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Latest Fed moves won't have much impact on cardholders

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Unable to further reduce interest rates, the Federal Reserve's latest meeting focused on other tools to encourage borrowing and, in turn, support a weak economy.

Comparing the prime rate
to average credit card APRs
Fed funds rates, Q4 2007 through present
The Federal Reserve left its federal funds rate at a range of 0 to .25 percent, keeping the prime rate at 3.25. It was once true that the national average credit card APR trended in the same direction as the prime rate, since many types of credit cards -- such as student cards and airline cards -- have their rates linked to the prime. But banks, seeking greater margins, have recently stopped passing on rate cuts.

As analysts expected, the Fed's two-day meeting had little to offer the average credit cardholder. Instead, the central bank provided "fine points of very targeted new tools that the Fed has" for increasing the availability of credit, says Robert A. Dye, senior economist with PNC Financial Services Group in Pittsburgh, Pa.

Those tools include the purchase of up to $300 billion of longer-term Treasury securities and the introduction of Term Asset-Backed Securities Loan Facility (TALF). By purchasing Treasuries, the Fed aims to reduce rates on mortgages and other consumer debt, as a potential increase in prices for those government bonds lowers their rates -- carrying over into lower rates on other types of debt.

"In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability," the Fed said in a statement released today. "The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Experts say both the TALF and the purchase of Treasury securities could drive down annual percentage rates on credit cards. "Theoretically, both approaches should affect credit card rates, but the more directed approach," in the form of the TALF, could have a "larger effect," says Ann Owen, an economics professor at Hamilton College. Still, Owen says the impact on credit card rates could be offset somewhat by unemployment, "which is likely to increase the risk, and therefore the rate, associated with credit card lending," she says.

Other experts foresee potential losses for issuers, which would translate into APRs that are unlikely to come down much further. According to David Wyss, chief economist at Standard & Poor's, unemployment will continue to rise for another year. Since "credit card charge offs actually lag the unemployment rate," they should peak somewhere in late 2010, Wyss says. Charge offs occur when lenders conclude they are unable to collect a debt and remove it from their financial accounts. 

Before those charge offs take place, cardholders default -- or miss credit card payments. "As long as default rates on credit card loans continue to increase, I don't anticipate that the TALF funds will have a significant impact on reducing credit card APRs," says Jeffrey Clark, professor of finance at Florida State University.    

Under the weight of a slumping economy, Wyss nevertheless sees credit cards holding up better than housing. When it comes to unpaid plastic, "losses always go up in recessions," he says. As for the housing crisis, mortgage lenders "were more caught off guard because they are not used to seeing losses," Wyss says.

In its meeting concluding Dec. 16, 2008, the Federal Open Markets Committee cut the target for the benchmark federal funds rate to a range of 0 percent to 0.25 percent. That decision was approved unanimously by committee members. The rate has not changed since.

Previously, the rate's all-time record low was 1 percent, hit most recently in October 2008, and before then from June 2003 to June 2004. Prior to the Fed's campaign of rate reductions in September 2007, the federal funds rate stood at 5.25 percent.

In its announcement today, the Fed left its federal funds rate at a range of 0 to 0.25 percent, keeping the prime rate at 3.25. It was once true that credit card APRs have trended in the same direction as the prime rate. That's no longer the case, as credit card rates have begun to increase recently despite the fed funds rate staying flat.

After cutting its key lending rate to effectively 0 percent late last year, the Fed is now limited in what it can do that would impact cardholders. Dye explains that part of the Fed's role is to communicate its thoughts, but with its fed funds rate unlikely to budge for the time being, "interest rate policy is not a communication tool for the Fed right now," Dye says. Instead, the Fed needs to talk about other options under the umbrella of credit easing policy, he explains.

In the meantime, cardholders can expect more of the same from issuers. "Banks have been reducing credit lines and credit card limits to reduce their risk exposure if consumer credit quality continues to deteriorate," says Florida State's Clark. "I believe they will continue to do that."

See related: Unable to cut rates, Fed seeks new economy-boosting tools, Fed report: Banks continue to tighten lending standards 

Published: March 18, 2009


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