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Savers bound to feel fallout from a Fed cut

Action on rates would lower deposit yields. Lock in long-term CDs now, experts advise.

September 03, 2007|Tom Petruno | Times Staff Writer

People with money in the bank may soon help foot the bill to stabilize Wall Street.

Many investment pros are betting that the Federal Reserve will cut its benchmark short-term interest rate this month to ease the credit crunch that has bedeviled financial markets.

If that happens, rates on bank savings accounts and certificates of deposit also could see their first significant fall in more than three years.

Historically, banks and savings institutions haven't wasted much time in paring deposit rates once the Fed trims its key rate, said Ray Montague, manager of deposit customer services for Calabasas-based Informa Research Services Inc., which tracks savings rates.

"Banks usually are really fast to cut rates and slow to raise," he said.

Some experts are advising people to lock in longer-term certificates of deposit soon, at least with a portion of their savings, in case rates begin to slide.

"Locking in a CD is particularly attractive now," said Greg McBride, senior analyst at in North Palm Beach, Fla. "The yields haven't yet reflected the idea of a Fed rate cut."

There's a lot at stake. Savers have more than $5 trillion in bank savings accounts and CDs nationwide, up from $2.7 trillion at the start of the decade. Many older Americans, in particular, live partly off the interest they earn on bank deposits.

Those deposits have risen faster than assets in stock mutual funds since 1999, which may demonstrate that many Americans have been relatively conservative with their nest eggs.

Savers suffered from 2001 to mid-2003 as the Fed slashed its benchmark rate, the so-called federal funds rate, from 6.5% to a generational low of 1%, in an effort to bolster the economy.

It was a great time for borrowers, but at savers' expense. The average annualized yield on one-year CDs nationwide was just slightly above 1% four years ago this month, according to Informa Research.

Beginning in mid-2004, the Fed began to tighten credit, but slowly. Policymakers raised their key rate by a quarter of a percentage point every six weeks or so, reaching 5.25% by June 2006. The Fed then went on hold.

Nationwide, the average yield on one-year CDs of at least $25,000 now is 4.17%, Informa Research says. That yield has mostly held steady for the last 12 months.

The Fed faces a difficult decision with interest rates, because policymakers aren't sure whether the summer turmoil in financial markets will have a lasting effect on the economy.

Since June, rising home loan delinquencies have caused investors to flee mortgage-backed bonds, fearing huge losses. That has fueled a general aversion to risk-taking that has caused many banks and investors to pull back from lending money -- sparking a credit crunch.

The stock market has been roiled as well. Major indexes are down 5% to 10% from their record highs of recent months.

By cutting its main short-term rate, the Fed could bolster the financial system and give banks more confidence to lend.

Given the level of fear in the marketplace, "banks are not going to do much lending without a reduction in their cost of funds," said Brian Bethune, an economist at Global Insight Inc. in Lexington, Mass.

For now, many economists expect the Fed to drop its key rate from 5.25% to 5% when policymakers meet Sept. 18 and that one or two additional quarter-point cuts are probable by year-end if the crunch doesn't show signs of abating quickly.

Any drop in the Fed's rate almost certainly would translate into lower rates on bank deposits. Interest yields on money market mutual funds, which invest in short-term corporate and government IOUs, also would be expected to decline.

Indeed, investors in money market funds that buy only government IOUs already have seen a sharp decline in their yields. That's because the credit crunch has caused some investors to rush into short-term U.S. Treasury securities as a haven. As demand has surged for those IOUs, the Treasury has had to pay less in interest to attract buyers.

The seven-day average annualized yield on government-only money market funds for individual investors slumped to 4.01% last week, down from 4.48% two weeks earlier, according to rate-tracker IMoneyNet Inc.

Still, it isn't certain that the Fed will cut rates at all, some analysts warn. And even if the central bank does act, the decline could just be temporary. If the economy picks up, the Fed could be raising rates in 2008.

Even so, McBride at said savers should consider shifting at least some of their cash in short-term accounts into longer-term CDs, such as one-year issues, on the chance that rates have peaked for the time being.

And with federal deposit insurance coverage the same at every bank -- up to $100,000 per account and $250,000 for individual retirement accounts -- analysts advise shopping for the highest yields available.

One of the highest-paying banks is Countrywide Bank, which is part of Calabasas-based Countrywide Financial Corp., the biggest mortgage lender.

The bank faced deposit outflows two weeks ago, after rumors swirled that the parent company could face bankruptcy.

To keep depositors on board, "we've been spending a lot of time educating people about FDIC insurance," said Pierre Habis, head of retail deposits at Countrywide Bank, referring to the Federal Deposit Insurance Corp.

The bank also has raised rates. In California, it's offering 5.75% on a one-year CD of at least $10,000, up from 5.50% two weeks ago.

Habis said the bank's efforts to halt outflows have worked. Countrywide Bank brought in more new customers last week than in any other week this year, he said.

Savers who are wary of banks that are focused on the mortgage business, despite deposit insurance protection, still should shop for above-average yields at other institutions, McBride and other analysts advise.


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