Buyer Beware: The Weakest Banks Often Offer the Highest Interest Rates

by Xin Lu on 8 July 2008 15 comments

Today the troubles of IndyMac bank was splashed in the headlines. Its stock has fallen to nearly $0 and depositors are making a run at closing their accounts . IndyMac has been consistently been paying one of the highest CD interest rates in the nation, and it is a prime example of a financially weak bank that offers high rates to attract new deposits.

Last year, Countrywide also did the same thing and offered the highest yielding CDs in California to attract new deposits. Now they have been "rescued" by Bank of America. Ailing banks generally use the new influx of money to pay for everything from debts to interest owed to other customers. In a way this is a real Ponzi scheme because money from later investors are used to pay earlier obligations.

Most American consumers do not have to worry about their money because certificates of deposit and savings accounts less or equal to $100,000 are insured by the Federal Deposit Insurance Corporation (FDIC), and that means that when the bank fails FDIC steps in and moves the insured deposits to another institution. However, that new institution no longer has to pay the originally promised interest rate.

The flipside of this is that because of FDIC, desperate banks do not care if they are unable to pay the high interest rates they promise. Ultimately if the bank fails, the FDIC uses government money to bail out the depositors and shifts the burden to taxpayers. This could be a disaster if too many banks fail.

As always, be careful where you put your money, and research the institutions that hold your money. If you must buy a high yield CD or open a high yield savings account at troubled bank, make sure it is FDIC insured to mitigate your risk.Finally, if the interest rate offered sounds too good to be true, then it probably is.

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8 Jul. 2008 | 8:38 PM Sam

Let me add mine:

There are 4 Things YOUR Bank Doesn't Want You To Know

1) Your Bank Is loaning Your money out to investors and charging them an Interest fee of 5-6%.
Of course this rate may vary but it doesn't even matter in the big scheme of things. There are certain investors who are reinvesting this same money and receiving 1-1.5 percent interest a DAY. Yes I said "A DAY", which amounts to over 30% PER MONTH. Now let's say the reinvest $10,000. Each day they are earning $100-$150 a day in interest seven days a week. Most people could quit their job on that money alone. Even at the lower 1% they make $3,000 on their $ 10,000 in 30 days. In 3 months their initial investment is doubled.

2) Your Bank offers lower lending rates to these investors because these same investors are taking a percent of the Bank's money and quietly investing it for these very same banks. Well, actually it's not the banks money it's yours. I really have to watch myself here because these are very serious people who I really don't want as my enemies although it's probably a little too late for that.

3) Your bank goes out if it's way to find excuses to make you open a Savings account to attach to your checking account. Their favorite pitch is to "protect you from over-draft fees" by adding a savings account to your existing checking account. Checking accounts fluctuate because we use them to pay our bills and attach credit or debit cards to them. Savings account funds pretty much just sit there earning a ridiculously low interest which makes it available for YOUR bank to play monopoly with your money and in return give you a couple of hundred dollars a YEAR if your lucky. Are you starting to get the picture?

4) Your bank and it's investors are not only capitalizing on the insane interest their earning but they are earning free advertising while their money is sitting in these accounts. That's right, free advertising for their business or their Internet website. It's crazy, yet it's true.

8 Jul. 2008 | 9:48 PM Devan

Hmmm...I wonder if there is a regulatory body like the FDIC in most other countries?!?! Or a global body that has the same powers?!

My dilemma is that whilst I live in Australia, I have a large amount of money invested in a Finnish and an English bank!

8 Jul. 2008 | 10:33 PM Andrea Karim

I just KNOW someone here is going to show up and recommend a credit union. My good friend has been pressuring me to join Verity for months, and I've been resisting, mostly because... well, I just feel resistant. But I suppose that they are NCUA-insured - is that as safe as FDIC-insured?

8 Jul. 2008 | 10:55 PM Xin Lu

I think NCUA is the FDIC equivalent for credit unions. So I think it's as safe as the FDIC. I'm not too clear on what the difference is besides the name.

9 Jul. 2008 | 9:41 AM Kelja

Xiu Lu, you are right on about those CD's which pay higher interest rates. More risk = higher expected return.

Are you aware the FDIC has recently hired and un-retired numerous auditors expecting many banks to go under in the coming year?

Also, FDIC insurance does cover deposits up to $100,000 in savings accounts - not money markets! And, yes, they cover up to that amount, but, in the event of a large number of banks going under, will not pay it back all at once or quickly. They'll pay it back slowly and in small installments.

Almost all banks and Credit Unions are up to their eyeballs in toxic paper - mortgage bonds that may very well turn out worthless. That's the main way they generate, or are supposed to generate, profits to pay interest on deposits. No institution is immune to the mess.

Keep inflation in mind as well. Government figures are faulty to say the least. One trip to the grocery store and gas station will tell you that. I fully expect inflation to be running over 10% within 12 months of NOW - and that's what official government figures will say. That's how much your dollars will erode in earning power each year.

It's a very tough environment out there. Be careful.

9 Jul. 2008 | 9:52 AM Skeptical of the Skeptics

Sam,
I understand your trepidation, but I don't understand your explanation. Who are these 'investors' who are getting a 1.5% daily return? And how can I become one? 1.5% per day is more than Warren Buffett ever made in his entire career (he was lucky to get 30% annual). By your calculations, 1.5% per day is over 30% per month. Extrapolating from that, that's over 360% per year. At the end of a year, starting with that $10,000 you mention, you'd have over $230,000. After 5 years you'd have over $68 BILLION! I daresay, if that was possible...well, I don't know, but I'd be in a spaceship stocked with sandwiches out by Alpha Centauri.
'Serious people' indeed.
If you want to put it into perspective, look into the Savings and Loan crisis of the late 80s early 90s. We may or may not be headed down that path, but a good way to help the situation is by leaving your money in the bank.
NCUA is an independent federal body, much the same as FDIC but separate.

9 Jul. 2008 | 10:55 AM Wilson

The real issue is why the FDIC examiners didn't rescind FDIC coverage for banks like Countrywide that offered -10% down-payment mortgages. The taxpayers (of China) should not be funding yet another Ponzi scheme.

9 Jul. 2008 | 1:30 PM Philip Brewer

@Wilson:

Rather than rescinding coverage, the FDIC just closes the bank down. (They didn't used to be able to do that. But since the early 1990s, they can close the bank down even before it's insolvant, if its capital gets too low.)

Also, the money they use to pay off insured claims is not taxpayer money. The FDIC is funded by fees paid by the insured banks. They can borrow money from the Treasury, if necessary (which means that the taxpayer is potentially on the hook if the insurance fee doesn't cover all the costs of paying off the insured depositors), but so far they have always paid the Treasury back for any such borrowing. Gory details here: http://www.fdic.gov/bank/historical/brief/brhist.pdf

The real danger is not the occasional bad bank--the system handles those well. The danger is systemic problems, such as the current credit crisis, where everybody was making the same mistakes, and they all go bad at once. (The system is designed for situations where everyone is making their own mistakes, so only a handful go bad at any particular time.)

9 Jul. 2008 | 10:45 PM Nuclear

Sam acts as if this the way banks operate is some kind of secret that they don't want anyone to know about. If it's a secret, it is very poorly kept. The problem is that many Americans border on financial illiteracy. Many don't understand how compound interest works and many more do not know that making a 'spread' on money is the second oldest profession in history.

In the most simplistic terms, all financial institutions borrow short and lend long. They take your money and give you a short term interest rate (CD or savings account) and immediately lend the money out longer term at higher rates (car loans, mortgages etc.). The difference is between the two is the banker's profits. As long as the bank makes prudent loans with stringent guidelines (no interest only loans, all loans documented etc.), the system functions fairly well. Banks have always needed short term financing to be rolled over- deposits or credit must be replaced to keep the bank capitalized. In reality, the depositor has always assumed the risks right along with the bank. This is why there is FDIC because after the Depression people were afraid to put their money in banks and without depositors banks cannot make money.

So this is not a conspiracy. The US operates on what is called a 'fractional reserve system'. Banks must have only 10% or so of cash on hand at any given time- the rest is being put to work making the bank money. If there is a run on the bank, all your money isn't there and it never has been. The problem today is that insatiable greed and political corruption allowed the banks to run amok. With the help of Wall St, the Federal Reserve (which is really a private bank)and the federal government, the financial industry created the largest debt bubble in history and now we will all pay the price.

10 Jul. 2008 | 9:23 AM Kelja

You're right that the FDIC uses a reserve collected from the member banks to pay for failed institutions. That's the theory anyway. Fact is that reserve is negative right now and since the FDIC expects banks to fail at a historic rate the next two years, the reserve has no chance to recover.

I think we're on the cusp of a systemic financial failure.

Bear Sterns, by the way, wasn't covered by the FDIC, but still was 'rescued' by the FED. Many of the big financial institutions and regional banks are teetering on collapse. The only thing holding the mess together is the FED which is trading treasuries for their worthless mortgage paper. This supposedly is a short-term LOAN but as it will get rolled out indefinitely, it's the FED giving it away.

There's always a consequence for any action (Newton?). This will end up inflating the currency beyond belief. I easily see a better than 10% inflation rate within the next 12 months - using government skewed numbers.

That's gonna hurt!

24 Sep. 2008 | 4:52 AM marn

very wonder full article so insert of the all of them to read very thankyou

24 Sep. 2008 | 4:53 AM varin

The `Indian Bank` Association IBA has made a strong use for an early division on payment of interest on reimbursement that Government would make for

24 Sep. 2008 | 4:54 AM raviram

farm loan waiver saying that the banks balance sheet would be affected otherwise.
The reimbursement for the Rs.71,000 crore

24 Sep. 2008 | 4:56 AM kidoei

all banks took lot of some gain but public opion and to the anlayis to the factness

24 Sep. 2008 | 5:05 AM cone

bank also the early the gain the allot of the kind the effect of the public

Buyer Beware: The Weakest Banks Often Offer the Highest Interest Rates

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