The Federal Reserve Board's latest inflation-fighting strategy will make it more difficult for many Washington consumers to borrow money, will push local home mortgage rates even higher and will slow the District of Columbia's booming construction business dramatically, local lenders predicted yesterday.
But the tightening of credit that pushed the prime rate to a record 14.5 percent yesterday will not necessarily mean that consumers seeking a loan to buy a car or pay for a vacation will pay higher interest rates.
Washington region bankers, mortgage brokers and savings and loan executives agreed that the economic impact will be far different than in the 1974-75 recession, when the supply of loan money simply dried up.
Unless the administration restricts credit even more, there will be money available -- if consumers and businesses are willing and able to pay the higher interest rates demanded.
For a consumer who buys a car or charges a new rug on a credit card, interest rates will be little if any higher than they were a year ago, when the prime rate was 4 percentage points lower than it is today.
The interest rates on consumer loans are limited by the state and local usury laws, in the case of credit cards, have been at the legal maximum for some time, lenders pointed out.
"The effect on consumer loans will be minimal," said Sanford Teu, senior vice president of Fidelity American Bank in Virginia. "Most banks are fairly inflexible on those rates."
Instead of raising rates on small loans, banks are likely to follow the course outlined by J. G. Manderfield, president of First American Bank of Maryland. He said his bank would tighten credit terms.
Like many banks, First American uses a "credit scoring" system to decide whether to grant a loan, awarding points for income, home ownership, length of employment and other factors. "We'll probably have to raise it [the passing score] a few points," Manderfield said.
The result, bankers agreed, will be that customers with poorer credit ratings will have a hard time borrowing money for the next several months.
Small businesses, which typically borrow money at a percentage point or two above the prime rate, also may be hurt by higher rates and tighter credit terms.
With the prime at 14.5, those firms will have to pay 16.5 percent interest or more, and the cost of money will be even higher than that.
Most banks require business borrowers to keep "compensating balances" in their checking accounts, equivalent to 20 percent of the loan.
When the cost of the compensating balance is added to the 16.5 percent interest rate, the total interest cost approaches 20 percent.
Even higher rates face the builders and developers who make up Washington's supposedly recession-proof construction industry. In addition to paying a couple of points above prime and maintaining compensating balances, developers usually must pay 1 percent of the total project cost as a special fee to the lender.
Two of Washington's biggest commercial mortgage brokers predicted that those rates will lead developers to postpone projects, producing layoffs in the construction business.
"I have no doubt that a 14.5 percent prime is going to encourage some people to delay starting a project," said Mallory Walker, president of Walker and Dunlap.
"It's going to have a tremendous short-term effect on the construction business," said James O'Brien, who heads the Washington office of Coldwell Banker, a major national real estate and lending firm.
O'Brien and Walker said some builders may have trouble getting construction loans. Such loans are made mostly by large banks that belong to the Federal Reserve System. The Federal Reserve last week increased the reserve requirement for member banks, effective Thursday, in effect reducing the amount of money the banks can lend. Construction loans are often the first to be cut back.
Bankers and savings and loan executives reported that they expect money to be available for consumer loans and home mortgages, because those funds come from different sources.
As Thomas Moore, president of Central National Bank of Maryland, said, banks often try to link specific types of loans to specific sources of funds.
Loans whose interest rates are tied to the prime usually are made with money that comes from interest-related sources, such as the 6-month certificates of deposit on which the rate is pegged to Treasury bill rates.
Six-month CDs are paying about 10.6 percent interest, Moore said, so banks have to reinvest that money in loans that pay even higher rates.
Consumer loans generally are made with money from another source -- noninterest-bearing checking accounts or savings accounts that pay about 5 percent interest.
But the amount of money available to bankers from low-interest savings and checking accounts is limited, bankers said, because customers are smart enough to shift their funds to higher yielding sources.
"We have to watch very carefully to be sure we aren't lending money for less than it costs us," said Charles Daniel, president of Union First National Bank of Washington.
Consumer loans here carry a maximum legal rate of 1.5 percent, while the Federal Reserve as of yesterday charges banks 13 percent for money they borrow overnight. "How good does a customer have to be to lend him money at a loss?" Daniel asked.
Mortgage money is still available because of the secondary mortgage market, which has grown rapidly in the last three or four years, said Thomas Owen, president of Perpetual Federal Savings and Loan, Washington's largest.
Most local mortgages come not from savings deposits but from money borrowed through the Federal National Mortgate Association and similar firms, Owen said.
Mortgage rates may not go up immediately, he said, because the larger lenders made advance commitments for funds before the prime rate jumped. But when those commitments expire, rates will move up from their present 11 percent level, he said.