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Fed Rate-Cut Rally Could Recede Quickly

Like the tides, the wave of good feelings that swept over Wall Street and Main Street with the Federal Reserve's big rate cut could ebb just as quickly.

Homeowners opening up statements for their adjustable-rate mortgages come October will experience a jolt when the rates jump, but not as severe a jolt as it could have been.

Federal Reserve Board Chairman Ben Bernanke delivers the board's Monetary Policy Report to the Senate Banking Committee in Washington Wednesday, July 19, 2006. "The recent rise in inflation is of concern," and possible increases in the prices of oil as well as other raw materials "remain a risk to the inflation outlook," Bernanke said. (AP Photo/Dennis Cook)
Dennis Cook
Federal Reserve Board Chairman Ben Bernanke delivers the board's Monetary Policy Report to the Senate Banking Committee in Washington Wednesday, July 19, 2006. "The recent rise in inflation is of concern," and possible increases in the prices of oil as well as other raw materials "remain a risk to the inflation outlook," Bernanke said. (AP Photo/Dennis Cook)

And, Wall Street's mood swings -- reflecting bouts of panic and then some relief -- are expected to linger.

That's because the Fed's action, while perhaps providing some help, won't cure problems in the ailing housing market, which are still expected to drag well into next year.

It will take time for builders to work off a glut of unsold homes. That means the housing slump will continue to hold back the economy and probably lead to more job cuts in construction, manufacturing and other industries.

The Fed's action also won't stop home foreclosures and late mortgage payments from rising in the months ahead.

In a bold move, Fed Chairman Ben Bernanke and his colleagues on Tuesday sliced a key interest rate by one-half a percentage point to 4.75%. It was the first rate cut in more than four years.

Their aim is to prevent the economy from being thrown into a recession by a housing meltdown and a credit crunch. Lower rates should induce people and businesses to boost spending and investing, which would help energize economic activity.

Wall Street investors were cheered by the move, sending the Dow Jones industrial average zooming 335.97 points. It was the Dow's biggest one-day point jump in nearly five years.

Over the short term, the rate cut can provide an important psychological boost. It could make investors, businesses and others less inclined to clamp down or make drastic changes in their behavior that would hurt the economy.

"This does not heal the financial markets, but it can help in the process of healing. But we're not there yet," said Ken Mayland, economist at ClearView Economics.

The improved mind set, though, could turn out to be fleeting.

"I think the honeymoon is going to be pretty short for the euphoria of this Fed cut," said Greg McBride, senior financial analyst for Bankrate.com. "A half-point cut can only do so much. It doesn't transform the housing market into sunshine and daffodils."

The housing market is suffering through its worst slump in 16 years. Home sales are expected to keep on sagging. Home prices, which saw double-digit gains in many areas during the boom, have cooled off significantly. Affordability is still an issue for would-be home buyers, experts say.

Pain will continue to be felt by borrowers, lenders and investors of "subprime" mortgages -- higher-risk loans made to people with spotty credit or with low incomes.

Teaser Rates

Analysts estimate that 2 million adjustable-rate mortgages will jump from very low initial teaser rates to higher rates this year and next. Steep prepayment penalties have made it difficult for some to get out of their mortgages. Some overstretched homeowners can't afford to refinance or even sell their homes.

The Fed's action does provide a bit of relief. For owners facing a reset on Oct. 1, their new rate will rise to 6.75%, versus 7.50 if it had reset a few months earlier, McBride said.

"The payment is still going up by hundreds of dollars a month. So people are not going to feel warm and fuzzy," he said.

The subprime mortgage meltdown has forced some lenders out of business, and whacked investors.

Congress, meanwhile, is working on plans to help struggling homeowners avoid foreclosure, although it could take a few months for a final package to be approved.

For consumers, whose confidence has been rattled by the housing and credit problems, much turns on whether employment conditions continue to deteriorate.

The economy lose 4,000 jobs in August, the first decline in four years. The unemployment rate, now at 4.6%, is expected to climb close to 5% by the end of the year. A softening job market eventually will probably mean slower wage growth.

Howard Chernick, economic professor at Hunter College, doesn't think the Fed's rate cut will make people rush to the malls.

"Consumer spending is influenced by employment and wages," Chernick said. "Aside from the euphoria some might now feel, I don't think there is going to be a big effect."

It will take months for the Fed's rate cut to ripple through the economy, with the hope that it will bolster activity.

Analysts expect the economy to slow to a rate of about 2% in the July-to-September quarter. That would be just half the pace of the previous three months. Growth in the final three months of this year could turn out even weaker.

Ex-Federal Reserve Chairman Alan Greenspan, in an interview Monday with The Associated Press, said the odds of a recession are growing.

"Obviously the odds have moved up to more than a third, but I doubt if we are anywhere near 50% yet." Earlier this year, his prediction of a one-in-three chance of a recession caused Wall Street to nosedive.

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