More than 100 banks have failed this year, and even the government acknowledges that many more will probably fold before 2009 draws to a close. In most cases, ordinary citizens who have accounts are protected by FDIC insurance. Yes, there's certainly a hassle involved, especially if you have bills set up on auto-payment with the failed bank, but the FDIC guarantees that they'll make good on your money up to $250,000.
Unfortunately, this guarantee doesn't extend to the interest rates on long-term savings vehicles like certificates of deposit. As this article reports, a growing number of people are losing the high interest rates on their CDs when a bank with which they have money invested folds.
Even well into the recession, some banks were offering healthy returns of up to 4 and 5 percent on CDs. As it turns out, many of these were doing so in a desperate, last-ditch bid to drum up cash before their bad investments and debts overtook them. Many customers, however, welcomed the high CD rates, viewing them as a safer bet than the risky stock market that would still give them a decent return on their investment over time.
Now, though, many are finding that their investments are running into trouble. Here's why: When a bank fails, the FDIC takes it over and sells off the "healthy" parts - that is, customers' actual accounts and investments - to another bank. But to get them to do that, they often have to sweeten the deal. One way they do this is by letting the new banks change the rates customers get paid for their investments. And by "change," we mean "lower."
The article (link above) gives one example of a woman who had been promised a 5.7 percent rate on a five-year CD. When her bank went belly-up, the new bank that took over the accounts sent her a letter informing her it was dropping that rate to 1.6 percent. This is a situation that could potentially impact millions of Americans, since we have altogether a whopping $2.6 trillion invested in theoretically fixed-rate CDs.
The switcheroo is infuriating, but legal, which means there isn't anything bank customers can do about it. When it takes over a failed bank, the FDIC is effectively acting as a bankruptcy judge. This means they have the power to cut what creditors (that would be the customers in this case) are owed. The rate-cutting is a big cost savings for the acquiring bank; the article quotes one expert who says a bank could save up to $10 million by cutting your rates after it takes over your bank.
So what can you do to avoid this situation? First, split up your savings; don't put all of it into one account and don't put it all with one bank. Secondly, remember that old bit of advice: If a rate being offered seems too good to be true, it just might be.
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