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."

But the Fed can't force banks, who have been stung by huge losses from loans gone bad, to lend. And if you have marred credit, lenders "will still be nervous about extending credit to you," says Mark Zandi, chief economist at Moody's Economy.com. mco

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.

Recessions are commonly defined as a contraction in economic activity for two consecutive quarters but are officially determined by a panel of economists who look at a wider variety of indicators, including employment, income and industrial production. The last recession was from March to November 2001 and is considered one of the shortest and shallowest downturns in U.S. history.

"Nothing the Federal Reserve did today changes the probability that we are in recession or about to enter one," Reinhart says, noting that there is a lag before Fed policy affects the economy. "This is really about the shape of the economic expansion late this year and into next."

Fed policymakers noted in their statement that although some of the tightening in credit markets that began in August had lessened, "Broader financial market conditions have continued to weaken, and credit has tightened further for some businesses and households."

Policymakers also said new data suggest a further weakening in housing and some deterioration in the job market.

The impact on consumers

Here's how the rate cut is likely to affect consumers in their daily lives:

•Mortgages. The cut will give the biggest boost to borrowers with variable-rate mortgages, says Keith Gumbinger, vice president of HSH Associates, which tracks mortgage rates. Home equity loans, which typically are half a percentage point above the prime rate, should fall to about 7% from an average of 7.74% at the first of the year, he says.

Fixed mortgage rates were falling before the Fed's rate cut, in part because they are tied to the yield on the 10-year Treasury note, which often falls on bad economic news. The average rate on 30-year, fixed mortgages had fallen to 5.87% last week from 6.07% the first week of January, Gumbinger says.

He expects rates to fall further.

Does that mean it's time to refinance your mortgage?

"This could be an opportunity for good-quality borrowers to get out of (loans) they don't like," Gumbinger says. Financial analysts generally recommend that you refinance if you are going to stay in your home for several years and if you can get a rate that's a full percentage point lower than your current one.

Anne Baumgartner, 66, of Phoenix, is hoping for lower mortgage rates and a potential boost to the housing market because of the Fed's move. She has a home for sale in the Coconut Grove neighborhood of Miami.

"I welcome the cut in interest rates," she says.

•Credit cards. Card holders could get a break on their interest rates, but the benefits will be limited mostly to borrowers with good credit, says Greg McBride, senior analyst for Bankrate.com. rate Those borrowers have seen average rates for variable-rate credit cards drop to 13.1% from 14% in September.

Borrowers should be aware, however, that changes in credit card rates don't always closely follow action by the Fed. It could be three months before borrowers see the lower rates reflected in their monthly credit statements, McBride says.

And the rate cut will have little impact on credit card users who are paying "penalty" rates of 33% or more because they've made late payments or have low credit scores, McBride says. As card issuers struggle to cope with rising delinquency rates, they're reserving their lowest rates for borrowers with stellar credit, he adds.

"The card holder with a strong credit score is the type of consumer that's in demand," he says. "They have a lot more bargaining power. Not only do they see the lower rates, but they're also getting the low-rate offers sent to them in the mail each week."

•Car loans. The rate cut should translate into lower rates on auto loans. And more special-financing deals could crop up during the next few weeks.

"Zero-percent financing or 2% financing has been successful in the past for people with good credit," says Ralph Ebersole of Cars.com, a research site partially owned by USA TODAY gci parent Gannett as well as other media companies. "I think in a short period of time, we'll see those rates again."

But the Fed's rate cut won't make it much easier for borrowers with poor credit to get auto loans, because lenders remain worried about the risk of default, says Jesse Toprak, executive director at automotive website Edmunds.com.

Defaults on auto loans have been rising in recent months. If they climb further, then consumers with poor credit could actually see their borrowing costs rise despite the Fed's interest rate cuts, he says.

•Saving. The decline in rates for certificates of deposit "will certainly accelerate," McBride says. Last week, the average rate for a one-year CD dropped 0.15 percentage points to 3.32%, according to Bankrate.com.

That's frustrating news for savers such as Vivian Adrian, 77, of Milwaukee. A lot of the retired secretary's savings are in CDs, which haven't been earning much. At the same time, her expenses are rising, particularly for food and health care.

Rate cuts are "fine for people who want to borrow money, but for us savers …," she says. CD rates "haven't gone above 5% for the last six years, and I remember when they were above 10%."

Even now, though, savers who shop for deals can find above-average rates, McBride says. Some credit unions, regional banks and online banks are still offering one-year CDs with rates of up to 4.5%.

Expect money market mutual fund yields to fall three-quarters of a percentage point to about 3.25% within the next 30 days, says Peter Crane, president of Crane Data.

Not a unanimous decision

The Fed's move was the biggest cut since 1990, when the economy sank into an eight-month-long recession while rates were twice the current level. Before Tuesday, the Fed had not cut interest rates outside its regular meeting schedule since Sept. 17, 2001, the day stock markets reopened after the 9/11 terrorist attacks.

The Fed's decision, which came after policymakers met via video conference Monday evening, was not unanimous. St. Louis Fed President William Poole dissented, arguing the Fed should instead wait until its scheduled meeting next week before making such a decision.

The move Tuesday was the fourth rate cut for the Fed since mid-September, when it first cut interest rates from 5.25%, and comes as a stream of economic data have suggested the U.S. economy slowed dramatically at the end of 2007. The unemployment rate jumped in December from 4.7% to 5%, the highest in more than two years. A key manufacturing gauge suggested factory activity declined last month while retailers reported a disappointing holiday shopping season.

"We will be tightening our belts this year — no vacations and less impulse purchases," says Alesia Peterke, 40, a stay-at-home mother of three in Ladera Ranch, Calif. "We do not fear for our well-being today, though we realize that our retirement mutual funds are in some jeopardy, and we have already seen our home value slip down 3% since we purchased" it last year.

The Dow Jones is down 15.5% from its high in October. Stock markets around the globe, meanwhile, have been tumbling, pinching returns for U.S. investors who recently have looked overseas for bigger returns.

"People are confused and frightened," says Milton Ezrati, economist and strategist for mutual fund company Lord Abbett. Investors had yanked an estimated $27 billion from stock funds through Friday, according to website TrimTabs, which tracks the funds.

If you're investing for a long-term goal, such as retirement in 10 or 20 years, most analysts agree that you shouldn't pay too much attention to the market's day-to-day swings.

Instead, you should create an asset allocation goal for your portfolio — for example, 40% bonds and 60% stocks. If a few bad weeks tilt your portfolio to 50% bonds and 50% stocks, consider selling some of your bonds and adding enough new money to your stocks to get your portfolio back in balance.

After Tuesday's rate cut, participants in a market in which investors bet on future Fed moves were expecting another half-percentage-point cut next week at the conclusion of the Fed's two-day meeting Wednesday, according to Action Economics. "The Fed's statement is about as clear as they can be that more cuts are on the way," Wachovia wb senior economist Mark Vitner said in a statement to clients.

The economy has moved into the political spotlight as presidential candidates are putting greater emphasis on pocketbook issues and as lawmakers in Washington work to quickly put together a fiscal stimulus package to provide a boost to consumers and businesses.

President Bush met with Democratic and Republican congressional leaders Tuesday to discuss a stimulus bill. The White House has said it wants a package centered on business and personal tax cuts, while rebate checks, similar to those delivered to taxpayers in 2001, have been discussed. Democrats are also calling for such measures as expanded food-stamp and unemployment benefits.

"I believe we can find common ground to get something done that's big enough and effective enough," Bush said.

Contributing: Jayne O'Donnell, Kathy Chu and Adam Shell