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Investors' search for safety yields hazards

February 21, 2009|TOM PETRUNO

Until last year, many Americans may have figured they had a good idea of what constituted a truly risky investment or financial strategy.

Then came the collapse of housing prices, the hemorrhaging of the global banking system and the worst stock market crash since the 1930s.

We thought we knew something about risk. We didn't know nearly enough.

We thought we knew the difference between investing and speculating. Now, every money decision just feels like a spin of the roulette wheel.

Case in point: On the other end of my phone line one day this week was a 95-year-old Times reader from West L.A.

In December, he bought a one-year, federally insured certificate of deposit from Alliance Bank of Culver City. Its yield: 4%.

That was supposed to be a risk-free return -- perfect for a nonagenarian who just wanted to preserve his capital and earn a little income, and who certainly wasn't going to put that cash into the miserable stock market.

But when Alliance failed this month, its CD customers got a shock: California Bank & Trust of San Diego, which acquired Alliance in a deal with the Federal Deposit Insurance Corp., refused to honor the failed bank's CD terms.

The new owner sent letters to Alliance customers telling them that the annualized yields on their CDs would be reduced to just 1.4%.

If depositors didn't like the new terms, they were free to cash out -- with interest earned to date and without an early-withdrawal penalty, the letter said.

The condensed story of Alliance, which had nearly $1 billion in deposits, is that it had been paying CD yields well above the national averages, trying to attract clients and stay afloat. Under FDIC rules, when a failed bank is sold, the acquiring bank isn't obligated to stick with the failed institution's deposit rates.

That fact may not be well known to bank customers. Acquiring banks often have agreed to make good on the acquired bank's CD terms. That's what JPMorgan Chase & Co. did with deposits of failed Washington Mutual last year, for instance.

But Steven Borg, a senior vice president at California Bank & Trust, told me that his bank wasn't interested in the kind of hot, speculative money Alliance attracted to its CDs.

My 95-year-old reader, who asked that his name not be used, conceded that he always looked around for the highest deposit yields he could find. So do many other Americans. Federal deposit insurance is the same at every bank, so high-yielding CDs were the last free lunch out there.

"I didn't consider myself a speculator," the reader told me.

Ah, but he was speculating -- on Alliance's ability to survive, or on a successor bank honoring those above-average CD yields. Now he'll get his money back, but with savings rates overall sharply lower than in December, he won't find another one-year CD at a 4% yield. The income he had counted on won't be coming in.

And with bank failures rising as the economy sinks, he'll have to think twice about hunting for the most lucrative yields or risk landing with another bank that may not have long to live.

In the grand scheme of things, this is far from a financial catastrophe of the sort that millions of Americans have endured over the last year. But it demonstrates how the investment landscape continues to be upended -- in this case, for people who thought they were at the most conservative end of the risk-taking spectrum.

That group also would appear to include the investors who pumped billions of dollars in savings into an offshore bank run by R. Allen Stanford of Houston-based Stanford Group Co.

The Stanford International Bank of Antigua sold investors so-called certificates of deposit, promising to invest the proceeds in liquid financial instruments. But the Securities and Exchange Commission sued Stanford this week, claiming the business amounted to an $8-billion fraud.

Allen Stanford actually invested much of the CD proceeds in high-risk ventures, including private-equity deals and real estate, the SEC alleged. Where the money went, and how much will be returned to now-panicked investors, will be the subjects of many news stories to come.

It's hard to feel pity for Stanford's investors, who knew their "CDs" weren't FDIC-insured. But like my 95-year-old reader, many of Stanford's clients must genuinely have believed that they were investing conservatively, not speculating.

Ditto for the investors who trusted Bernie Madoff, the man behind the alleged $50-billion Ponzi scheme the SEC busted in December. And for people who have stuck with now-devastated blue-chip stocks like Citigroup, General Motors and General Electric.

You may feel that all of these folks are getting exactly what they deserved. Fools and their money, as the line goes.

The problem, for the rest of us, is that the thing the economy, the financial system and the stock market need most today is confidence.

How do we get that back if every financial decision comes to feel like little more than a bet at a Vegas table game -- only with worse odds?


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