Meltdown 101: How Can The Fed’s Rate Cut Help?

WASHINGTON (AP) – Will U.S. consumers benefit from the interest rate cuts announced Wednesday by the Federal Reserve and several other countries’ central banks?

For most people, probably not much, at least for a while. But people with strong credit could see lower credit card rates soon, and the move could eventually help point the economy in the right direction.

Here are some questions and answers about the interest rate cuts.

A: Not in the short term, most economists say. The cuts don’t directly address the main problem behind the financial meltdown: the reluctance of banks to lend money.

But the coordinated rate cuts might deliver a psychological boost to the financial markets. That’s because the cuts mean that once banks do start lending again, many borrowers will be able to get loans at lower rates. That, in turn, could help counter fears that the global economy is on the verge of a steep recession.

The U.S. stock markets weren’t immediately encouraged. The Dow fell 189 points Wednesday, or 2 percent, to 9,258, and the S&P 500 dropped 11.3 points, or 1.1 percent, to 984.9.

A: Because right now, banks aren’t making very many loans at any rate. In today’s economic climate, they’re worried about borrowers’ ability to pay them back. They’re also hoarding cash because they lost money on bad mortgages and mortgage-linked investments.

“People who couldn’t get loans yesterday … can’t get a loan today,” said Carl Weinberg, chief economist for High Frequency Economics, a consulting firm.

A: The Fed cut the federal funds rate, which banks charge each other for overnight loans. Cutting it is the Fed’s main tool for energizing a sluggish economy. In normal times, a cut in the rate is supposed to ripple through the credit markets, lowering rates for mortgages and auto and other loans. But the effect is likely to be more limited this time, because of banks’ reluctance to lend money at all.

A: Economists hope the new $700 billion bailout package will encourage banks to offer more loans by removing bad mortgage-related assets from their balance sheets and providing more capital for them to lend.

In addition, the Fed this week said it will buy up huge amounts of short-term debt, known as “commercial paper,” that companies use for short-term needs such as payroll. The goal is to jump-start a crucial part of the credit market by making cash available to businesses for their most urgent expenses.

A: Credit card users may see some benefit, particularly if they have good credit.

“Within one or two billing cycles, individuals … should see their interest rates decline,” said Keith Leggett, senior economist with the American Bankers Association.

But card issuers may provide those lower rates only to those with the best credit scores, said Greg McBride, a senior financial analyst at Bankrate.com.

Borrowing costs should also drop almost immediately for consumers with variable-rate home equity and other loans that are tied to the prime interest rate, which Bank of America Corp., Wells Fargo & Co. and other banks cut by a half point Wednesday.

A. That depends on how your rate is set. Adjustable-rate mortgages tied to Treasury rates are likely to drop as many Treasury yields have fallen in recent weeks, McBride said.

But those that are tied to the London Interbank Offered Rate, or LIBOR, will likely see a “big payment increase” in the next couple of months regardless of the Fed’s cut, McBride said.

That’s because LIBOR, which is the rate at which big international banks lend to each other, has spiked in recent weeks – those banks just aren’t eager to lend each other money, so they’re charging higher rates when they do.

A: They probably won’t see much benefit. Fixed mortgage rates typically track the yield on the 10-year Treasury note, which is set in the bond market. The yield on that note rose by almost a quarter point Wednesday. Fixed mortgage rates have remained above 6 percent for most of the year despite the Fed’s previous rate cuts.

By CHRISTOPHER S. RUGABER, AP Business Writer

Associated Press writer Eileen AJ Connelly in New York contributed to this report.

(Copyright 2008 by The Associated Press. All Rights Reserved.)