CD Rates May Not Be Honored in Bank Failure
If you wanted to close your certificate of deposit early, you'd pay a penalty. Unless your CD were callable, your bank can't close it early with one exception. Fortunately, it's an exception all banks loathe.
We learned that Certificates of Deposit aren't risk-free, they are susceptible to inflation risk. Fortunately, they aren't at risk when a bank fails either. However, should a bank fail, the acquiring bank may not be required to honor existing CD rate agreements.
There are two possible scenarios when a bank "fails:"
- The failing bank actually fails, is received by the FDIC, and subsequently sold to an acquiring bank. In this scenario, the acquiring bank is not required to honor the CD agreements of the failed bank. They can choose to honor them but they are not legally obligated to.
- The failing bank doesn't actually fail, the FDIC simply helped broker its sale to an acquiring bank. In this scenario, the mainstream media may report a bank as having failed when it fact is hasn't. The FDIC did step in and assisted with the transition but never took it over. In this scenario, it's as if the acquiring bank bought the failing bank, perhaps with a loan from the FDIC (or protection against losses). In this case, the acquiring bank is required to honor the CD agreements of the failed bank.
While the fear of major banks failing has, for the most part, passed us; it's important to understand this distinction (though 32 banks have already failed in 2009, vs. 25 in 2008). One of the telltale signs a bank is in dire straits is when their CD rates are abnormally high relative to their peers. Washington Mutual had an absurd 5% APY CD when other major banks were in the 3-4% range. In that case, JP Morgan honored the 5% APY CDs even though they weren't required to.
Jim writes at the personal finance blog Bargaineering.
(Photo: spinadelic)
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Comments:
@Megladon: Yeah, it's not clear at all. Maybe it means if a bank fails and is forced to close out all CDs.
The only other situation I can imagine is if a bank decides to give you the full amount of your CD (plus all interest) ahead of time instead of waiting until the maturity date. This doesn't really make sense for them to ever do this, unless maybe if there's a period of severe deflation going on.
Well, GMAC Bank does have a 2.8% APY CD going right now, which is the highest I've seen. I wouldn't say "abnormally" high, but nonetheless...
@Gene Gemperline: Compared to all the other rates I have seen recently that is definitely abnormally high.
My CD is going to mature soon and I am shocked how far rates have fallen in the last year.
One other thing I'm curious about... if the bank is sold and the acquiring bank does not want to honor your CD rate, do you get all your money as of that moment? Or are you forced to spend the remaining time at the lower rate of interest? (I'm guessing the first option.)
Either way, CDs are a bad investment now imo. Rates are laughably low, and some experts are concerned about upcoming inflation.
But what's the right place to invest instead? Don't ask me...
Banks that accept the "shotgun" purchase of another bank through FDIC do not have to honor the CD's either. The FDIC has let them break their CD contracts this past year with CD holders and I'm surprised it's not more common.
If they choose to not honor the rate you are given an opportunity to cash out penalty free.
I got a 4% 8 month CD with WAMU last fall just before they were taken over. I was hesitant to go for longer because of a lack of certainty as to where the econoclusterfucktastrophe was headed I didn't want to lock up $ for too long. It'll be a long time before we see 3% for even a 1 year CD again, currently for 1 year the best you can get(per bankrate.com) is 2.29%.
Holy fear mongering. The "fear of major banks failing" has not only passed us, it never existed. Who cares if a bank fails, the FDIC will just sell it off to someone else. The only people who acted hysterical over it were the same ones who pointlessly lined up at IndyMac when they could have transferred their money out without a problem over the phone.
Which is exactly why you should be investing in any bank with FDIC insurance, even if they have a unbeleivably large rate. If the bank that takes over doesn't honor the rate than you can simply go elsewhere, the money isn't locked in.
WHATEVER you do with regard to CD's, be careful about investing more than $100K in any one Bank, as that is the FDIC limit after 12/09 (the newly expanded $250K coverage expires then). When INDYMAC failed, 50% of all money above $100K invested in CD's just DISAPPEARED, as FDIC did not cover it and did not address the issue when they sold INDYMAC assets. This will become BIG NEWS soon as lawsuits are initiated.
I jumped on a 16 month 4% cd when consumerist warned me that rates were about to drop. YAY!
This happened to me. New Frontier Bank in Colorado was shut down by the FDIC after they had been repeatedly warned to boost their reserves. No other bank was interested in taking over the bank. You had 30 days to come get your savings and checking and re-arrange direct deposit
Even though our CD had more than a year to run, it was closed out and a check sent to us. The check included interest up to the date of the bank being shut down at the rate the CD promised.
@PopulistOutrage: See my comments below about New Frontier Bank in Colorado. It was shut down by the FDIC and no other bank took it over. If you had invested in the bank itself that investment is worth zero now.
Of course, this was not a major bank with as it had only three branches.
GMAC rates are high because they need BILLIONS in capital. There are some others in the same territory though, so they have good company. I opened a regular savings account since they are at 2.2 while my favorite ING is only at 1.5.
@cyberguy:
There is a small local bank that is pinching depositors from the "big guys". The strategy seems to be to open a NICE building within a 1 mile radius of $1 billion in deposits. Profitable because they don't do "get rich" schemes the others have done. But, I did notice they offer accounts at 1/2 of prime if you have atleast $25k. The rate increases as you have more money and what caught my eye is they have higher rates for 100k or 250k points...both of which would be INSANELY STUPID to have with this bank...even though they are profitable.
@cyberguy: 12/31. We've got to hope that they continue to keep the limit at $250,000 beyond that timeframe though. The $100,000 cap was put in place in 19freakin80, when it was worth a lot more, and hasn't been raised since.
Can't RELY on them extending it, messy situation with penalties to withdraw if they don't, so makes NO SENSE AT ALL to exceed the historical $100K!
Providing that FDIC has enough money to cover the debts of falling banks, that's ok.
During an economic boom, banks might pressure the government to reduce the money allocated to the fund and then, when a recession hits, you suddenly don't have adequate protection.
OK, but what does it mean to not honor an existing CD? Is your money just gone? Does the acquiring bank get to decide your rate is retroactively .01% and the term is 20 years? Or does it get to close your CD and charge you penalties? Any of the above?
I took advantage of Washington Mutual's 5%. I was surprised that Chase has honored that rate!
"your bank can't close it early with one exception. Fortunately, it's an exception all banks loathe"
Did i miss something, whats the 1 exception?