Expect Even Lower CD Rates

Want some insight into why savings, CD rates, and money market rates are low and about to get lower? The FDIC recently ruled banks that are not “well capitalized” will not be allowed to sell fixed investment products for more than 75 basis points (or 0.75%) above the national average.  Whatever “well capitalized” means is subject to FDIC’s terms.  This effectively puts a cap on the highest rate any bank can offer.

Bad for the Banks

As mentioned in this CNN blog post, “It’s not uncommon for a struggling bank to ratchet up interest rates on its deposit accounts as a way to attract capital.”  It’s in fact it’s the primary tool they can use to attract customers. How else can a bank attract customers? By offering free toasters?  By restricting a badly capitalized bank, the rate in which they can offer their products, doesn’t this make it that much harder for a bank to increase their capitalization?  If they can’t get the capitalization, won’t this make it harder for them to become a healthy bank?  It can be a vicious cycle.

You may think the FDIC was created to help the consumer, but in reality it’s helps the banks. Rulings like this are solid proof they do nothing to help savers.  Let’s look at the FDIC from the banker’s perspective.  If you could make loans and investments without the fear of failure, would that change your risk for investing?  With the FDIC in place, banks can make riskier investments.  They know the FDIC will rescue their customers, should they make fatal errors.  It’s a moral hazard for banks and the surviving banks pick up the tab.  With 140 banks that failed in 2009, the FDIC is woefully under-capitalized.  More than likely, the FDIC will require the “good” banks to prepay three years of FDIC insurance.  This is the classic economic term “There ain’t no such thing as a free lunch” (TANSTAAFL).  Like in physics, every action has an equal and opposite reaction.  The healthy banks will have to react to the FDIC prepayment to ensure they themselves stay healthy. The possible situations:

• The banks let it eat into their profit margin
• Forces banks to increase their fees to customers
• Lowers the interest rates banks offer on their products

More than likely #2 and #3 will occur.

Bad for Savers

This makes things even worse for savers.  Yet again our government is punishing savers in the end.  This is either forcing savers to eat into their principal, or invest in riskier assets.  This is no accident and has an ulterior motive.  Though you won’t find any formal proof, this was done on purpose by the FDIC and the Federal Reserve.  What’s the reason behind this?  It forces investors to take their money and move into other assets, such as stocks and bonds. Though not the primary cause, the current low bank rates assisted in the re-inflation of the stock market.

Investing in these low return bank investments are in reality very risky.  You might be thinking, “Risky? How can a fixed 1.98% CD be risky?”  The issue is your real rate of return.  Just trying to beat or match inflation becomes very difficult.  As I state with my 4% investing rule, I won’t add any new CDs to my security bucket, and will seek other investments when the existing CDs mature.  You definitely have other options that offer higher rates of returns with not as equal increase in risk.

So Suze tell me how FDIC insured bank products are a risk free investment?  Every investment has risk, even FDIC insured investments. Suze is correct though; it might be risk free to the consumer owning an account with a failed bank.  Should the bank fail, you will get your principal back.  The issue is, with current interest rates, you run the risk in real dollars (that’s after inflation) of loosing money.  The additional issue, someone has to pay for the failed bank.  After all, a bank fairy does not exist.  With FDIC requirements expect lower returns, and higher fees from the surviving banks.  In the end, other investment options might be worth looking into.