Savings and CD rate averages continued to decline last week, with the one year CD average falling from .419% to .418% APY. Five year average CDs fared even worse falling from 1.204% APY to 1.196% APY. Online savings rates from the banks offering the top 30 nationally available rates remained steady at .732% APY for the seventh week in a row.

Election Impact on Savers

With the election over we can now look towards the fiscal cliff as the next big event that may impact the fortune of savers. Here are a couple of scenarios and some thoughts on how each one might impact savers.

• We go over the cliff. Taxes will rise across-the-board, including on income from savings and CDs. As a result, the already meagre gains from money in the bank will become even smaller. As the economy slows from tax increases and spending cuts, the government will keep interest rates pegged at record low rates for an even longer period of time.
• The cliff is averted via a temporary detour. Congress and the President decide that in this lame-duck period (for Congress) to bypass the fiscal cliff and put in a temporary respite from tax increases and budget cuts. This will maintain the status quo. Rates will remain low for an extended period of time (perhaps through 2016) on deposit accounts but no significant new taxes will be taken out of income.
• A grand bargain is struck to avert the cliff. A grand bargain is potentially the best outcome for savers, depeneding on the contours of the deal. A compromise would show that the government can still function and boost confidence in the economy. Most of the compromises being discussed now would not increase income taxes on the vast majority of savers. So, increased confidence and little to no tax increase may result in higher rates in the medium term as the economy continues to grow and recover from the financial crisis of 2008.

Savings Options

Should a saver open a savings account or a CD? A shorter-term CD or a longer one? The chart below shows the comparison between the yield of a 5-year CD and a 1-year CD. Notice that this difference has shrunk considerably over the past year as the yield on 5-year CDs has dropped by more than the yield on a 12-month CD. This drop continued last week.

Not much has changed with the various product spreads. While the spread started the year at 1% or 100 basis points, it is now .778%. As a comparison, in 2008, this spread stood at .43% while in 2010 it went as high as 1.56%. So right now, it's somewhere in the middle. Why does this matter? Because back in 2010 banks were paying a saver a lot more to invest in a 5 year CD versus a 1 year. Today, banks are giving about half the premium they did a few years ago to lock up your money for 5 years. In 2012, I advised savers to consider investing in 5-year CDs because of this premium: the economy looked stuck for quite some time, and inflation did not appear to be a problem. Now, with the premium down, and the economy growing (albeit not that fast) it's a bit of a harder case to make. If the government takes the economy over the fiscal cliff, then it makes sense to put money in longer-term CDs as the potential for another recession becomes much higher. If a compromise can be reached, I'd invest in shorter-term CDs. Consumers might want to consider laddering their CD portfolio in this rate environment.

What about the comparison between savings and CDs?

This spread has actually been growing. Online savings rates have, for the most part, maintained their rates while CD rates continue to fall. For short term savings, it appears to make more sense to park money in an online savings account versus a CD. Online savings accounts have remained very stable over the past year.

Interest Rates

My rate prognosis depends on what happens with the fiscal cliff. The most likely scenario is that a temporary fix is put in place that averts a jump in taxes and cuts due to sequestration. Based on that, I believe that:

Rates will continue to drift lower for the next 12 months. After that, it's hard to tell. I suspect that rates may go up before 2015.

For now though, savers can make the best of a tough situation by getting the very best rates on their money. Remember, even in today's environment, there is competition for your cash.

I hope this is helpful. If it is, let me know and I'll keep writing. Drop me a note or post a comment below.

Have a nice week. Until next week...

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BestCashCow released its list of the top ten fastest growing banks in the U.S. Banks were ranked based on organic growth of assets and return on equity for the period between June 30, 2011 and June 30, 2012.

The Federal Savings Bank, based in Overland Park, KS, tops the list with 147% growth in assets and a 48% return on equity last year. The Federal Savings Bank is a veteran-owned and operated bank formed in April 2011 following National Bancorp Holdings' purchase of Generations Bank. The bank's focus on providing mortgage loans to veterans and first-time home buyers has been the primary driver in its growth over the last year.

"The Federal Savings Bank has experienced tremendous success in the last two years by exercising a disciplined approach to measuring, monitoring and controlling our business plan," said Steve Calk, Chairman and CEO. "We have focused extensive investment in the customer experience and our infrastructure, while expanding nationally at a controlled and profitable pace. All of this has been possible by hiring and empowering women and men of superior character and work ethic, including a large number of returning combat veterans."

Rounding out the list of fastest growing banks in the U.S. are:

Despite the pressure of low interest rates, many small and community-based banks are thriving," said Sol Nasisi, president of BestCashCow. "They are able to do so because they have the right formula to succeed in today's economy. They have well-defined markets, entrepreneurial cultures and solid balance sheets and at the end of the day, success breeds success. As these banks continue to grow and effectively compete in their local markets, more and more consumers are looking to them for their next mortgage, business loan or credit card."

The Transaction Account Guarantee Program (TAG) is scheduled to expire at the end of the year. TAG, which was originally part of The Temporary Liquidity Guarantee Program (TLGP) of 2008, adds unlimited insurance coverage to noninterest bearing accounts, such as checking accounts, regardless of balance. It is entirely unrelated to the FDIC regular deposit insurance coverage whose maximum cap of $250,000 has been made permanent through recent legislation. Only those accounts that total over that cap will be left exposed. Accounts of this type exist at 90% of our financial system’s banks and hold a staggering amount of money, with a total of 750,000 accounts containing over $1.5 trillion in deposits. The dollar figure associated with accounts of this type has increased by 85% since the TAG program’s initiation.

Many associated with the financial system have expressed concern that such an abrupt end to the program as the one currently scheduled could lead to a major disruption. Among those fearful that a cessation of the program might erect yet another roadblock for the economy include Sheila Blair, the former FDIC chairperson, who has suggested that the program should be slowly phased out thus avoiding the potential for a mass withdrawal of money from the accounts that would be affected by TAG’s termination. While the nation’s largest banks, those who fall into the category of “too big to fail” are unlikely to be significantly affected, the end of TAG poses a greater threat to medium and small banks whose capacity to handle large outflows of capital might be strained beyond their ability to remain solvent. Although only approximately 10% of the $1.5 trillion expected to be impacted is held at such institutions of lesser size, the financial system is ill positioned to sustain another round of bank failures as the negative impact on an already sluggish economy would not be insignificant.

Several banks have issued research reports which focused upon the potential impact of an abrupt end to the TAG program. Per a Goldman Sachs study there exists the possibility of a mass exodus from the banks housing the affected accounts. A similar Bank of America assessment concludes that due to risk aversion amongst many depositors, a portion of the $1.5 trillion in the currently fully insured accounts that would lose their coverage upon the cessation of TAG would leave the banks and seek safe havens elsewhere, such as in money market funds or Treasury and agency securities. Such an influx of money into the Treasury market could push some bonds into having negative yields, as well as having an adverse affect on the smaller and medium banks less well equipped to handle such a scenario. The money is less likely to leave the system entirely than it is to cause some dislocation for individual banks, however, so the overall damage may be mitigated.

There are four general outcomes that could result if TAG indeed expires at the end of the year:

• It is possible that much of the money will simply stay put as a significant percentage of the overall funds is employed in transactional accounts used by businesses as a necessary tool for their daily operations. A mass shift of money used in this manner would be difficult.
• The cash will migrate to larger, more credit worthy institutions, i.e. the “too big to fail” group of banks that are unlikely to be allowed to go under by the government in the event that there occurs a negative financial or economic development of significance. This would alleviate the concern of investors with the long term viability of smaller banks.
• The cash will be shifted into money market funds. While there is little money to be made there given the current interest rate environment, it does represent the path of least resistance.
• Finally, the cash could be invested into short term Treasuries, a move that comes closest to replicating the FDIC coverage given the extreme unlikelihood of government issued bonds not being paid back to investors in full.

If the first scenario proves true, then the expiration of TAG is rendered to near irrelevance, as the money will, for the most part, stay put. If any of the other three scenarios prove true, either individually or in combination, the fear that small and medium size financial institutions may experience crippling banks runs, might prove to be well founded. Given the recent credit crisis and the instability and uncertainty associated with the global marketplace due to ongoing economic troubles, most notably in Europe and China, the wisest move would seem to be to follow Sheila Blair’s suggestion to engage in a slow phase-out as opposed to an abrupt termination. Prudence and caution are rarely unwise approaches, particularly when dealing with things as complicated as our domestic banking system and the global economy.