Long Term Perspective
In the 1980s, the spread between the federal funds rate and the bank's prime rate was 174 basis points, less than the 302 basis point spread averaged in the 1990s. While it appears that banks got greedy in the 1990s, the reality is that the "bank prime rate" has a different meaning today. In the 1980s, the prime rate was considered the lowest rate reserved for banks' best customers. In the mid to late 1980s, the best customers were getting charged lower rates than the prime rate. Banks changed the name of the prime rate to "corporate base rate." These days, many consumer and small business loans are tied to this rate. As a result, the spread is fixed at 300 basis points.

Short Term Perspective
The bank prime rate is an administered rate, not a market rate, and is tied directly to the federal funds rate. Whenever the Federal Reserve Board announces a change in the fed funds rate target, banks will alter their prime rate within 24 hours by an equal amount. If the prime rate were tied to market rates, it would fluctuate in tandem with yields on Treasury securities.

Interest rates on equity loans and credit card debt are typically tied to the prime rate. The Fed raised the federal funds rate target 17 times since June 30, 2004, and the prime rate is no longer as low as it was two years ago. Some consumers are still able to obtain low loan rates through "special offers". Credit card companies continue to offer reduced interest rates on balance transfers or new purchases for limited periods. Auto-financing rates offered by banks as well as auto financing companies have also risen in the past two years.

The Fed kept the funds rate target at 5.25 percent at the August 8 FOMC meeting. As a result, banks left unchanged their prime rate, a key lending rate that determines home equity loan rates as well as credit card rates.