Consumers and businesses struggling with tight credit markets should find relief from the Federal Reserve’s cut in interest rates Tuesday.
“This is not going to cure the ills of the housing market, but it is a step in the right direction, and it will help some people,” said Greg McBride, a senior financial analyst with in North Palm Beach, Fla.
Tuesday’s reduction in the federal funds rate was the first by the Fed in four years. It caps smaller moves the central bank made last month to ease a credit crunch that has made loans, and mortgages in particular, harder to obtain.
Rising mortgage defaults have chilled credit markets, forced dozens of lenders to shut down, thrown tens of thousands of people out of work and raised fears that the U.S. economy could suffer a recession.
In a move designed to pump more money into the economy, the Federal Reserve cut its target for the federal funds rate that banks charge each other from 5.25 percent to 4.75 percent.
It also cut the discount rate that it charges banks for short-term loans from 5.75 percent to 5.25 percent.
Stock investors applauded the rate cut, which was double the amount expected.
The Dow Jones industrial average rose nearly 336 points Tuesday to close at 13,739.39, its biggest one-day move since Oct. 15, 2002.
“People are more confident that the Fed is being responsive,” said Sacha Millstone, a senior vice president with the Millstone Evans Group of Raymond James & Associates in Boulder.
Consumers should see the rate cut show up in the next month or two in lower payments on home-equity lines of credit and eventually on variable- rate credit cards.
Many banks dropped their prime rate, a benchmark for commercial and consumer loans, from 8.25 percent to 7.75 percent.
On a $30,000 home-equity credit line, that should mean a savings of $12 a month, McBride said.
Rates for conventional 30-year mortgages had fallen from above 6.8 percent in June to around 6.3 percent this month on lower Treasury market rates, according to .
Tuesday’s rate cut should also ease pressure on borrowers holding adjustable-rate mortgages.
A borrower holding a typical adjustable-rate mortgage made three years ago at 4.5 percent now will likely have to bear an increase to 6.75 percent rather than a jump to 7.5 percent that appeared likely a few months ago, McBride said.
Likewise, businesses should benefit if the rate cuts shore up consumer spending.
Local car dealers, homebuilders and Realtors expressed optimism that the Fed move could help their situations.
Although it is still too early to call, KB Home Colorado president Rusty Crandall said he was hopeful the rate cut would stabilize the new-home market, which has suffered a one- third decline in sales in metro Denver in the first half of this year compared with the same period in 2006.
“Traditionally, when there has been a reduction of the federal funds rate, it has translated into more demand for new housing, which is exciting for the homebuilding industry,” Crandall said.
“There will still be head winds for the consumer,” said Scott Anderson, a senior economist with Wells Fargo in Minneapolis. “Home price declines will intensify, but may not be quite as severe as if the Fed hadn’t cut.”
Borrowers still need to have good credit to take advantage of falling interest rates. Rates are lower, but underwriting standards remain tighter.
The Fed moved boldly because it had to, said John Claxton, a senior vice president with RBC Dain Rauscher in Denver.
Stock markets could remain volatile as financial companies unveil losses from the still-undisclosed bad loans and investments they hold.
“We don’t know or understand the breadth or depth of what we have with this credit crunch now. The Fed is admitting that in their comments today,” he said.
A few analysts fear rate cuts could fix a short-term problem at the cost of stoking inflation down the road and undercutting the U.S. dollar.
Lower interest rates make the country a less attractive destination for foreign investors and could further weaken an already ailing U.S. dollar, said Chuck Butler, EverBank’s president of the world markets group in St. Louis.
Foreign investors are barely investing enough now to allow consumers and the federal government to keep up their deficit spending, he said.
It is uncharted territory if those investors decide to chase better return opportunities elsewhere and the country is left to fund its own deficits.
Savings and certificate of deposit rates at banks also are likely to fall, taking a nick out of returns on those accounts.
Staff writer Margaret Jackson contributed to this report.
Staff writer Aldo Svaldi can be reached at 303-954-1410 or asvaldi@denverpost.com.
