Hidden Losses: Decline in Purchasing Power of US Bank Deposits May Have Topped $140 Billion

In the official version of how the financial crisis was handled, US bank deposits were kept safe from major losses by government interventions. A combination of FDIC insurance for depositors, bailouts to keep several prominent banks from insolvency, and large-scale government supports for the credit markets prevented a meltdown that would have cost Americans billions.

It may indeed be true that these policies averted a deeper crisis. What's often forgotten, though, is that these interventions came at a steep price to depositors that may have cost them billions anyway--possibly over $140 billion during the past year. That's how much purchasing power was lost as a result of federal policies that have kept bank account interest rates artificially low, even while inflation has made a comeback.

Losing $140 Billion: The Story By Numbers

A MoneyRates.com analysis puts the loss in purchasing power of US bank deposits at an estimated $140.4 billion this past year. Where did this number come from? It's impossible to calculate this loss precisely, of course, but the following is a reasonable basis for estimating its magnitude:

• According to the FDIC, total deposits in US banks nearly a year ago (June 2009) stood at roughly $7.56 trillion.
• Also using FDIC figures, an annual interest rate of 0.40% was used as an approximation of national average money market account rates over the past year. Of course, not all deposits are in money market accounts, but this does represent a compromise estimate between savings account rates (which are typically lower than that of money market accounts) and CD rates (which are typically higher). Moreover, many of the nation's deposits can be assumed to be in non-interest-bearing checking accounts.
• According to the Bureau of Labor Statistics, the Consumer Price Index gained 2.3% for the 12 months ending March 2010.
• Adjusting the representative 0.40% bank rate for inflation yields a negative return in purchasing power terms: a decline of 1.86%.
• Applying that decline of 1.86% to the total deposit value of $7.56 trillion yields a loss in purchasing power of about $140.4 billion over the course of a year.

With macroeconomic numbers, it's easy to lose sight of what hundreds of millions or billions of dollars really mean. If you take the $140.4 billion loss and spread it evenly across all American households, it comes out to a purchasing power loss of more than $1,100 per US household in a single year.

Policy Implications

In normal economic times, bank rates manage to keep up with or ahead of inflation. But keeping interest rates low has been a central part of government policy over the past year. Low interest rates can stimulate the economy, and in this instance they have the added benefit of helping bank profit margins. Banks can pay very little to take in deposits and then lend those deposits out or invest them at higher rates of return.

That's all well and good, unless you are one of those depositors who is effectively paying more than your share for this economic recovery.

Do these hidden losses imply that the decisions that were made in the financial crisis--and the government policies that have been followed since then--were wrong? Not necessarily. It can be argued that letting inflation eat into the savings of bank customers is the least of all the evils circling the economy. It can also be argued that those same depositors would have suffered far greater losses if the entire system had failed.

Fair enough, but politicians, policymakers, and voters all make better choices when the true cost of their decisions is known. Keeping interest rates low is often represented as a cost-free policy, but the truth is that it may well have collectively cost bank depositors over $140 billion in the past year. While the Federal Reserve seems hesitant to raise interest rates because the stock market trembles at the mere mention of the idea, the Fed should also remember that keeping rates low has consequences as well.

As for your personal financial policies, you should make shopping actively for bank rates a point of emphasis, in order to slow the rate at which inflation is eating into the purchasing power of your deposits.