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Cold Water on the Credit Spree

May 16, 2000

The Federal Reserve Board appears certain to raise interest rates today as part of its yearlong drive to cool the red-hot U.S. economy. The Fed wants to send a clear message to borrowers: Credit will cost more. That message surely won't be lost on the millions who have been borrowing at a growing clip. In this period of rising interest rates, that borrowing could prove to be hazardous to their financial health.

Regulating the cost of borrowing is the Fed's most effective way of fine-tuning the nation's economy. Since last June the Fed, convinced that the fast pace of economic growth cannot be sustained, has raised the key short-term interest rates five times, each time a quarter point. It is poised to raise the rates by as much as half a percentage point today. A Fed interest rate increase usually triggers a chain of similar increases for loans by commercial banks. That pushes up borrowing costs for everything from mortgages and car loans to credit card charges.

Consumer spending, which accounts for more than two-thirds of the economy, has been the engine of America's unprecedented decade of growth. But in recent years, consumers have been spending more money than they have earned, dipping into savings and buying on credit. Families are piling up debt as never before; added up, consumer debts have, for the first time ever, surpassed their after-tax income.

That is not necessarily alarming, considering that much of the debt was incurred up until about a year ago by homeowners who took advantage of low interest rates to refinance their mortgages. Those loans are secured by real estate, which has been rising in value.

The higher interest rates, while hurting all borrowers, are particularly burdensome for credit card holders who are already saddled with interest rates as high as 20% and who are facing further increases. In a Times poll released a week ago, more than a third, 37%, of those questioned said they had some or much difficulty paying for installment loans or making car payments. Families just starting out and low-income households in general are in an especially vulnerable position.

For Fed Chairman Alan Greenspan, there are not that many options. Jacking up interest rates raises borrowers' payments, but that's well worth it if it helps to forestall overall inflation, which would raise prices for everyone. Signs that the consumer spending binge is upsetting the economic balance between supply and demand and accelerating inflation are beginning to appear. The interest rate surge is a wake-up for consumers.

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