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Fed Cuts Key Interest Rate Again

Second rate cut in as many weeks; Fed hopes to spur spending

By Mark Huffman
ConsumerAffairs.com

January 30, 2008

A week earlier the policymakers cut the Fed's Federal Funds Rate by three-quarters of a point in an emergency meeting.

In Wednesday's regularly scheduled meeting, the Fed cut the Federal Funds Rate, the rate at which banks loan money to other banks, usually overnight, a half point to three percent. The Fed also cut the Discount Rate – the rate at which the Federal Reserve loans money to banks – by a half point.

Of the two, the Federal Funds Rate is likely to have a larger impact on consumers, since it has the effect of encouraging banks to lend money. It also usually results in a reduction in a bank's prime lending rate, resulting in lower interest rates on many different types of loans.

Driving the Fed's action is growing concern about the outlook for the U.S. economy, which is showing signs of slipping toward a recession. However, Wall Street also appeared to exert significant influence on the policy makers, with investors threatening to flee from stocks unless the Fed continued to ease credit.

In fact, Federal Reserve Chairman Ben Bernanke and his OMC colleagues observed in their rate cut announcement that "financial markets remain under considerable stress."

Good news for consumers?

In the meantime, the falling interest rates should mean consumers who qualify may get lower interest rates on vehicle loans and, eventually, home mortgages.

Economists have expressed concern about the number of subprime loans with very low "teaser" rates that are scheduled to reset to market rates in 2008. Last year's record wave of foreclosures, it was feared, could be equaled, or exceeded, this year.

When the mortgage reset occurs, a subprime borrower could go from a rate as low as 3.3 percent to a double-digit rate, resulting in an increase in their monthly mortgage payment of several hundred dollars. Many, on a tight budget to start with, would quickly go into default.

With interest rates falling, the threat has been lessened, if only slightly. When rates are reset, they will be established at a lower rate than they would have otherwise. While it's likely that many subprime borrowers will still be unable to make the higher payments, some undoubtedly will.

More importantly, others may qualify to refinance into a 30-year fixed rate mortgage at a very low rate, perhaps less than a point above their teaser rate. Locking in that low rate not only heads off catastrophe, but provides that affordable payment over the life of the loan.

The Fed action also encourages consumers to keep spending, since keeping money in the bank will provide even less in the way of interest.

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