TIME: Almanac 1993/TIME Almanac 1993.iso/time/112591/1125200.000

Text File | 1992-08-28 | 7.9 KB | 173 lines

                                                                                BUSINESS, Page 64

THE ECONOMY

Down and Dirty


Washington's easy-credit strategy has been a boon for borrowers,
but its inability to start a recovery sends Wall Street into a
sudden skid

By JOHN GREENWALD -- Reported by Bernard Baumohl/New York, Dan
Cray/Los Angeles and William McWhirter/Detroit


    At first they seemed like a sure cure. But those tempting
low interest rates that Washington has engineered to boost the
U.S. economy have started cutting both ways. They have been a
boon for hundreds of thousands of homeowners who have rushed to
refinance their mortgages at rates not seen since 1977. "It was
definitely like finding money," says Michael Meyers, 41, a
Chicago advertising-agency owner who swapped his 10.75% mortgage
recently for one with a rate of just 8.5%.

    Yet the same low rates have been the bane of savers --
particularly senior citizens -- who have watched their income
from investments rapidly shrink away. A six-month bank CD that
paid 8% interest a year ago now yields just 4.9%. "People are
turning off their phones for a month to get by," laments Irene
Farr, 73, a retired clerical worker who lives in a senior
community in South Bend, Ind. "They just have no way to live.
It's a dignified form of destitution." Moreover, the low rates
that have caused such pain have so far failed to pull the
economy out of its slump.

    The stock market gave the flagging recovery an apparent
vote of no-confidence last week when the Dow Jones industrial
average plunged 120 points on Friday, to 2,943.20, for its fifth
largest drop ever and the steepest decline since it fell 190.58
on Oct. 13, 1989. Analysts said the free fall reflected fears
that the U.S. was sliding back into recession after the economy
eked out a modest 2.4% gain in the third quarter. "The equity
markets are finally realizing what sad shape the U.S. economy
is in," says Allen Sinai, chief economist of Boston Company
Economic Advisers.

    Happy borrowers and disgruntled savers are among the winners
and losers of Washington's singular reliance on interest-rate
cuts as the main tool of economic policy. With the federal
deficit expected to reach $350 billion in 1992, politicians are
reluctant to cut taxes or increase spending in a way that would
spill even more red ink. That leaves low rates as Washington's
preferred prescription for increasing consumer spending and
stimulating business growth.

    In keeping with that tactic, the White House and Congress
took aim last week at the most stubbornly high rates of all:
the interest that banks charge on credit-card balances. While
the prime rate has fallen from 10% a year ago to 7.5% today,
credit-card rates remain stuck at an average 18.8%. Banks say
they need that interest to offset the cost of rising
delinquencies. But President Bush last week urged bankers to
reduce their rates. Not to be outdone, the Senate voted 74 to
19 to put a cap on credit-card rates under a formula that would
lower the current level to 14%. That move may have helped
trigger Friday's stock-market plunge by threatening to cut the
profits of America's already ailing banks.

    In fact, falling interest rates have done little this year
to encourage consumer spending. Such barometers as car sales
and housing starts have remained dismayingly weak, mostly
because Americans have been worrying about their incomes and
jobs. "What is happening here is the reverse of what the
government really wants," says Walter Williams, president of
American Business Econometrics, a consulting firm. He argues
that recent cuts in rates have taken a bite out of many people's
earnings, since 75% of U.S. households receive some interest
income, and forced them to keep their wallets shut. Says
Williams: "The net effect of each Federal Reserve easing has
been to reduce the total amount of money that consumers have to
spend."

    Faced with falling income from their nest eggs, consumers
have scrambled to switch their savings from such investments as
CDs and money-market accounts to riskier but higher-yielding
stocks and mutual funds. "People are getting sticker shock when
they go into a bank to renew their CD," says William Lefevre,
chief market strategist for the investment firm Tucker Anthony.
Americans have reduced their investments in once popular CD
accounts by $80 billion, or 5%, so far this year. Much of that
cash has flowed into the stock market, which has been pushed to
record heights. Even after last week's tumble, the Dow has risen
nearly 12% in 1991.

    More cautious savers have put their money in mutual funds,
which gained $193 billion in assets in the first nine months
this year, compared with $87 billion for all of 1990. Among the
hottest investments are bond funds that buy government IOUs
maturing in two to five years and yielding more than 7%. At
Fidelity Investments, the largest U.S. manager of mutual funds,
assets of the Spartan Limited Maturity Government Fund ballooned
tenfold, from $162 million in January to $1.6 billion this
month.

    The main thing investors want to avoid is locking too much
money into long-term instruments, in case rates go up again
soon. A scary scenario along those lines briefly flared up last
week when the government reported that its index of wholesale
prices surged at an unexpectedly strong annual rate of 8.4% in
October. The news depressed bond prices, since inflation drives
up interest rates on new issues and causes the market value of
existing bonds to fall. But the market rebounded a day later
when Washington said the Consumer Price Index, which measures
costs at the retail level, rose at an annual rate of just 1.2%
in October. Economists placed greater trust in the CPI report,
contending that the surge in the wholesale index was merely a
fluke.

    The fear of losing money in volatile stocks and bonds has
prevented some wary investors from seeking better returns. Anna
Weston, 73, a retired Motorola parts inspector who lives in
Tempe, Ariz., suffered losses on bond investments in the 1980s
when interest rates rose. Instead of risking another drubbing,
she put her money into a CD but now has withdrawn $30,000 of her
$50,000 deposit to make ends meet. "I was counting on that
interest to supplement my Social Security," she says.
Increasingly desperate, Weston took a part-time job last spring
with the local office of the Gray Panthers senior-citizens group
so she could have enough money to indulge her passion for
showering gifts on her grandchildren. Says she: "I feel cheated,
after I worked so many years."

    On the positive side, U.S. companies have welcomed cheap
rates as a tonic for depressed profits and tight money. American
firms are on track to issue some $320 billion worth of bonds
this year, up sharply from $235 billion in 1990. Owners of
small businesses are likewise lining up for low-priced funds.
Jeff Tuma, 39, who runs the Embers restaurant in Mount
Pleasant, Mich., decided last summer to renovate the eatery and
launch a catering service to go with it. "Banks are obviously
looking for good loans right now, and they have tons of money
out there for the right people," Tuma says.

    Some American consumers have felt both edges of the
interest-rate sword. Detroit advertising executive Bruce Wagner
recently saved about $150 a month by refinancing his mortgage
at a rate just above 9%. But Wagner agonizes over the need to
shift his children's college-education money out of CD accounts
to get a better yield. "I don't particularly want to," he says,
"but I'm going to have to find something else besides what had
been a very secure and comfortable way to save." Such dilemmas
seem certain to grow more acute so long as interest rates remain
the only instrument in Washington's tool kit for fixing the
economy.