Fed rate cut won't end banks' woes

Trader John Shepley calls out a trade in the 10 Year U.S. Treasury Note pit at the Chicago Board of Trade after the Federal Reserve cut interest rates October 31, 2007.

NEW YORK (Reuters) - The Federal Reserve decision on Wednesday to cut interest rates probably won't do much for banks struggling with rising credit losses as the housing market retreats.

Banks recently completed a lackluster third quarter, with many boosting loan losses as homeowners and real estate developers struggled to pay bills. Lehman Brothers Inc. analyst Jason Goldberg said results at 51 percent of major U.S. banks missed Wall Street forecasts, the most in at least 11 years.

The Fed's decision to cut its key overnight lending rate to 4.50 percent from 4.75 percent will lower a variety of rates pegged to short-term market rates, such as those on credit cards and home equity lines of credit. It may also allow banks to lower rates on deposits. Following the cut, banks began lowering their prime lending rate to 7.50 percent from 7.75 percent.

Yet because rate cuts typically take six months to work into the economy, according to economists, Wednesday's rate cut and even the Fed's half-point cut in September will need time to have their full effect.

"The challenges remain the same: There is weakness in the housing market and a possible contagion effect harming other consumer lending, including credit cards and auto loans," said Rodrigo Quintanilla, head of North American banks and broker-dealers for credit rating agency Standard & Poor's.

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Banks have been among the worst-performing U.S. equity sectors this year. Through Tuesday, the S&P Financials index was down 9.4 percent in 2007, compared with a 7.9 percent gain in the S&P 500.

Financial stocks comprise one-fifth of the S&P 500. Some, including mortgage lender Countrywide Financial Corp, have slid more than half.

A healthier economy might spur business activity and keep a lid on loan losses. A Commerce Department report Wednesday showed surprisingly brisk 3.9 percent annualized economic growth from July to September, the highest in 1-1/2 years.

But the Fed said this rate will likely slow, "partly reflecting the intensification of the housing correction."

"Rate cuts don't cure past mistakes," said Gary Townsend, a banking analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia. "To the extent banks have not lent wisely, such as in subprime mortgages or some residential construction in Florida, those loans may already be bad now."

Moreover, some banks, including Citigroup Inc, Bank of America Corp and Wachovia Corp, have large capital market exposures, and were hurt this summer when that market seized up.

Morgan Stanley's Betsy Graseck on Wednesday downgraded the sector to "cautious" from "attractive," and projected a "consumer credit recession" in 2008. She also downgraded Citigroup, Bank of America and Wells Fargo & Co.

"We expect significant deterioration as tighter credit standards, imposed by banks and capital markets, squeeze consumers and as unemployment rises and housing values fall," Graseck wrote. "We see further downside risk to earnings per share if a consumer credit recession spills into corporates."