Lenders Take a Bigger Bite

By Barbara Rudolph

No one accused the bankers of stealing Christmas, but their decision last week was not exactly conducive to holiday cheer. Leading U.S. banks boosted the prime lending rate from 10% to 10.5%, the highest level since May 1985 and the fourth increase so far this year. For consumers who hold adjustable-rate mortgages or home-equity loans, in which payments are tied to the prevailing trend, last week's upward lurch in the prime was about as welcome as the Grinch.

Led by Chase Manhattan, bankers were responding to what they see as a relatively tight credit policy on the part of the Federal Reserve Board. Under Chairman Alan Greenspan, the Fed has allowed rates to rise because of its concern that the economy is expanding fast enough to kindle inflation.

While the economy grew at a relatively modest 2.6% annual rate during the third quarter, the expansion actually amounted to 3.2% if the effects of the summer drought are excluded. That level of growth, while not quite inflationary in normal times, is straining against a shortage of workers and factory capacity. Unemployment in the U.S. has remained at low levels, though the Government reported last week that the jobless rate for November inched up to 5.4%, compared with 5.3% the previous month. Factories were operating at 84% of total capacity, the highest level since February 1980.

Another key reason for the rising interest rates is the federal budget deficit, which is expected to total $137 billion in fiscal 1990. Paul Volcker, the former Fed chairman and now a Wall Street financier, warned a congressional commission last week that unless the Government reduces its huge borrowing needs, "there is the risk of a real financial disturbance. It would bring about the kind of recession that would be the most difficult to handle." One way in which the deficit has triggered higher rates is by undermining foreign confidence in the dollar, which plunged more than 3% against the Japanese yen in the three weeks after the U.S. election. To stabilize the currency, the U.S. has had to allow interest rates to rise as an incentive to foreign investors.

That is scant comfort to millions of Americans who are facing heftier payments on loans. Harold Goldberg of Chicago, a 52-year-old accountant who last year took out a $20,000 home-equity loan, estimates that his monthly repayment will rise $40 this month, to $183. Says he: "I'm just grateful that I didn't borrow any more than I did."

By most accounts, the Fed is attempting to nip inflation before it buds, a policy some economists believe could be dangerous. Says Sidney Jones, a professor at Georgetown University's business school: "The Federal Reserve is overreacting to the risk of what it perceives as an overheated economy. I don't think it's there." Adds Edward Yardeni, chief economist for Prudential- Bache Securities: "I hope Greenspan doesn't do too good a job of keeping the lid on, because it could cause a recession. I don't think he will, but he could take some of the joy out of the Christmas season."

CHART: NOT AVAILABLE

CREDIT: TIME Chart by Joe Lertola

CAPTION: Prime Rate % per year

With reporting by Gisela Bolte/Washington and Janice C. Simpson/New York