding Foreclosure Takes More Than Hope --- • Fannie Mae and Freddie Mac Suspend Foreclosures • Consumer Prices Plunge in October • Paulson Rejects Bailout Money for Detroit • Another Glimmer of Hope in The Housing Market • Buyers' Beware Market • FDIC Backs More Aggressive Loan Modification Plan • Housing 2009 Forecasts Mixed, But Mostly Grim • Foreclosures Up Five Percent in October • Feds Shift Gears On Bailout, Puts Focus On Consumers • More Homeowners Under Water in Third Quarter • Feds Mount New Effort to Help Struggling Homeowners • Lenders Embrace Workouts for Struggling Homeowners • Obama Can't Quickly Raise Homebuyers' Hopes • At Last: Bailout Trickling Down to Struggling Homeowners • New Home Sales Rise in September • How to Appeal Your Property Tax Bill • Existing Home Sales Rise in September • Administration Considers More Help for Homeowners • Foreclosure Activity Drops in September • Southern California Home Sales Surge 65 Percent in September • HOEPA: New Hope for Outlawing Abusive Mortgages • FDIC Chief: Not Enough Help for Homeowners --- • More ...

In theory, consumers should be cheered by the news that the Federal Reserve has decided not to hike interest rates, but many observers say consumers are already so overburded by heavy debt loads and high energy prices that their jubilation will be both slight and short-lived.

The Fed yesterday declared at least a temporary pause in a two-year-long run of interest rate hikes that has left analysts wringing their hands and hiked lending costs for consumers.

Maintaining the interest rate at its current level of 5.25 percent offers some relief for borrowers, as banks and other lenders tie their own interest rates to the prime rate.

"Economic growth has moderated from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices," the Fed said.

However, the Fed maintained that "inflation risks remained," leaving the door open for another potential rate hike later this year.

The markets responded tepidly to the Fed rate pause, with the Dow Jones dropping nearly 46 points on fears that the temporary halt would be brief.

The vote was the first under Fed chairman Ben Bernanke to have a note of dissent. The vote to hold the line on the federal funds rate was 9-1, with committee member Jeffery Lacker dissenting. Lacker, president of the Federal Reserve Bank of Richmond, VA, believed the interest rate should go up to 5.5 percent in order to ensure that inflation remained under control.

In a speech to a gathering of economists in West Virginia in April, Lacker expressed skepticism that events such as Hurricane Katrina and the exorbitant price gains in the housing market were contributing to greater economic harm down the line.

"To some, it seemed obvious that the high energy prices would lead to a significant and persistent reduction in consumer spending, which would bring overall economic activity to the edge of recession. That didn't happen," Lacker said.

Maxed Out

The Federal Reserve has moved to tighten interest rates steadily over the last two years after they fell to historically low levels, enabling consumers to obtain credit far more easily than they normally could.

The availability of credit, even to those with poor financial histories, contributed heavily to the boom in the housing market, as families bought homes with massive loans using "creative financing."

However, as rates continued to increase and many homeowners found themselves too financially strapped to pay the bills, the housing market began to stall out. Bernanke noted that the cooling home market would have a profound effect on the economy as a whole, due in part to the usage of home equity loans and lines of credit to buy other goods or services.

The halt in rate hikes surprised many analysts and observers, who thought Bernanke's focus on combating inflation would lead him to push for another increase.

Despite this, the Fed continues to promote the idea of borrowing and utilizing credit to the utmost. The agency released a report containing survey data from 2004 and 2005 that claimed consumers are happy with the amount of prescreened credit solicitations available to them, and of the cardholders surveyed, more than 70 percent said the credit solicitations should continue coming.

The massive debt loads consumers are carrying would seem to suggest otherwise. A report from the National Consumer Law Center (NCLC) stated that the elderly are more at risk of taking on excessive debt than ever before, due to predatory lending tactics and deceptive solicitation by creditors.

Economist Dean Baker noted for The American Prospect magazine that the amount of total credit card debt consumers are carrying rose for two months straight in May and June.

Baker said that the increasing levels of credit card debt were consistent with the inability of homeowners to borrow against the equity of their homes, due to falling home prices. "If you need to borrow, and borrowing against the home is not an option," he said, "credit cards may be the next best alternative."

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