Fed Cuts Good for Banks but Not Seniors

Last week investors bore witness to JP Morgan Chase & Co.’s shocking and historic $2 a share fire-sale offer for Bear Stearns (the ante was raised to $10 a share Monday) and the government’s $30 billion bailout of the longstanding investment bank. The Federal Reserve (Fed) followed up with a three-quarter percentage point interest rate cut. That move bought the federal fund rate, the interest that banks charge each other, down to 2.5%, the lowest since 2004. Investors felt a bit of relief when the stock market rose. But with every breaking news bit, the market remains pendulous and investors remain wary.

The U.S. economy is at a crossroads. Typically, when the Fed sees the economy weakening, they lower funds rates to try to stimulate the economy. In explaining its

actions, the Fed said it had to navigate a difficult policy environment that included sluggish economic activity and rising inflation pressures. Financial markets remain under considerable stress, and the tightening of credit conditions, as well as the deepening of the housing contraction, are likely to weigh on economic growth over the next few quarters. The Fed also said it is ready to cut rates further if necessary.

Some say it was a good move by policymakers in general. “The Fed is trying to stabilize and shore up financial markets,” says Gerald Loftin, principal of Renaissance Financial Group in Norwood, Massachusetts. “Financial institutions will be the first ones to drive the economy out of this recession. Once you start looking at earnings, three quarters from now we are going to see that these large banks have made substantial gains in the market,” he says. “Once their spread starts growing in terms of profits they may eventually pass it down to consumers.”

As the economy appears to get better, people become optimistic, Loftin says. If consumer confidence rises and stock markets act in a positive manner, this could have a positive implication on the U.S. economy.

But what does all of this mean for the average investor or consumer? If you have a large balance on your credit card, don’t hold your breath waiting for that rate to fall. Also, don’t rush to refinance your fixed-rate mortgage on your home hoping to get a better deal. On the other hand, the Fed’s rate cut will lower the payments for most homeowners with adjustable-rate mortgages.

Loftin says that the Fed’s rate cut had a drastic immediate effect in the liquidity markets such as CDs, savings accounts, and money markets. “I don’t think we are going to see a decline in mortgage rates or credit card rates. If you look at mortgage rates a year ago, they have been holding fairly steady.”

With rising gasoline and food prices and lower-interest income, retirees and seniors will be among those squeezed hardest by the Fed rate cut, says Jason J. Tyler, a senior vice president at Ariel Capital Management L.L.C. (No. 2 on the be asset managers list with $16.1 billion in assets under management) in Chicago. “Anyone who lives on a fixed income, whose capital is invested in bank deposits or CDs, will be receiving an even lower rate on those investments.”

A year ago, 5% on a CD with a 5-year maturity wasn’t hard to find. Now it is. One-year CD rates are about 2.90% and 5-year CDs are at 3.23%. Savings accounts rates could drop to around 2% in the next few months. Visit www.bankrate.com for updates on nationwide rates on CDs, money markets, mortgages, home equity loans, car loans, and credit card rates.

Tyler says that with financial intuitions able to borrow a lot more cheaply, some of those savings will pass on to consumers. As borrowing costs come down, individuals and corporations will be able to borrow at cheaper rates. “The Fed is trying to do everything it can to get people to borrow and to go out and spend money,” he says.