The Economy Down and Dirty

By John Greenwald

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.

CHART: NOT AVAILABLE

CREDIT: [TMFONT 1 d #666666 d {Source: Federal Home Loan Mortgage Corp.}]TIME Graphic by Steve Hart

CAPTION: Mortgage rates

CHART: NOT AVAILABLE

CREDIT: TIME Graphic by Steve Hart

CAPTION: Housing starts

Portion of income derived from interest

Time and savings-account deposits

NASDAQ Composite Index

CHART: NOT AVAILABLE

CREDIT: TIME Graphic by Steve Hart

[TMFONT 1 d #666666 d {Source: Bank Rate Monitor}]CAPTION: Auto loans

CHART: NOT AVAILABLE

CREDIT: TIME Graphic by Steve Hart

[TMFONT 1 d #666666 d {Source: Motor Vehicles Manufacturers Assoc.}]CAPTION: Domestic auto sales

CHART: NOT AVAILABLE

CREDIT: TIME Graphic by Steve Hart

[TMFONT 1 d #666666 d {Source: Bank Rate Monitor}]CAPTION: 1-year CD interest yield

With reporting by Bernard Baumohl/New York, Dan Cray/Los Angeles and William McWhirter/Detroit