Why rates you pay banks lag behind what they pay

SUNDAY OUTLOOK

May 22, 1994|By John E. Woodruff

A year ago, interest on savings accounts plummeted dizzily but credit card charges and personal lines of credit seemed to hang at 19 percent forever. Today, consumer credit charges leap every time the Federal Reserve moves but bank savings rates are hanging just above 2 percent. Even money market mutual funds are up only half a point. Why is it always so hard for consumers to get a decent rate on savings but so easy to pay high rates for credit?

James McDonald

Vice president, T. Rowe Price Associates Inc.

The six-month treasury note is up about 1.35 percentage points, and the yield on our Prime Reserve Fund is up about one-half point. So money-market funds are always behind the leading short-term interest rates, but they do move.

What controls this is the maturities of the securities in the fund's portfolio. A new rate affects your portfolio the next time a piece of paper you hold expires and you have to buy a new one. So you try to have longer maturities when rates are high and falling, so that you keep the high rate for the longest possible time. And you try to have shorter maturities when rates are low and rising, so that you'll move into the higher rates as early as possible. When the Fed moved in February, we thought that was the

beginning of a series of increases, so we moved toward very short maturities in order to move into higher rates sooner.

Bank passbook and CD rates move in a very different way, because they are not true market rates in the same sense as money-market funds. When banks need money to lend, they start advertising CD rates, inviting consumers to lend them money, which the banks lend out again at a higher rate. Their profit is in this "spread" between the two rates. For some years now, demand for bank credit has been very low. Banks still have little need for money to lend, so they have no reason yet to raise CD rates. There are some signs that loan demand is beginning to pick up now, but until it does, banks have no business reason to catch up to the market.

Ruth Susswein

Executive director, Bankcard Holders of America

Isn't it ironic that down was such a creeping process and 19.8-percent credit cards could last for so long, but that up is so sensitive to market forces?

There is a reason for this. For a long time, credit card issuers were afraid to reduce their fixed rates for fear that they would then be committed to a lower rate and unable to move if rates went up.

Eventually, for many of them the way out was to link their rates to the prime rate, which allowed them to come down but to keep the flexibility to go back up when rates started to move up again. That brought the typical rate down from over 19 percent to under 15 percent. Today, some 55 percent of the cards consumers hold are linked to the prime rate. And, of course, their rates go up every time the Fed goes up. The typical rate is already back up well over 16 percent.

The right response to rising interest rates is to do what you should have done in the first place -- pay off your credit card accounts and stop paying this huge burden of credit card interest. For people who want help figuring out how to do this, our association has a Debt Zapper Kit that gives personalized instructions on how to tailor your own payoff plan.

The scary part these days is not only rates going up but also monthly minimum payments going down. That combination means many people will be paying off only a few dollars a month on debts that may run into the thousands. For the consumer, that is a recipe for personal disaster.

Alfred G. Smith

Chief economist, NationsBank

The late 1980s, with those juicy CD rates, were an aberration. That was driven not only by high interest rates in general but also by the attempts of the savings and loans to draw in funds to finance a move from the thrift industry into the banking industry after deregulation. That factor will not be with us this time, and I believe that the driver of the next upward move in savings rates will be small banks. That suggests that the move may be more subdued than the last one.

We have seen consumer deposits start to rise in three of the last five weeks, which is a change of some magnitude from what they had been doing for some years. Some of this may reflect money coming back from stocks and bonds, and some of it may reflect some banks becoming more aggressive in attracting deposits. So there are signs that some small banks are getting a little bit tighter than they were.

So far, I haven't seen any change at all in bank passbook or CD or even money market rates, nothing like what has been happening with money-market mutual funds.

In fairness to the banks, not all of their lending rates have gone up so fast. Auto loans, for example, have scarcely moved since before the Fed started tightening.

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