Country can take a little bump

The Economy

Fed may raise rates, but needn't raise Cain

August 22, 1999|By William Patalon III | William Patalon III,SUN STAFF

Among economists, the belief that the Federal Reserve will announce a quarter-point increase in interest rates after its Tuesday meeting is close enough to unanimous that Mitchell Held, a managing director at New York City-based Salomon Smith Barney, quips that "the only people who don't think so are Mrs. Smith's third-grade class -- and they're recalcitrant."

With that settled, the question becomes: How will America's vaunted Goldilocks Economy be affected by a quarter-point bump, coupled with the one in June and the one that will or won't occur in October.

On that point, a few sour notes temper the chorus of unanimity.

Clearly, most economists believe that the nation is in pretty good shape.

Companies are profitable and business is strong enough that many workers are trading up to higher-paying jobs. And mortgages remain relatively cheap.

Thanks to rising home prices and a powerful bull market for stocks, our average net worth has jumped 50 percent the past five years and totals $37.6 trillion, according to Lynn Reaser, chief economist for Bank of America Private Bank in Jacksonville, Fla.

Higher loan rates, such as those for mortgages, seem to show that the forward-looking market already has adjusted to the expected rate increase.

Even so, Reaser says, a mere quarter-point is no cause for a dirge.

"We've seen a tremendous economic expansion," she says. "People are generally feeling good, stocks are doing well and when we need a new job, we just put our hand up and we're offered more money."

But other practitioners of the "dismal science" of economics sing a gloomier tune. The refrain: We're addicted to debt.

Economists such as Maureen Allyn fear that our increasing dependence on debt will magnify the impact of any interest-rate increase -- perhaps slowing the economy more than the Fed intends.

"My concern -- and I'm not alone in this -- is that this economy has so much debt in it that we're more sensitive to interest rates -- and that [rate increases] probably mean more than they used to," says Allyn, the chief economist for Scudder Kemper Investments in New York City.

Those who sing from the contrarian hymnal make an interesting case.

Though consumer wealth approaches $38 trillion, one study says, the top 1 percent of Americans have a net worth that "dwarfs" that of the bottom 90 percent.

Currently, household debt stands at $6.2 trillion. Most is mortgage debt, though by one estimate "installment debt" -- what we owe on credit cards and for our cars -- stood at $1.345 trillion in May.

Then there's $5.4 trillion in corporate debt -- a figure that excludes the liabilities of financial-services firms.

The combined $11.6 trillion in consumer and business debt equals 130 percent of the nation's entire output of $8.9 trillion, meaning that America clearly continues to spend more than it makes.

"It's unbelievable," says Allyn. "We look like Thailand."

To understand how a Fed move Tuesday could directly affect consumers, consider two axioms of economics: Higher interest rates slow down the economy; and the economy works at "the margin."

With the first rule, in an economy where spending continues to rise faster than wages, it will cost more to borrow money. That should dull consumer spending -- and the economy, since consumer dollars fuel 70 percent of U.S. growth.

Banks, loan companies and credit-card issuers live on a tightrope, borrowing for a little less than they eventually lend. When rates rise, that "spread" narrows, more consumers default on their obligations, and mailbox-stuffing lenders charge more and lend less.

Mortgage rates rise, so consumers suppress their desire for extra bedrooms, add-ons like big decks and even furnishings -- which the smartest consumers appear to be doing already, says Bob Connelly, vice president for the Lutherville-based FNMC, formerly First National Mortgage Corp.

Rates are still low: 7.75 percent for a straight 30-year fixed home loan, down from just over 8 percent at the end of July, though about half a percentage point higher than they were at April's close.

However, economists say this upward creep in loan rates eventually will crimp business for lenders, construction suppliers and contractors, and furniture outfits -- all engines of the current expansion.

But it's the second economic maxim that will squeeze the bottom portion of the middle class, people on fixed incomes and the poor.

Consumers "at the margin" essentially are those on the economy's fringe. Those with lower incomes, lots of debt or rocky credit histories will have to pay more for credit, or perhaps won't be able to get it at all. For some, this ends their ability to juggle debt by adding credit cards or another consolidation loan. Bankruptcy beckons.

Should the Fed raise rates as expected, one economist says, most Americans should not be hurt. They may not be humming gleefully -- perhaps having forgone that bigger house, vacation or new car -- but neither will they be whistling past the graveyard by piling on more debt.

"If anyone is affected, it will not be the average, middle-income household," says Kevin McIntyre, senior economist for RFA in West Chester, Pa.

"It will be the low-income households who are already facing problems. These are people who would probably face problems within months or a year anyway. This will probably hasten their" defaults.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.