Personal Finance Blog By MoneyRates - September 2009

Talk of Federal regulation is swirling around two industries: banking and health care. Both are essential to our modern way of life, and both have their critics and backers. The health care system has never gone through a massive meltdown like banking did a year ago, but many people see it as suffering a slow decline: continually rising costs, deteriorating quality of care, and inadequate resources to meet the demands of an aging population. So, the question is, which industry is in greater need of regulation and reform?

For all its troubles, on a day-to-day basis, banking does operate much more efficiently than health care. One key: banking has been much quicker to embrace technology. Some may decry the lack of personal service this involves, but as long as cost efficiencies find their way into higher bank rates, most people don't mind. Speaking of bank rates, with resources like money-rates.com, bank customers can freely compare savings account rates, CD rates, etc. When it comes to health care, information -- and choice -- is much harder to come by.

As for service, while banking has become more automated, it still offers access to branches and human representatives for those who want the personal touch. Ask yourself this: have you ever had to wait an hour to see a banker? It's more likely you've experienced that kind of wait at the doctor's office.

The reforms needed for banking involve reining in the risk-taking incentives that can endanger the whole system. In some ways, this is an easier fix than health care, because it doesn't involve improving the way the business runs from the ground up. Both may be in need of attention, but they need very different types of solutions.

Banks offering high interest rates on savings accounts, CDs, and other deposits are attractive to savvy bank shoppers anyway, but a pending FDIC rule could make them even more appealing. Effective January 1, 2010, the FDIC will put a cap on bank rates offered by institutions categorized as "less than well capitalized."

The new rule addresses bank rates for several types of accounts, including savings, checking, and money market accounts, plus CDs of various lengths. The rule also distinguishes between regular and "jumbo" deposits, which are accounts of $100,000 or greater.

Essentially, the rule takes the national average of each account type, and dictates that less-than-well-capitalized banks cannot offer more than 75 basis points (0.75%) above that national average.

The logic behind the rule is clear -- and also debatable. Banks with less than perfect financial health will be barred from offering interest rates that are so generous that they might further jeopardize that health. On the other hand, those banks will be forced to be less competitive in the marketplace, thus hampering their ability to attract and retain depositors. This kind of restriction could actually hasten the downward slide of banks with weakened financial conditions.

Whether or not banks suffer from this unintended consequence remains to be seen. For depositors though, the rule would seem to give yet another reason to shop around for bank rates. Not only will the highest rates be most rewarding financially, but they should also be a sign that the bank offering them is not considered by the FDIC to have shaky capitalization.

The so-called "G20" nations will meet today and tomorrow in Pittsburgh. One particularly prominent issue is what to do about banks that are "too big to fail."

If you have CDs, savings accounts, or money market accounts, the G20 meeting may actually amount to something more than bland platitudes this year.

Big Banks Backed by Government No Matter What

The repeated and massive bank bailouts of the past year and a half have given rise to a belief that big banks will be bailed out by their respective governments no matter what.

In a classic case of perception becoming reality, this is now true--or at least enough big bank customers think it's true that it may as well be true.

Possible Solution: Extra Insurance for Big Banks

One idea that is being floated, and is especially favored by European central bankers, is that big banks that pose a "systemic risk" should be charged an extra insurance fee.

That this idea is popular is clear. German Chancellor Angela Merkel went so far as to pledge that banks must not be permitted to "blackmail states again."

What is less clear is to whom this extra insurance would be paid. To the individual governments themselves, or to some sort of global consortium? Also, how high should such insurance be priced?

Why should holders of CDs, savings accounts, and money market accounts care how all this shakes out?

Because another increase in bank costs may well be passed on to bank customers, for example through lower interest rates paid on CDs.

It's highly doubtful that big banks would just eat the costs.

Last week, the FDIC went out of its way to clarify its accounting policies, to show that the draw down of its deposit insurance fund was not as severe as it seems. This week, they are rather publicly weighing options for giving that fund an emergency shot in the arm.

So which is it -- is the fund healthy or not?

The answer to that question will help determine whether depositors finally get a break, in the form of higher savings account interest rates, CD rates, etc.

One option for replenishing the FDIC insurance fund is another special levy on banks. This is a cost that many banks will have to pass along to their depositors, which will put more downward pressure on bank rates. This doesn't see fair, when the root of the banking problem is borrowers not depositors. Moreover, it could be burdensome to banks which are on the border of shaky health, which would be counter-productive.

Supposedly, the option of the FDIC getting more funding directly from the government is politically unpalatable, because it would represent a bailout that would put yet another burden on taxpayers. Taxpayer frustration is understandable, but having the burden fall instead more narrowly on the backs of depositors is even less equitable.

Bank deposit customers should consider making their opinions on this known to their elected representatives. If a taxpayer bailout is politically unpalatable, it should be made clear that having depositors continue to bail out bad lenders and borrowers is also unacceptable.

There is a lot of talk in the financial press these days about "cash on the sidelines." Usually, cash on the sidelines is mentioned as a reason why stocks will continue to rise as more buyers enter the market.

But what if a lot of that cash goes into CDs? It's very possible.

Cash on the Sidelines Less Safe Today Than It Was Yesterday

Cash on the sidelines mostly refers to money being held in money market mutual funds. Nearly $3.5 trillion is stored in MMMFs as of today. But that figure declined by $62.6 billion in the last week.

Not coincidentally, the U.S. government ended its guarantee of money market mutual funds last week, on September 18.

In short, money market funds are not as safe as they used to be.

CDs Just as Safe as They Were Yesterday

The average money market mutual fund is yielding 0.06 percent right now. Investors in money market funds--which are NOT THE SAME as money market accounts--are obviously pursuing a low-risk strategy.

With the government pulling the insurance policy on money market funds, moving that cash on the sidelines into CDs may look appealing to the risk-averse investor. For instance, someone approaching retirement savings who wants to protect their retirement savings.

For such a person, the $250,000 per depositor per institution FDIC insurance on CDs is a great selling point.