The BankDeals Blog posted an excellent article today regarding a letter sent from the American Bankers Association (ABA) to FDIC Chairmwoman Sheila Bair. The letter asks the FDIC to intervene to force Ally Bank (formerly GMAC) to lower the rates it offers on certificates of deposit and savings accounts. Why? Here are a few excerpts from the letter:

Recognizing that the Internet forces banks to compete in a national market for deposits, the FDIC recently issued a proposal to amend its rules by suggesting a bank, under restrictions for deposit growth, use a "national rate" when determing whether the bank is offerfing rates that significantly exceed the market rate. Notwithstanding the government's concen about banks using high-rates to solicit out-of-market deposits, GMAC/Ally Bank is apparantly is permitted to solicit deposits over the Internet by offering rates that are generally the highest in the nation.

The letter ends by asking the regulators to force Ally/GMAC to lower rates:

ABA believes it is completely innapropriate, and indeed risky, for GMAC/Ally Bank to be allowed by regulators to continue to pay rates well above the market. We urge you to apply the same princples that would apply to other banks in a comparable situation to GMAC/Ally.

The ABA's argument is that banks should not be allowed to collect deposits above a certain average "national rate." So what ever happened to bank competition? The statement above alludes to the FDIC's program to force impaired banks from collecting depoists at an excessive rate. But Ally bank is not part of that program, yet. The letter states that the Treasury added $13 billion in capital to the bank but much of this capital was actually used for GMAC Financing and is unrelated to the actual bank, which existed as a separate entity within the company's finance division.

Nor are high deposit rates a cause of failure. Banks fail because of a run on the bank, usually precipitated by loan losses. Or they can be closed by regulators due to capital ratios, non-performing assets, etc. Bank of America, Citi, etc. were not bailed out due to high cd and savings rates. Bad loans made by ABA companies have caused the financial crisis, not a bank that is offering depositors a good deal.

Nor should the high deposit rates offered by Ally be a source of its losses. Ally may not make as much money, but it should be able to make money. Because of the slope of the yield curve there has almost been a better time for banks to make money. They can borrow money from depositors at 2-3% and lend it out to consumers at 5-20%. I recently received a notice from Chase that my credit card rate was increasing to Prime rate plus 14.99%, which is currently 18.24%. I'm not alone.

If banks can't borrow at 3% and lend out at 18.24% and make money, they shouldn't be in business.

Savers have already been punished as banks have dropped savings and cd rates precipitiously over the last year. This occurred because of a financial crisis precipitated by these same banks. Now, they want savers to subsidize their recovery by both funding the TARP and by accepting artificially low rates while at the same increasing fees and the rates they charge on various credit products.

Let the FDIC know that you want competition in savings and cd rates. Send them an email at [email protected].

Money market funds that invest the bulk of their cash in treasury bills may provide a negative return to investors if the Fed cuts rates any further. Low Fed Funds Rates combined with a rush to own the safety and security of treasury bills have pushed the yield on T-bills down to 0%. Money market funds that invest in Treasury Bills therefore receive a 0% return, or a very low return from their investment. Once the expenses of running the money market are factored in, the actual return of the fund will be less than 0%.

A Bloomberg article on this says:

'Record-low yields on government debt have already led money-market funds to waive fees to keep returns positive. If the Federal Open Markets Committee, as expected, cuts its target rate, some Treasury funds may allow returns to turn negative, said Peter Crane, president of Crane Data LLC, a money-fund research firm in Westborough, Massachusetts.

“No one has ever paid above and beyond their interest income to be in a fund,” Crane said. “But if we see another cut, we’ll likely see negative yields."'

If returns turn negative, Crane believes that the funds will cover the shortfall by charging customers in the form of monthly fees. The end results would be a negative return for investors. This is different from a money market fund breaking the buck. When a fund breaks the buck, the value of its assets fall, wiping out some of the principal of the money market. That is what happened to the Reserve Primary Fund (RFIXX) when it lost considerable money due the bankruptcy of Lehman Bros.

Remember, this would only happen to money market fund that invest primarily in US Treasuries. The BestCashCow Money Market Fund Rate Table lists several funds that are far above 0%, the highest paying 2.57%. This is a far cry from September when the collapse of Lehman froze the money markets and drove yields up to the 4-5% range.

The question is how long will Treasuries stay below 0%. Even if the Fed drops the Fed Funds rate to 0%, some believe that Treasury yields will still rise. Bill Gross, manager of the world's biggest bond fund had this to say on Bloomberg TV:

"“Treasuries have some bubble characteristics, certainly the Treasury bill does. A Treasury bill at zero percent is overvalued. Who could argue with that in terms of the return relative to the risk? There is no return.”

After bank deposit accounts and treasuries, money market funds are considered the safest and most liquid places to store money. Despite being safer than money market funds, bank savings and money market accounts pay far more interest. For example the top savings account on the BestCashCow rate table pays 4.00% APY why the top money market fund pays 2.57%.

Money market funds, which are not FDIC insured should be not confused with money market accounts, which are.

Many Massachusetts savings banks have additional insurance for deposit amounts above $100,000 from the Depositors Insurance Fund (DIF). All deposits held in member banks above $100,000 are insured in full by DIF. The location of the depositor or the branch does not impact the coverage. Thus, a resident of California that wants to open an account at a DIF member bank in Massachusetts is fully covered. Out-of-state branches of a participating Massachusetts bank are also covered.

DIF not a government program but instead a privately funded program to protect the soundness of Massachusetts banks. The DIF website states:

"The DIF has over $300 million in assets, plus an additional $100 million of reinsurance. During the recession of the early 1990s, the worst financial period in the history of the Massachusetts savings bank industry, the DIF paid out more than $50 million to protect over 6,500 depositors in 19 failed member banks. Yet the DIF emerged from this period financially stronger than before the recession began."

DIF reviews the financial statements of its member banks on a quarterly basis to ensure their soundness and is "examined annually by the Massachusetts Division of Banks and audited by an independent auditor."

A list of DIF banks is here.