Hitting the roof: Debt ceiling stalemate puts savings accounts at risk
July 19, 2011
Economists warn that interest rates will soar if the stalemate over the federal budget results in a default on Treasury bonds. So why have interest rates declined as the deadline has approached?
Maybe the financial markets have faith that the country's political leaders will stop playing chicken with the global economy, and will find a responsible solution. A more realistic explanation might be that falling interest rates represent investors going into duck-and-cover mode.
Interest rates hang in the balance
A default by the U.S. government, or even an impaired ability to pay its debts, would theoretically lead to higher interest rates because lenders would demand more reward for investing in bonds, since receiving interest and principal payments on those bonds would no longer be viewed as a sure thing. Anyone who has ever had credit problems can understand that - the shakier your history of paying your debts, the higher your credit card rate will go.
U.S. Treasury bonds are, effectively, the government's credit card. That's how the government routinely borrows the money it needs to operate. Curiously, though, as the risk of default has mounted, Treasury bond rates have fallen, not risen.
The reason is that when faced with uncertainty, investors instinctively reach for conservative investments, such as Treasury bonds. In the short-run, this may have increased demand for those bonds, causing rates to fall. However, if default forces investors to realize that Treasury bonds are no longer low-risk investments, interest rates could quickly spike upward.
No-win situation for savings accounts
If you think that higher CD, savings, and money market rates could be the silver lining to the budget stalemate, think again. Yes, if the government defaults, it is possible that CD, savings, and money market rates could rise. However, the federal insurance that backs those accounts would no longer be such a sure thing if the government defaults.
So, the possible outcomes seem to be that either budget cuts will slow the economy and depress interest rates, or a budget crisis will make savings accounts riskier. In short, a no-win situation for savings accounts.