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Savings flood undermines CD rates

By Claes Bell, CFA ·
Tuesday, May 31, 2011
Posted: 1 pm ET

Some more bad news on CD rates this week.

Despite the fact that global recession is supposed to be a few years behind us in the rearview mirror, with slow growth, inflation fears and sovereign debt crises popping up all over the place, uncertainty is everywhere. It's no surprise, then, that a new report from Market Rates Insight shows skeptical investors are still keeping their money safely tucked away in U.S. savings accounts:

Deposits in domestic branches of FDIC insured institutions reached an all-time high of $8 trillion at the end of the first quarter 2011, despite the fact that the national average rate for deposits remained low at 0.86 percent during the same time period.

During the first quarter of 2011, domestic deposits increased by $117 billion over the fourth quarter of 2010 -- an increase of 1.5 percent.  The increase, however, was not uniform across all deposit types. While liquid accounts such as checking, savings and MMAs increased by $171 billion or 2.9 percent, term account balances, i.e. CDs, decreased by $53 billion or 2.7 percent.

This seemingly endless glut of deposits is really bad news for CD investors. A big reason banks offer CD accounts is they help banks raise funds for lending. With so much money flooding into banks' deposit accounts, they don't need to offer CD investors high rates to stay well-funded.

If you're not seeing the connection here, imagine your local bank as an ice-cream factory. The main ingredient in its ice cream is milk, and a big part of its operating expenses is buying milk from surrounding dairy farms to keep the churns going.

Imagine the media began broadcasting reports of people who eat cheese spontaneously combusting. Americans quickly decide they don't want to eat cheese anymore and regulators freeze the sale of many brands of cheese. Just as quickly, dairy farms are stuck with all the milk they used to sell to cheese makers, and they begin trying to find buyers elsewhere.

The ice-cream factory is deluged with discount offers from dairy farms desperate to find a place for all the milk their cows are producing. At the same time, though, U.S. consumers begin to suspect the spontaneous combustion problem could apply to ice cream as well, and ice cream sales decline.

Think that ice-cream factory is going to pay as much as it used to for milk in that scenario? Me neither.

Unfortunately, the same laws of supply and demand apply whether you're talking about and ice cream factory or a bank. Faced with a massive glut of consumer deposits and weak demand for their loan products, banks will likely keep offering historically low CD rates until market conditions improve.

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June 02, 2011 at 4:56 pm

Thats a good analogy. It makes sense that the banks dont have to "lure" money in with good rates if they already have cheap access to our money.