Rate cuts can hurt if you depend on interest income

`I'm doing OK now, but eventually it's going to start hurting'

November 07, 2001|By Eileen Ambrose | Eileen Ambrose,SUN STAFF

June McComas of Solomons isn't angry with Alan Greenspan, she just wishes the Federal Reserve chairman understood what a series of interest rate cuts this year means to people like her.

"I just think somebody ought to clue him in," said McComas, a 63-year-old retiree who keeps the bulk of her money in certificates of deposit.

When one that had been earning more than 7 percent matured this year, McComas found she couldn't reinvest the money at anywhere near the same rate unless she tied it up in another CD for more years than she wanted. She parked most of the money in a money market fund earning 2.5 percent.

"I'm doing OK now, but eventually it's going to start hurting," said McComas, who works part time as a receptionist.

Yesterday, Fed policy-makers cut rates for the 10th time this year to resuscitate an economy that many believe is in a recession. The half-percentage-point cut put the benchmark federal funds rate - what banks charge each other for overnight loans - at 2 percent, its lowest level in 40 years.

Lower rates are a boon for businesses and consumers borrowing money. But there's a flip side.

"While people generally have the notion that lower interest rates are good for the economy and good for most people, they forget to take into account the people who are living off savings," said John Bond, chief executive officer of Columbia Bancorp in Howard County.

And if you're dependent on interest income from short-term, conservative investments, "you've seen your income roughly cut in half or more" in the past year, said Bond. "It really hurts if that's your primary source of income."

Many of those relying on interest income are retirees, whose only other sources of income may be Social Security and perhaps a pension.

At least inflation is low, so people aren't spending a lot more to maintain their lifestyles. But the cost of medical care, often a major concern for retirees, has been rising in the past two years.

The average one-year CD now earns an annual percentage yield of 2.43 percent, compared with 5.57 percent a year ago, according to Bankrate.com.

The average five-year CD earns 4.07 percent, down from 5.95 percent last year.

"Do you have a checking or savings account? Look at your interest. Tell me it's not ridiculous," said Gil Holle, 64, a retired hospital engineer in Baltimore County.

Holle said he earns 0.25 percent on his checking account and 1 percent on savings. "You're penalized for saving money," he said.

A 7 percent CD matures this week, and Holle's banker recommended inflation-indexed savings bonds that now earn 4.40 percent. He'll do that or roll the money into a short-term CD and see where rates go.

"They can't go much lower," he said.

The Rev. Betty Ure, who retired as a minister in 1992 and works part-time at a Columbia church, has suffered a double hit. Half her money is in CDs and the other half is in stock mutual funds, which have taken a drubbing this year.

"It's kind of hard to know where to put your money," said Ure, 75.

Ure said she set up her portfolio so she should could live off interest and dividend income, but now finds herself dipping into principal. She's nearly depleted her savings account and is selling off mutual fund shares that have lost value so she doesn't owe capital gains tax.

She's making other adjustments. She's stopped shopping at malls, postponed replacing her 7-year-old car despite enticing zero percent financing and plans to cut back on holiday gifts.

"I'm going to do a lot more homemade gifts or give my time instead of money," she said.

She donates 10 percent of her income to charity and is reluctant to cut back. "That's where they need it. If everyone does it, then we are in rough shape," she said.

Ure said she and others in her Ellicott City retirement community worry about running out of money in a prolonged downturn. Still, she said, she's better off than many others and gives Greenspan high marks.

If lower rates are what it takes to revive the economy, then so be it, "even if it means some of the rest of us have to suffer," she said.

McComas, too, is making changes, cutting back on travel and holiday gifts. She recently bought 200 shares of Oracle Corp. for about $10 each. It closed yesterday at $15.23 a share.

"That's for the long term," she said. "That might make up for some of the interest I lost now. "

When will higher rates return?

"Even if the recession is officially over in the first to second quarter, that doesn't mean we're out of the woods. The economy could start to grow feebly and could grow feebly for a year or two and still feel like a recession," said Christopher Carroll, an economics professor at the Johns Hopkins University.

"The Fed is not going to raise interest rates again until the economy has experienced a pretty substantial amount of recovery," Carroll said.

Higher rates may not return for a year or two, he said.

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