April 16, 2009
Thursday

The government's extraordinary efforts to bring down interest rates to help banks and borrowers have been murder on savers.

Over the past year, yields on safe havens such as Treasury bills, certificates of deposit and money-market funds have fallen even more steeply than mortgage rates.

The average yield on taxable money-market funds has fallen to just 0.23 percent from 2.22 percent a year ago, according to iMoneyNet.

The average yield on a one-year CD has fallen to 1.35 percent from 1.94 percent over the past year, but it was as high as 2.73 percent in October, according to Bankrate.com.

Meanwhile, the government's insurance programs for bank deposits and money-market funds keep changing, making it hard to make longer-term commitments.

The drop in rates hurts all savers, but falls hardest on retirees such as 79-year-old Howard Shirley, who lives in San Francisco on an airline pension, Social Security and interest from bank CDs.

He usually buys one-year CDs with staggered maturities, so that one comes due every three or four months. About two years ago, he also bought a 13-year CD that paid 6 percent, which was higher than the going rate but could be "called" or redeemed by the bank before maturity.

A month ago, the bank called the CD and he was forced to replace it with one paying 2 percent. He's getting roughly the same rate on his other CDs as they mature. As a result, his CD income will drop to about $10,000 this year from around $24,000 the past couple years.

For Shirley, that will mean fewer meals out. But for his friends who don't have a pension, the rate cut will mean more severe cutbacks.

"Retirees who depend on fixed-income securities are taking drastic cuts in their income. This needs to be considered in Obama's recovery package," Shirley says.

Greg McBride, senior financial analyst with Bankrate.com, puts it bluntly: "Savers are subsidizing borrowers," he says.

If there's a silver lining, it's that inflation is falling even faster than savings rates.

"Last summer, you could earn 5 to 5.5 percent on CDs and savings accounts, but inflation was running at a 5.5 percent pace," on a year-over-year basis, McBride says.

Today, if you shop around, you can find a one-year CD yielding 2.5 percent, but inflation "is running at almost a zero pace," McBride says.

In that respect, "you are better off now than last summer," he adds.

What often happens when savings rates plummet is that many people start taking on additional risk to obtain higher yields.

McBride says people should resist that temptation with money they can't afford to lose.

"Make sure that whatever money you have in a bank or credit union is covered by deposit insurance," he says.

Last year, the government temporarily raised the basic deposit insurance limit at banks and credit unions to $250,000 for nonretirement accounts. This applies to institutions that are members of the Federal Deposit Insurance Corp. and National Credit Union Association.

On Dec. 31, the basic limit will fall back to $100,000 for nonretirement accounts (but remain at $250,000 for retirement accounts) unless Congress extends it.

The U.S. House has approved a bill that would permanently increase the limit on nonretirement accounts to $250,000. The Senate is working on a similar bill.

For now, savers with more than $100,000 in nonretirement accounts at a single institution should be cautious when buying CDs that mature after Dec. 31.

The future of insurance for money-market funds is even more uncertain. Last year, the government agreed to temporarily insure all assets that were in money-market mutual funds as of Sept. 18, 2008.

That insurance was supposed to expire April 30, but last week, the government extended it through Sept. 18. The insurance does not cover money that was contributed after Sept. 18, 2008.

It's hard to say what, if anything, will replace this insurance when it expires.

Mercer Bullard, an investor advocate who heads Fund Democracy, says the mutual fund industry does not want to continue the insurance program because it will lead to more government regulation.

An industry group has endorsed a plan that would require money funds to invest in a way that would make them better able to meet a sudden flood of redemption requests without jeopardizing their stable share price. This would include investing some assets in shorter-term, higher-quality securities. In an emergency, a fund also could halt payouts to investors for up to five days.

Bullard opposes these changes. He says the portfolio adjustments will reduce yields and while a redemption halt could save an individual fund, it could spark a run on other money-market funds by spooked investors. He prefers that money funds continue to participate in an insurance program.

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