August 17, 2009 Update

I wrote the following back in June, before the lazy days of summer:

"Individual bank rates may fall a bit from here but for the most part rates seem to have bottomed, as shown by the chart below. Even savings accounts, the most liquid and sensitive to the Fed Funds Rate (currently at 0%) has flatlined and is no longer on its steep downward slope. Indeed, we've even seen a few banks increase their rates."

Ah, if only that were true. Savings and CD rates continued to drop over the summer even as the stock market went on one of its longest winning streaks in history, shooting above 9,000 and getting giddy analysts to call for it to rise above the 10,000 mark before long.

As the chart below shows, there was nothing to be optimistic about from a savings or cd rate perspective. The average savings account rate according to the BestCashCow rate table is paying 1.8% APY. And those are the top rates in the country! If you walk into Bank of America or Chase, they'll ask you to pay them - practically. Last year at this time, the average savings rate was 3.6% APY. Nothing to write home about but still a lot better than today. The story is much the same with CDs.

The average 12-month CD rate is only slightly better than the savings account rate at 2% APY and banks will pay you 3.22% APY to lock your money in for 5 years.

As the chart below shows, the spread between savings rates and 36-month CD has remained fairly steady over the summer - both have gone down!

So what's a saver to do? With the economy looking like it's on the mend and the Fed and government still pumping trillions, it's hard to justify locking money into a long-term CD. The time to do that was 18 months ago when rates were 5% APY+. For now, I think it's best to stay short-term and wait. An improving economy will force the Fed to eventually raise rates, and that will cause yields to start rising.

The spread between the average BestCashCow savings rates and 36-month CD rates remains steady as the economy stabilizes and investors, banks, and consumers wait to get the next read on where the economy is going.

The FDIC reported today that the situation is still grim in the nation's banking sector. The number of problem banks rose from 305 to 416 and the FDIC's deposit insurance fund fell to $10 billion from over $40 billion last year. Combined, the banking sector lost $3.7 billion in the second quarter amidst a continued slump in real estate, accelerating unemployment, and increased foreclosures. Many are expecting the commercial real estate market to face significant problems, which would further strain bank's balance sheets.

At this point, one big bank failure looks like it could wipe out the FDIC's insurance fund. The collapse of Indymac cost the fund almost $9 billion alone.

So should you be worried about FDIC insuance? The answer is no. There are several reasons for this:

First the FDIC fund is not actually down to $10 billion. The FDIC has taken over $20 billion out of the insurance fund and put it in reserves in anticipation of future losses. So in essence, the $10 billion is actually a safety cushion after the FDIC is done paying with its projected payouts. $10 billion is not a large cushion though and one unexpectedtly large bank failure could still wipe out the fund. That brings us to point #2.

If necessary, the FDIC will raise more money from banks by assessing a special levy. The Deposit Insurance Fund is funded via a levy on all banks. In tough times, the FDIC can increase this levy, as it did last winter, or it can ask for a special payment from the banks. If banks continue to deteriorate, look for one if not both.

Third, the Federal government has extended the FDIC a $100 billion line of credit which can be tapped at any time. In addition, should the line of credit be used, the FDIC is backed by the full faith and credit of the US, and more money will be appropriated by Congress, assuming there is any money to appropriate.

While 2008 and 2009 have been tough years, they haven't approached the carnage of the Savings and Loan crisis in the 1990s based on the number of bank failures or the combined assets of those failed banks. FDIC has done a very good job of conserving its funds by preventing outright failures and conserving its funds by partnering with other banks and investors to sell impaired banks. This has spared the FDIC the full brunt of any deposit losses - think WaMu, Wachovia, National City, etc. Expect this kind of public/private partnership to continue.

Based on all of this, I would deposit my money in a savings account or a CD and sleep soundly at night.

Emigrant Direct and Dollar Savings Direct (both owned by Emigrant Bank) has started to list its foreclosed homes for sale on its online banking website.

They have put a link to "real estate opportunities" just below the sign in for online banking accounts.

While it seems a little unusual, it makes sense for the bank to use this avenue to get exposure for its inventory of foreclosed homes and to try to a direct to market approach with these properties through its deposit vehicles.