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Jose Luis Magana/AP
Federal Reserve Chairman Ben Bernanke

Is the Fed’s Record-Low Interest Rate Cut the Answer?

December 17, 2008 04:15 PM
by Anne Szustek
The Federal Reserve made an unprecedented move by lowering the benchmark federal funds interest rate to between 0 and 0.25 percent. But is it enough to revive spending?

Will Consumers Be Saved by Zero?

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In a bid to roll back an already entrenched recession and rev up consumer spending, the Federal Reserve sliced interest rates to as low as 0 percent on Tuesday—one of the “all available tools” the Fed mentioned in its statement about the groundbreaking move.

In other words, to paraphrase a certain ubiquitous television commercial, all qualified American buyers may be eligible to benefit from 0 percent financing during this arguably legendary credit crunch.

Other moves the Fed is ready to take include using its $2 trillion balance sheet to buy up debt backed or issued by government-sponsored mortgage agencies as well as “longer-term” U.S. Treasury debt.

Meanwhile, consumer prices over the month of November saw a 1.7 percent drop, the biggest decrease since records began in 1947, according to statistics released by the Labor Department. This was largely on the back of a 17 percent drop in energy prices. Prices for goods besides food energy stagnated from October through November.

“Not only is growth collapsing but so is inflation,” Comerica Bank chief economist Dana Johnson, chief economist at Comerica Bank, told Investor’s Business Daily, although he expressed confidence in the Fed’s bargain-basement interest rates and the $700 billion bailout package. “There is so much stimulus being applied that when the economy does turn around, it’s going to do so fairly impressively,” he continued in Investor’s Business Daily.

Opinion & Analysis: Will the Fed cut keep shopping spirits bright?

Loans and credit lines tied to prime interest rates are three percentage points above the Federal Reserve funds rate, and rates at some financial institutions, including Wachovia and Bank of America, have already dropped to reflect the Fed’s Tuesday move.

Credit card customer Susan Marinucci told San Francisco ABC station KGO that she hopes to benefit from the record-low interest rates. “That would be great. I’m paying quite high now 9.9 percent at credit union so it would be wonderful.”
The lower interest rate makes it less expensive for financial institutions to expand and borrow funds, and people looking to refinance their mortgages or consolidate their student loans stand to see more immediate returns from the Fed’s rate cut.

But in actuality, unless there is some sort of impetus to get banks to lend during this recession, consumers’ access to money supply may not be as improved as it would seem.

“The banks will think long and hard about the minimum rate they’re willing to extend credit at,” John Arfstrom, bank analyst at Dain Rauscher, told the Minneapolis-St. Paul Star Tribune. “The banks have a lot more power in this cycle than they had two or three years ago.”

Credit cards are offered at fixed rates, so those are not likely to drop, unless a customer makes a specific request to their lender to have it lowered. And it can take months for Fed fund rate cuts to be reflected in mortgage rates. “I don’t see the prime rate being lowered has actually moved mortgage rates down,” Lawson and Associates Mortgage Planners managing partner Brandon Knapp told KGO. “What has actually moved mortgage rates down is the purchasing of the treasuries because that’s provided direct liquidity into the market.”

Reference: Mortgage guide

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