Personal Finance Blog By MoneyRates - September 2009

Senator Christopher Dodd is reportedly planning on introducing legislation to curb high bank overdraft charges. These charges have been on the rise lately, as banks look for various ways of shoring up profitability. Certainly, overdraft charges can seem excessive, but is legislating against them really the right solution?

According to research firm Moebs Services, the average overdraft fee has increased from $25 to $26 this year, but these fees are even higher among major Wall Street banks. Banks with over $50 billion in assets charge an average of $35 for overdraft fees. These fees have become a significant source of income for the banking industry, with total revenue from overdraft fees projected to exceed $38.5 billion this year. For 44.5% of banks, overdraft fee revenue actually exceeds their net income.

One way to look at these fees is that they are like extremely high interest on a loan. However, there is a genuine cost to banks when customers overdraft their accounts. Without a means to recoup those costs -- and just as important, without the ability for banks to create a meaningful disincentive for customers to overdraft their accounts -- overdrafts could further weaken the financial soundness of the banking industry.

Besides, it's not as though bank customers don't have choices. First of all, they can avoid overdrafting their accounts. Second, they can opt out of overdraft protection -- the vast majority of banks allow customers that choice. Finally, if customers don't like a bank's fee policy, they can always use money-rates.com to start shopping for another bank.

If banks are forced to eat the expense of overdrafts, they will make up the costs elsewhere, such as by offering lower savings account interest rates or CD rates. Overdraft fees may seem overly punitive, but legislating them could end up punishing the wrong customers.

In September of 2008, a $62.5 billion money market fund operated by the late Lehman Brothers "broke the buck," meaning that the net asset value (NAV) of the fund dropped below the value of the investor contributions.

That is not ever supposed to happen, and when it did, the Great Panic of 2008 was officially underway.

Government Safety Net for Money Market Funds

Fearful that a run on money market funds which then totaled approximately $3.5 trillion would spell the utter and complete destruction of the financial system as we knew it, the government moved to protect money market funds with a guarantee that investors would at least get their money back no matter what.

On September 18, 2009, that safety net will be pulled.

Money Market Accounts NOT THE SAME as Money Market Funds

Even experienced financial folks sometimes get confused between money market accounts and money market funds, so the general public can be forgiven for fearing that September 18 will live in infamy as the day money market accounts tanked because the government took away the guarantee.

However, these fears are highly unfounded. Money market accounts, just like savings accounts and checking accounts, are protected by the FDIC up to $250,000 per depositor per institution.

Money market accounts are basically savings accounts. Money market funds, by contrast, are investments in securities. Those are two totally different risk scenarios.

September 18, 2009 will be just another day for depositors to money market accounts.

Nothing to see here.

It has been widely reported that the FDIC's deposit insurance fund has been rapidly declining, raising concerns that it might require special funding soon to support the growing number of banks classified as troubled. In response, the FDIC has publicly clarified its accounting to show that the fund is not actually declining nearly as rapidly as thought.

The key issue: the FDIC is setting aside a portion of its fund as a reserve contingency to handle troubled banks. As this reserve has grown larger, the figure the FDIC reports as remaining in the fund has declined. However, with troubled banks already somewhat accounted for by the reserve, this is not as big an issue as it had appeared. In fact, since the reserve has not yet been heavily drawn upon, the FDIC insurance fund actually grew in the second quarter of 2009, from $41.5 billion to $42.4 billion, when the reserve is included in the total figures.

The health of this FDIC insurance reserve is significant to depositors in two ways. Naturally, having that fund in healthy condition is a source of reassurance for all bank depositors. Each person likes to think his or her bank is healthy, but since potential problems tend to be buried deep inside a bank's accounting structure, it's always good to know the FDIC fund is there as a backstop.

The second significance of the health of the FDIC fund is that is could help savings account interest rates, along with money market rates and CD rates. When the fund is drawn down, the FDIC has to charge higher insurance premiums--and this tends to come out of the bank rates available to depositors. A healthier FDIC fund should mean less of a future burden for depositors to shoulder.

So, Ben Bernanke says that this brutal recession has "very likely ended." For Money-Rates readers who hold money in CDs or savings accounts, this silver lining may appear obscured by a dark cloud:

Worries over inflation. Already, CD rates are too slow to keep up with even a moderate rate of price growth.

However:

1. Foreign Goods Help Keep U.S. Prices Low

The assumption that as the economy improves, inflation will become a problem, discounts the global nature of the U.S. economy. Foreign goods, especially from China, are cheap enough to affect pricing power.

When you could only get toys from F.A.O. Schwartz, F.A.O. Schwartz could raise prices with impunity. Now, Walmart rules that out.

2. Conspicuous Consumption Is Idiotic

There will always be people who want to have the big, flashy car and the mansion that they can barely afford. But there are less of those people now, perhaps, than there have been in decades.

The price-sensitive mentality of the U.S. consumer, worried about unemployment and struggling under a heavy debt load, is another reason why inflation may have trouble getting off the ground.

3. Mortgage Rates Still Lower Than Low

What would you rather get, five percent on a CD or a five percent mortgage?

For most people, it is better to get a lower mortgage rate than to make more money on CDs. Low mortgage rates give smart savers the opportunity to build a sustainable cost structure for years to come.

A low mortgage payment makes retirement planning much easier.

Where are bank rates going next? Whether you've been shopping for money market rates, savings account rates, or CD rates, you've probably been shaking your head over how low bank rates are in general. The question is, can they go any lower?

The next clue may come this Wednesday, with the release of August's Consumer Price Index (CPI) number.

One of the reasons why bank rates have been able to fall so low has been the low inflation--or actually, the deflationary--environment. The deflationary trend may start to get harder to sustain. Inflation increased at a pretty strong clip during the first seven months of 2008--seasonally adjusted, it was on track for an annual gain of 5.8%. That means that inflation only had to increase at a slower rate for the first seven months of 2009 for the year-over-year inflation numbers to start declining. That's exactly what happened, as seasonally-adjusted inflation grew at an annualized rate of 2.4% in the first seven months of 2009.

The year-to-year comparisons get trickier over the rest of this year, however. During the last five months of 2008, the seasonally-adjusted CPI actually declined at an annualized rate of 7.7%. That's an unusually strong deflationary trend. If the CPI doesn't repeat that this year--which is unlikely, given how much lower oil prices are at this point this year, and the fact that the economy is starting to look healthier--you'll start to see year-over-year inflation numbers go up. It seems likely, therefore, that the deflationary trend is about to reverse.

As for the effect on bank rates, this should start to push them upward. If not, depositors will really be in a squeeze, between low rates and rising prices.