My New Blog

WASHINGTON – Jan. 24, 2008 – Here’s a look at how the Fed’s action will affect different sectors of the economy:

The Federal Reserve’s move Tuesday to sharply ease interest rates may have injected some confidence into the financial markets. But there’s one problem: The Fed can’t force lenders to open the credit spigot wider.

Mortgage-related losses and consumer loan delinquencies have so far defied the Fed’s efforts to ease the raging credit crisis. The fear now is that even the Fed’s most aggressive effort to date may not succeed in getting more money into the hands of businesses and consumers fast enough to curtail the economic slowdown.

And if it doesn’t? A trifecta of problems -- a housing slump, high energy prices and tightening credit -- could inflict more pain. Consumer spending, the engine of the economy, may slow further. Businesses could lay off more workers. And the nation could find itself in a full-blown recession.

The rate cut “may help to some small extent, but this is one of those times where there are forces tugging in different directions,” says Joel Naroff, founder of Naroff Economic Advisors in Holland, Pa. “If we continue to have (these) major credit restrictions, that’s obviously going to slow the economy further. ... You have a good chance of recession.”

The Fed’s rate cut succeeded in calming jittery investors Tuesday, who had begun the session with a binge of selling. But it’s too early to tell whether the cut will ease the woes of the nation’s banking system and lead to increased lending to consumers.

Bank of America and Wachovia, two bellwethers of the industry, reported dismal earnings Tuesday. Bank of America’s profits for the fourth quarter plunged 95 percent from the prior year’s; Wachovia’s earnings fell 98 percent.

In a conference call, Bank of America’s Ken Lewis said, “This has easily been the toughest environment since I’ve been CEO.” He added that he didn’t expect a rosier outlook anytime soon.

As long as the credit crisis goes on, it will remain difficult for banks to package consumer loans and sell them to investors, says Lyle Gramley, a former Federal Reserve governor who is now a senior economic adviser at Stanford Washington Research Group. “And because they’re writing down assets, they’re losing capital” to make new loans, he adds.

Restored confidence in the credit markets would encourage lenders to ease their loan standards, Gramley suggests. That hasn’t happened in the past, in part because the fall in home sales and prices has made it hard for banks to price their assets. And despite a succession of rate cuts, the Fed had sent mixed messages about whether it would continue to cut rates.

But Tuesday’s action, Gramley says, could build confidence because the Fed conveyed its intent to focus mainly on the credit crisis’ impact on the economy.

Housing

Some areas could get a boost.

The Fed’s rate cut won’t instantly resolve what Cleveland Fed President Sandra Pianalto recently termed a “free fall” in the housing market.

New home sales and construction are down more than 50 percent from their most recent peaks. Millions of subprime mortgages will adjust to sharply higher rates this year. More prime borrowers are having trouble meeting higher payments or refinancing their mortgages as their home prices fall.

But the rate cut will help some homeowners and buyers. The question is: How many? Economists are divided about the answer.

“Ultimately, it has got to help the housing market,” Naroff says. The lower rates, coupled with further rate reductions, could eventually help revive the housing markets, he says.

But Mark Vitner, senior economist at Wachovia, thinks the cut won’t “have that much of an impact.”

The reason, he says, is there are different housing markets in the country. In some sunshine states -- California, Florida, Nevada and Arizona -- prices must still fall sharply before they’ll be affordable for the average working family. In the Midwest, the problems in real estate are a byproduct of lost manufacturing jobs. Lower rates won’t provide any near-term boost for these housing markets, Vitner says.

Lower rates, though, should give a boost in the rest of the country, Vitner says, where the current challenge is tighter lending guidelines.

“More people will qualify for loans at lower interest rates, but this will not solve the problems,” he says. “The Fed’s action was really to stop problems in the real estate market from further spilling over into other parts of the economy.”

For current homeowners, says Fred Arnold, president-elect of the California Mortgage Brokers Association, the Fed cut will lower rates on home-equity lines, which are tied to the prime interest rate.

“It’s a blessing for people who can’t refinance out of their home-equity loans because their home is worth less than they owe,” he said.

And for homeowners in California, where prices in many areas have fallen steeply, that’s a problem.

“Fifty percent of the homeowners who call me for advice I can’t help because their equity has gone down,” he says, “and we’re talking prime borrowers, not subprime borrowers, in many cases.”

For those with subprime adjustable-rate loans, the Fed cut won’t provide very much help, he says. “They are still going to see quite a bit of a payment shock, just not as great as a year ago.”

And it’s doubtful the lower interest rates will save many of the hundreds of thousands of homeowners who have already fallen behind on their mortgages. Given the black mark on their credit records, lenders are hesitant to help them refinance in most cases, unless there is a lot of equity in the home.

Small businesses

Getting loans could get easier.

Small businesses -- numbering 28 million in the U.S. -- are hoping that the Fed’s rate cut will make it easier for them to borrow money.

Most small businesses are retail, services and construction companies that are especially vulnerable to a downturn because they need bank financing to grow and they lack the cash to weather long economic slumps, says Scott Anderson, senior economist at Wells Fargo.

“Small businesses are on the front lines of this whole slowdown,” Anderson says. “They’ve had good profits and cash flow, but things are deteriorating rapidly.”

Those that rely on community banks won’t be as hard hit as small companies seeking financing from big commercial banks hurt by the housing crisis, says Dan Danner of the National Federation of Independent Business (NFIB).

But if the economy slows and consumers stop spending, Danner says, small businesses won’t borrow money to expand operations and invest in equipment. In the NFIB’s “Small Business Economic Trends Report” this month, 7 percent of small business owners surveyed reported trouble with financing.

“Our guys are very hopeful that the Fed’s actions will stimulate the overall economy and keep consumers out there,” Danner says.

Melody Foster, CEO of The Cozy Home in Draper, Utah, is cautiously optimistic that her home decor store can last even if a recession hits.

Big businesses

Companies could see savings.

The market for commercial paper -- short-term IOUs issued by major corporations -- has firmed since the fall, says John Lonski, chief economist for Moody’s Investors Service. “The tone of the market has improved,” Lonski says. He’s even seeing increased issuance of asset-backed commercial paper, which is backed by mortgages and other loans.

The biggest benefit for big businesses from the Fed’s rate cut: lower interest expense, Lonski says. Companies will be able to refund their debt at lower rates and pocket the savings.

But companies with poor credit still aren’t getting much respect from Wall Street, Lonski says. Few are able to issue the high-yield, high-risk junk bonds that have been common since the 1980s.

Meanwhile, the market for mortgage-backed bonds is still shaky, making lenders leery about making some loans, such as “jumbo loans” -- those above the $417,000 limit for purchase by Fannie Mae and Freddie Mac.

Consumer debt

Credit card rates could fall.

Tuesday’s rate cut should translate into lower rates on auto loans in the next few weeks, says Mark Zandi, chief economist at Moody’s Economy.com.

“Rates matter a lot in terms of sales,” Zandi says. “If sales are flagging, and lenders can bring down their rates, they will.”

Meanwhile, more than 90 percent of credit cards have variable interest rates, so the Fed rate cut “clearly will benefit consumers,” says Robert McKinley, CEO of CardWeb.com. A three-quarter-point decline in short-term rates is “pretty substantial,” he says, even for borrowers who are saddled with penalty rates of 30 percent or more. “This may give consumers more incentive to pay their bills on time,” he says.

But Harold Black, a finance professor at the University of Tennessee-Knoxville, says the rising credit card delinquency rate could dampen the impact of the rate cut. On Tuesday, Joe Price, chief financial officer of Bank of America, said the number of its credit card customers who were 30 days overdue in California, Florida, Arizona, and Nevada rose five times over the rest of the bank’s portfolio. Other big lenders have also reported an increase in late payments.

“If we have growing delinquencies, the last thing credit card issuers would want to do is make credit easier,” Black says. “And you do make credit easier and more affordable if you lower those rates.”

Curtis Arnold, founder of CardRatings.com, says he thinks many consumers will see a drop in credit card rates within a few weeks. But if delinquencies and defaults continue to rise, the relief may be temporary. Most credit card contracts give issuers the right to raise rates in response to market conditions, Arnold notes.

Copyright 2007 USA TODAY, a division of Gannett Co. Inc. Written by reporters Noelle Knox, Edward Iwata, John Waggoner, Greg Farrell, Sandra Block and Kathy Chu. All rights reserved.