Fed's move reflects concern
— -- The Federal Reserve's biggest interest rate cut in 18 years Tuesday likely will lower some borrowing costs for consumers, but it is unlikely to be a panacea for all of the economy's ills and means that savers will face lower returns on their money.
In a dramatic and surprising move that reflected serious concerns about a deteriorating U.S. economy, the Fed cut its target for a key interest rate by three-quarters of a percentage point to 3.5%, the lowest since September 2005. The action followed a plunge in financial markets around the world, as foreign investors expressed alarm that tightening credit in the USA — largely stemming from the crisis in the mortgage industry — would stifle economic growth.
In a statement, Fed Chairman Ben Bernanke and his colleagues said they took the rare action in advance of a formal meeting later this month "in view of a weakening of the economic outlook and increasing downside risks to growth." Many financial analysts said the statement seemed to indicate that another rate cut could come as early as next week, when Fed policymakers are scheduled to gather in Washington.
Although financial markets ended the day down, the final losses were not as bad as initially feared. After sliding 464 points after the opening bell, the Dow Jones industrial average closed down 128 points at 11,971.19, the lowest since Oct. 17, 2006. It was the first time since Nov. 3, 2006, that the Dow closed below 12,000.
Just after the Fed's announcement, lenders cut the prime rate for their best customers by three-quarters of a percentage point to 6.5%. The prime rate also is the benchmark for the rate on many home equity loans and credit cards, so consumers may see costs on such borrowing dip because of Tuesday's action. The idea behind the Fed's move is to encourage financial institutions to keep lending money to businesses and consumers, rather than fuel an economic downturn by limiting credit.
Quicken Loans chief economist Bob Walters says there's hope that the Fed's move could lead to greater availability of credit to consumers and businesses. There's been a decline in available credit for some types of lending, and Tuesday's rate cut could help, he says.
"The real benefit is money is being pumped into the banking system," Walters says. "Since (banks) have more of it and since it is cheaper, they will likely ease their credit standards and loan money."
Greater lending helps boost consumer spending, which accounts for more than two-thirds of U.S. economic activity. It also helps businesses fund investments as well as their day-to-day operations, including paying their workers.
The dark side of the Fed's move is that it is a clear signal that the nation's chief economists are alarmed about the direction of the USA's economy.
Vincent Reinhart, former director of the Fed's division of Monetary Affairs who is now at the American Enterprise Institute, said that despite any consumer benefits from the interest rate cut, he still puts the odds as high as 2 in 3 that the USA is in a recession or about to enter one in the next few months.
