Misconceptions about the Fed rate cuts

The Federal Open Market Committee lowered its target for the federal funds rate by 75 basis points Jan. 22 and another 50 points Wednesday.

The interest rate that banks now charge to lend money amongst themselves overnight is 3 percent.

While the moves have been welcome throughout the financial markets, they might not be the personal panacea that many consumers, especially those facing foreclosure, are expecting.

"There is a common misconception that mortgage rates will drop correspondingly with the Federal target rate, but the correlation is minimal," said Jon Paukovich, director of real estate lending at Ent Federal Credit Union.

Mortgage rates have fallen since November, but that's because of a perceived weakness in the economy, not any rate decisions made by the Fed.

Paukovich said that only credit cards and home equity lines of credit with variable interest rates based on prime rate will be affected when the Fed changes the overnight rate.

Mark Patterson, tax partner at Stockman Kast & Ryan said that the economic stimulus package being debated in Congress will help the economy faster than any Fed rate cuts.

"Refund checks will get circulated directly into the economy, but rate cuts take time to work their way through the system," he said. "And when businesses refinance loans at lower rates, it will improve cash flow, which will be reinvested into the economy."

Jim Richard, an associate professor of economics at Regis University, said the Fed's early rate cut sent a message to corporate America that the issue of an impending recession is critical -- and they'll worry about inflation later.

"A common misconception is that government will solve this recession," Richard said. "They have addressed the issue, but economic turnaround will come from the private sector."

He recommends that consumers and investors watch Warren Buffett, Wilbur Ross Jr. and Bill Gates.

"They are bottom feeders -- and savvy," he said. "If they're buying, the market is close to bottom."

The downside to rate cuts

While most bankers and those in the financial industry agree that the rate decreases were necessary, there are some downsides that the average consumer might not anticipate.

"Larger banks will probably be hesitant to drop interest rates, since they will have higher losses (than smaller banks) in unsecured and auto loans during the next few years," said Bill Vogeney, senior vice president and chief lending officer for Ent. If there is a recession, and Vogeney doesn't see how one can be avoided, consumers will begin defaulting on auto loans.

"Every time there is a spike in prices at the pump, we have a spike in repossessions -- especially of bigger trucks and SUVs," he said. "Increases impact people's ability to handle their finances -- more so if they have a long commute at 12 to 14 miles per gallon."

Non-borrowers will experience a negative impact from the rate cuts because savings interest rates will decline for money market accounts, certificates of deposit and interest-bearing checking accounts.

Richard said the average American should not buy into the panic mentality.

"Many people view recession as some kind of disease -- but it's actually part and parcel of capitalism," he said. "Just as the swallows return to Capistrano each year, recessions happen. It's tough -- but it's part of the game."

The key to staying in the game is using volatility to the advantage of a portfolio -- and rebalancing, said Ron Florance, senior vice president and director of asset allocation at Wells Fargo.

"Volatility is here to stay and we need to use it as a friend and not panic," Florance said.

Recession is not the be-all and end-all of economic catastrophes.

"It was a real eyebrow raiser when Moody's (Investors Service) talked about downgrading U.S. government debt (credit rating) from triple A to double A," Richard said. "If that happens, it would really hit the fan. For long-range problems, continual government deficits are much worse than a recession."

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