Who's really bailing out the banks?RW: In spite of the rock bottom rates on saving accounts, CDs, and money market mutual funds, households continue to flock to the safety of these insured funds. And in response to increasing demand for saving instruments - the personal saving rate rose from 0.3% in February 2008 to 4.2% one year later - banks will draw down yields further.
Taxpayers, for sure. But the largely unsung victims of the financial system rescue are loyal bank depositors -- especially older people who have relied on interest income from savings certificates to live.
To save the banks from soaring loan losses, the Federal Reserve did what it always does when the industry gets into trouble: Policymakers hacked their benchmark short-term interest rate, which in turn pulled down all other short-term rates, including on savings vehicles.
But this time the Fed went to rock-bottom on rates. In December, the central bank declared that it would allow its benchmark rate to fall as low as zero.
Savers still are paying the price for that gift to the banks. Average rates on certificates of deposit nationwide have continued to slide this year, according to rate tracker Informa Research Services in Calabasas.
The average yield on a six-month CD fell to 1.27% this week, down from 1.86% on Jan. 1 and 2.24% a year ago. Anyone who has a CD maturing soon should be prepared for serious sticker shock.
Banks have been able to continue whittling down savings yields because the industry overall is flush with cash -- not just from the Fed's efforts to pump unprecedented sums into the financial system, but also because the events of the last year have left many people too afraid to keep their money in anything but a federally insured bank account. At least you know your principal is guaranteed.
Even as short-term interest rates have dived since the financial crisis exploded in September, the total sum in CDs under $100,000, as well as savings deposits and checking accounts, has soared by $507 billion, to $6.07 trillion, according to data compiled by the Fed.
Buy what Tom doesn't' say is that rock-bottom rates are here to stay. According to the FOMC statement:
"economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."And how long is that? Well, recently the Bank of Canada, whose interest rate policy tends to move in sync with the Fed's, released its monetary policy statmement. The BoC cut its overnight rate target to 0.25%; but more importantly, it made a definitive statement of how long might be an extended period:
"Conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target."It looks like saving rates will be low for a while, folks. The massive economic contraction is dragging down prices, and the IMF is forecasting U.S. deflation throughout 2010 (see Table A5 in the World Economic Update). Using the BoC's statement as a proxy for extended period, the near-zero federal funds target will hold saving yields low until June 2010, fourteen more months from now.
Disclaimer: To me, deflation remains to be a mechanism to clear markets rather than a macroeconomic hindrance. And furthermore, the IMF's outlook is very gloomy. Clearly, with 0% growth in 2010 for both the U.S. and the sum of advanced economies, the IMF expects an onslaught of defaults that are already in the pipeline, defaults that are not currently priced into market activity. We will see, though. The World Bank is projecting 2% U.S. growth in 2010.