Consumers get scant relief from debt deal

August 1, 2011 - 6:44 PM

Just like their government, consumers and individual investors will avert immediate disaster if the debt ceiling agreement wins congressional approval by Tuesday. The stock market shouldn't crash and interest rates won't start skyrocketing.

But even before a vote took place, it was clear the deal carries implications for Americans' borrowing, spending and investments.

By slashing government spending more than $2 trillion, state and local governments may face greater pressure to raise taxes and cut jobs. That would only make it tougher for struggling individuals to make ends meet and find work.

And because the compromise stopped short of immediately implementing the more sweeping changes that had been sought, ratings agencies could still downgrade the U.S. credit rating in the coming months. That could jolt investor confidence, prompt markets to drop and make loans more expensive and harder to get.

For consumers, the accord provides no relief from economic reality, said Jack Ablin, chief investment officer for Harris Private Bank in Chicago.

Although the immediate consequences of the agreement may be limited, the deal puts the pressure back on a stagnant economy with little prospect for significant improvement any time soon.

"We're back to the same things we've been worrying about for the past couple of years," said Greg McBride, senior financial analyst for Bankrate.com. "Job growth is anemic, economic growth is uninspiring, and people have a lot of hesitation when it comes to things like job security and taking the plunge into homeownership."

The outlook for various areas of personal finance:

STOCKS

The short-lived nature of Monday's rally after a tentative agreement was announced underscores just how skeptical investors are in the face of weak economic data. After surging nearly 140 points at the opening, the Dow Jones industrial average tumbled on a surprisingly weak manufacturing report. It was down as much as 145 points before finishing the day down 11.

A "relief rally" of 2 to 3 percent, or roughly 200 points in the Dow, could still occur once a deal is formally passed, according to market pundits. But few foresee the market rising sharply beyond that until signs emerge of stronger economic growth.

"What happens from here is hugely problematic," said Michael Farr, chief investment officer of Farr, Miller & Washington, an investment firm in Washington, D.C. "If you look beyond this particular (debt-ceiling) issue, all of the rest of the news is bad -- GDP, unemployment and housing numbers."

The bright spot is corporate earnings. Even if many corporations are keeping large amounts of cash on the sidelines, awaiting a recovery, their strength gives investors some reassurance that the market won't collapse again like it did during the 2008 financial crisis.

BONDS

If Congress raises the debt ceiling no later than Tuesday, a potential default will be avoided but a downgrade could remove the nation's gilt-edged AAA debt rating. Credit rating agencies Standard and Poor's and Moody's declined to comment Monday about the bill's possible impact on their decision-making process.

If it does come to pass, a downgrade could send Treasury yields modestly higher, with corporate, municipal and other bond issues doing the same. A downgrade means the government would have to pay investors more to take on the additional risk of buying its bonds.

Municipal bonds also could face pressure from the government spending cutbacks, which will increase the crunch for cities and local governments.

LOANS

A downgrade would nudge interest rates higher on a variety of consumer loans. Not only would Uncle Sam have to pay higher borrowing rates, so would everyone else. That's because many interest rates are pegged to U.S. Treasurys. So if a downgrade pushes up Treasury rates, mortgage, corporate and other loans would rise too.

— Home loans: Already-tight restrictions on lending could get tighter. Some borrowers could find it even more difficult to get approved for a mortgage.

Home-loan borrowers have been feeling the squeeze. For example, an Ohio woman with a portfolio of $2 million had to go to 10 banks before finding one that would approve her request for a simple mortgage refinancing, according to financial planner John Ritter of Ritter Daniher Financial Advisory in Cincinnati. A routine issue can negate the value of a large portfolio in the eyes of a lender.

"I don't think it's going to get any easier any time soon," Ritter said. "The creditworthiness that wasn't even looked at before is now really stringent."

The upside for prospective homebuyers: Any increase in interest rates could be partially offset by a drop in home prices. When mortgage rates rise, buyers are willing to pay less for a house.

The rates on home equity lines of credit could also climb.

— Student loans: The debt deal increases funding for Pell Grants, which provide up to $5,550 for low-income students. But the amount will still fall short of what's needed, leaving the program at risk of future cuts, according to Mark Kantrowitz, publisher of the FastWeb and FinAid websites about college aid.

If the U.S. credit rating is downgraded, interest rates would likely rise by 0.25 percent to 1 percent on existing private student loans and more on new private student loans, according to Kantrowitz. That would push up monthly loan payments anywhere from 5 percent to 12 percent depending on the duration of the loan.

For example, someone paying off $25,000 in student loan debt at 10 percent interest over 10 years could see payments rise from about $330 a month to $344, with an extra $1,680 in interest costs over the life of the loan.

— Credit cards: Higher costs on credit cards are not imminent, but rates could creep higher if there is a downgrade.

The federal credit-card act prevents rate hikes on existing balances. But interest rates would go up for most people on new charges if a downgrade leads to higher borrowing costs for banks.

The collective impact of higher loan costs goes beyond the individual loans, as McBride noted. "The more money that individuals are devoting to interest charges on credit cards and home equity loans and student loans, the less available to be spent elsewhere."

However, almost none of the spending cuts in the compromise plan would occur before 2014.

MONEY MARKET FUNDS, CDs

A downgrade would not force money-market funds to sell their Treasurys, so they should remain stable. Although these funds are required to own only high-quality securities, a downgrade wouldn't force an immediate sell-off.

The problem for retirees and others who depend on fixed income from these investments is that their returns continue to be meager. Even the best rates available nationally barely top 1 percent for a money-market fund or a one-year CD and are only 1.8 percent for a three-CD, according to Bankrate. That scenario isn't likely to change much in the near future, even if higher interest rates ultimately are coming.

"Retirees would love to have CDs that pay 3 percent or more," said Rob Russell, president of Dayton, Ohio-based investment firm Russell & Co. But the other side of that, he said, is that consumer loans will be considerably costlier once that happens.

TAXES

The legislation that congressional leaders agreed on does not include automatic federal tax increases. But the Bush tax cuts, extended once already, expire in 2013. Unless extended again, taxes would rise.

State and local taxes, as noted, also could be bumped higher as governments cope with the reality of less money available from Washington.

UNEMPLOYMENT

The deficit deal leaves out extended unemployment benefits for victims of the recession. President Barack Obama had pushed to extend them beyond their scheduled expiration next January.

With spending restricted, the government also would have less available to pump into programs directly aimed at creating jobs to stimulate the economy.