Federal Reserve's policy changes won't impact cardholders
By Jeremy M. Simon | Published: November 3, 2010
|PRIME RATE, FED FUNDS RATE
STILL AT ALL-TIME LOWS
The prime rate and the Federal Reserve's fed funds rate -- both of which are closely tied to credit card interest rates -- have been steady since Dec. 18, 2008. Prior to that, however, both rates saw massive drops as the nation dealt with the economic downturn.
The chart above shows just how far the rates have fallen since July 2007 -- just before the recession began. (NOTE: The prime rate, which most credit issuers use in setting credit card rates, is always 3 percentage points higher than the federal funds rate.)
The Federal Reserve announced steps Wednesday to support a fragile U.S. economy, but unlike more traditional changes to monetary policy, those moves won't directly impact credit cardholders.
At the conclusion
of its two-day meeting, the Fed voted to stimulate the economy through the purchase of government bonds. Importantly for credit card interest rates, however, the Fed left the federal funds rate at a range of 0 percent to 0.25 percent, in turn keeping the prime rate at 3.25 percent.
Holding the fed funds rate steady means responsible credit cardholders are protected, for now, against abruptly higher borrowing costs. The reason? Unless cardholders make a major borrowing blunder, the Credit CARD Act of 2009 requires 45 days' advance warning from banks of any annual percentage rate (APR) increases. The law permits an exception for APR changes following from Fed policy adjustments, but the central bank is unlikely to raise rates as long as the economic recovery remains in jeopardy.
The Fed's comments suggested the central bank remains worried about the economy's strength.
"Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth and tight credit," the Fed said in a statement. "Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters."
As widely expected, the FOMC announced it has decided to buy up Treasuries -- debt issued by the U.S. government -- in an effort to encourage both lending and spending. The Fed said it plans to purchase $600 billion in additional Treasuries between now and mid-2011.
Essentially, "this is intended to increase the money supply through the purchase of government bonds from the banks, insurance companies etc. This is intended to motivate the banks to increase their lending," says Dennis Moroney, research director in the bank cards division with advisory services firm TowerGroup, in an e-mail.
Moroney says banks are in a tough spot. "This is a bit of a chicken-and-egg problem for the banks. The banks want to lend, but they are concerned about further regulation, and they are still struggling to implement the changes to comply with current regulations," he says.
Credit remains costly
While the central bank's most recent survey of senior loan officers revealed a small number of U.S. banks actually loosened their lending standards in the second quarter, most borrowers -- especially those with poor credit scores -- will find that credit remains tight. That means higher interest rates, lower credit limits and higher minimum credit score requirements for card approvals.
For existing cardholders, however, the Fed's latest announcement means they have the power to avoid higher rates. That's because most new and existing plastic charges variable APRs tied to the prime rate, which rises or falls in lock step with the fed funds rate. Any change in the prime rate, therefore, impacts those variable APRs that are indexed to it. Until the Fed decides to boost lending rates, only late payments or other cardholder mistakes will cause a sudden rise in a card's interest rate.
Banks search for signs
When it comes to a loosening of credit, meanwhile, Moroney says banks may be looking for certain signs that it's getting safer to lend.
"I think the banks are looking for two things that, combined with the Fed action, will stimulate lending," he says. Among them: Tuesday's big Republican wins, which banks may view as stabilizing things on the regulatory front, and indications that consumers are doing better. "There are signs that consumer demand for credit , while still negative, is increasing. Credit is tight but not getting any tighter. All these are good signs, in that things are not deteriorating," Moroney says.
This is intended to motivate the banks to increase their lending.
|- Dennis Moroney
Research Director, TowerGroup
Moroney adds that senior level merchant executives have expressed confidence to him about holiday sales compared to last year.
"On a personal note, over the weekend I ran some errands, and I was amazed at the amount of shoppers out at the mall -- very, very busy," he says. "That's a good sign and supports what the merchants were telling me last week. Let's hope they are right."
The FOMC members voted 10 to 1 in favor of the decision, with only Thomas M. Hoenig dissenting, as he had at other recent Fed meetings. Hoenig said he "believed the risks of additional securities purchases outweighed the benefits," the Fed statement read. "Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy."
See related: Credit card reform law arrives, A comprehensive guide to the Credit CARD Act of 2009, Credit card lending standards loosen for 1st time in 3 years, Variable interest rate cards replacing fixed rates
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