How rate cuts ripple through the economy

Fed's half-point reduction is a boon to some consumers, but many businesses may still be reluctant to borrow.

New Yorker Cholene Espinoza is thinking about sending Alan Greenspan a holiday ham. After a recent refinancing, she dropped the interest rate on her condo from 7 percent to 5.35 percent. "I guess I would say he's at the top of my Christmas list," she says of the Federal Reserve chairman.

Ms. Espinoza is one of literally millions of Americans who, by means of refinancing, are lowering their monthly mortgage payments or cutting the amount they owe banks.

With its decision on Wednesday to cut short-term interest rates by 1/2 percent, the Federal Reserve Board will help keep this phenomenon alive.

In fact, the Fed's move is intended to have a wide ripple effect. It will make money cheaper for a variety of businesses. Some adjustable loans will become less expensive. And it may reassure investors that the Fed is trying to actively manage the economy.

"It's got to have some positive effect," says Bill Sullivan, a money-market economist at Morgan Stanley in New York.

However, economists are divided over whether Mr. Greenspan's gambit will ramp up economic growth. So far, business has not shown enough confidence in the economy to build new factories, which would pick up the slack for sluggish consumer spending.

Instead, says Mr. Sullivan, the economy may need some fiscal stimulus. With the Republicans controlling Congress, he says that may take the form of additional tax relief.

Until that happens, here's what the Fed's latest rate cut will do:

• Mortgages. A few weeks ago, long-term interest rates had hit levels not seen since John F. Kennedy was president. The latest Fed move will help mortgages stay close to those levels over the next few months, says Ellen Bitton, president of Park Avenue Mortgage Group in New York. This is good news for anyone who has not taken advantage of the low mortgage rates. "If you haven't refinanced in the last three months, you may be a candidate still," she says. "We are still seeing a lot of new applications."

In fact, Diane Saatchi of the Dayton-Halstead brokerage firm in East Hampton, N.Y., says that the low mortgage rates tend to heat up demand for real estate. Unfortunately, it does nothing to increase the number of houses on the market. "If there was a bubble, this will delay it coming back down," she says.

• Business. For large companies that have loans tied to the prime interest rate (the rate the most credit worthy institutions pay), interest rates will fall. This will make it cheaper to build new factories, showrooms, or warehouses. But will it give them the confidence that they can sell their products?

"First, there is a lot of spare capacity that must be used up," says Sullivan.

For many small and medium-sized companies, the rate cut won't help, says Jerry Jasinowski, president of the National Association of Manufacturers (NAM). "Money is cheap, but you can't get it," he says, citing a recent NAM survey that found 40 percent of its members were unable to get bank loans. "A lot of this is overreaction to legitimate concerns, such as the collapse of the dotcoms and the telecom meltdowns. The banks have overreacted."

• Consumers. The lower rates will definitely help some, but not all, borrowers. Any loan that is tied to the prime interest rate will go down. On Wednesday, for example, the M&T Bank Corporation in Buffalo, N.Y., lowered its prime rate from 4-3/4 percent to 4-1/4 percent. Other banks are expected to follow quickly. This drop may mean lower rates on some home-equity, auto, and personal loans.

However, it probably won't include credit cards, since nearly all those with so-called "floor rates," or minimum rates, have been triggered, says Robert McKinley, president of CardWeb.com. There is a lag time in adjusting credit-card rates, too, meaning that any cut won't show up until January. This, however, is when the companies usually adjust their pricing policies, which may actually result in rates rising, not falling.

For example, delinquencies – a sign of future losses – grew during the third quarter. "Credit-card issuers always pass along these added costs or losses to consumers through higher rates," says Mr. McKinley.

In fact, credit-card rates have been rising all year, even when the Fed didn't move rates in any direction. In January of this year, the average credit-card interest rate was 14.33 percent. At the end of October, it was 14.74 percent.

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