Bloomberg.com has a great article discussing some of the unusually high CD rate promotions that keep popping up.  The article is titled, “AIG, GMAC Help Drive Up Bank Rates Amid ‘Insanity’ for Deposits”.  The theme of the article is one that has struck a chord with us for last 2-3 months.  Some banks continue to run promotional CD rate campaigns to increase their deposit base and keep their businesses moving forward. 

Since the second reduction in the Fed Funds Rate over the past three months and the Treasury injection of liquidity, bank cost of funds has dropped.  Interest rates on mortgages are starting to finally come down some as well.  However, some banks continue to offer interest rates on CDs that are measurably above the national average.  See the following post entitled, “Where to Find 4% Guaranteed, Short Term” to read more about some of the banks with the highest CD rates on terms of one year or less.

When the costs of funds are dropping for banks the rates on bank CDs should come down as well.  The spread between Fed Funds Rates and bank CDs is not as well defined as rate spread such as Fed Funds to the Prime Rate but the spread will normally not stay this wide for a prolonged period of time.  The turmoil in credit is clearly triggering some banks to remain overly aggressive in reaching for depositor funds.  Surely a gain for the CD investor. 

The problem with the high CD rates lies in the banking community while the aggressive banks in need of customer deposits heavily market above average CD rates it can force competing banks to raise their rates to avoid losing their customers.  Even with a modest amount of thawing in commercial paper and a discount window run by the Fed that never says no, bank CDs can be a measurable cost of funds for a banks continuing operations.  The banks offering these high outlier rates are keeping competitor rates up and possibly raising their rates above a level that maintains a reasonable cost of funds for the bank compared to the interest rates on the productive use of those funds.  Keeping this margin tight for banks that already have profitability problems appears to be a recipe for continued strained income streams.

The enigma posed by these above normal CD rates may be a clue to underlying problems in the business model of some of these banks.  In the mean time, the consumer that stays informed on the location and offers of the best CD rates will undeniable come out ahead.

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