Borrowers with Adjustable-Rate Loans Have Some Breathing Room

A friend of mine told me today that she has a home equity loan, and said nervously that she hoped rates would remain low. I told her that she would probably be safe for awhile. But for how long? As luck would have it, Paul Krugman addressed this issue in his blog today, so he made my job easy. Take a look at the chart, below, which shows the history of the Fed Funds rate over the last twenty years.

The shaded regions indicate recessions, as defined by the National Bureau of Economic Research (the commonly accepted arbiter of recessions in the United States). According to the NBER, the 1990-91 recession began in July, 1990, and ended in March, 1991. The Fed didn't start raising short term interest rates until February, 1994, almost three years later. The 2001 recession began in March, 2001, and ended in November of the same year. The Fed didn't start raising rates until June, 2004, over two and a half years later.

Why did the Fed wait so long after the recessions had ended to start raising rates? The short answer is that while the economy had stopped deteriorating by the time the recessions ended, it was operating well below its potential. In other words, there was enough slack (read that, unemployment) in the economy that the Fed could continue providing monetary stimulus without fear of igniting inflation.

It seems reasonable to assume that the same thing will happen this time. In other words, the Fed Funds rate is likely to remain close to zero for at least two and a half years after the recession ends. When will that be? The consensus seems to be that the recession has at least another six months to run. Assuming that that's right, the Fed Funds rate will probably remain near zero through the end of 2011.

Most home equity loans are tied to LIBOR or the prime rate, which are in turn either directly tied to Fed Funds, or else are closely linked to it. If you have a home equity loan, my guess is that you'll be safe for at least another three years.