Fed Cuts Key Interest Rate Again

Oct. 29, 2008— -- With concerns looming about a long, deep recession, the Federal Reserve announced today that it would cut a key interest rate by half a percentage point to 1 percent, a level not seen since 2004.

"Recent policy actions, including today's rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth," the Federal Reserve's Open Market Committee said in a statement released this afternoon.

The reduction marks the second time this month the Fed reduced its key Federal Funds rate and its sixth cut this year.

"They're just going to keep doing it until the markets seem like they're over their problems," said Gerald O'Driscoll, a former vice president at both the Federal Reserve Bank of Dallas and a senior fellow at the Cato Institute, a libertarian think tank.

But O'Driscoll and other experts agree that the economy's problems are far from over. The Fed rate cut and other Fed initiatives, including a program to buy short-term debt from businesses, won't stave off a recession, they said.

"It's a matter of trying to make the recession shallower and last less time -- that's really what it's about," said Bill Stone, the chief investment strategist at PNC Wealth Management. "I think it's hard to imagine that we're not in a recession. I know it's not official, but to us, it's a fait accompli at this point."

Nevertheless, optimism about a rate cut helped stocks to record gains yesterday, with the Dow Jones Industrial Average spiking nearly 900 points. In the minutes before the rate announcement, the Dow was also up, this time by about 80 points.

Lowering the benchmark rate makes it cheaper for American banks to borrow money but it also yields benefits for consumers.

O'Driscoll said that borrowers who hold adjustable-rate mortgages with interest rates pegged to the Fed rate could feel relief once their mortgage rates reset. Some, he said, have already benefited from previous rate cuts.

"People whose rates have reset during this crisis, in many cases, have wound up with a lower mortgage rate than they had the last time it reset," he said.

Credit card interest rates could also drop for some people. Card rates are dependent on banks' prime rates, which are typically three points above the Fed's benchmark rate. When the Fed's rate drops, the prime rate does too and the change often trickles down to credit cards.

But there are limits to how much impact the Fed rate cut will have. Credit card companies, said Greg McBride of Bankrate.com, need to cover their overhead costs and set "floors" on their credit cards rates. Because of earlier Fed cuts, he said, some cards have already reached interest rate floors.

"Each subsequent rate cut has a diminishing effect on consumers," he said.

Companies have less flexibility to lower their rates, McBride added, because more consumers have been defaulting on their credit card debt.

Interest rates on home equity lines of credit will also decline, McBride said, but fewer will take advantage of that change.

"It's not going to ignite the type of borrowing and spending that we've seen in past cycles because many home equity lines have been frozen and homeowners no longer have the equity that they did a couple of years ago," he said.

Previous Fed rate cuts have typically meant bad news for savings account holders, who could expect to see their interest rates drop. But McBride said that these days, because financial institutions remain desperate for more depositors, consumers can expect to see banks maintain current interest rates on deposit accounts.

"The credit crunch is keeping a floor under deposit yields," he said.