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