Thursday, September 9, 2010

Interest Rates for Short-Term Savings -- Money Market Mutual Funds and Bank Accounts

The current low rates of interest are painful for those with cash to invest, and particularly painful for those living off their investments in retirement.

The interest rates obtainable in money market mutual funds is currently pathetic. For example, the year-to-date rate as of September 9 of Vanguard's Prime Money Market fund is 0.04%. Though there has been an outflow, inertia has served to keep many individual invested in the money market funds. Banks, though, are offering much higher, though historically low, rates on various types of savings accounts and CDs. A quick Google search will provide links to online banks offering around 1.3% interest for savings accounts with a transaction limit of six withdrawals per month. Also, the bank accounts are safer than the money market mutual funds, because they benefit from FDIC insurance. The federal government's insurance for money market mutual funds, which was provided for existing accounts during the 2008 crisis was quietly ended.

This rate disparity is reminiscent of the late 70s and 80s, when "disintermediation" was the word bankers hated to hear. The popularity of  money market mutual funds began in the 1970s -- a period during which banks and savings and loans were restricted in the rate of interest they could pay by Regulation Q. These funds essentially helped save the mutual fund industry during a period when individuals were not interested in investing in the stock market. Money flowed out of banks and into money market mutual funds in a period of high and increasing interest rates.

Now, the reverse seems to be happening in this new, low interest rate environment. Banks are providing higher rates than the competition, and, if this persists, money market funds will shrink much more than they already have. Individuals will find the bank CDs and savings accounts attractive, especially since this is now a period where one does not fear looking stupid in avoiding the stock market. For individuals, the bank accounts also look good since these government-backed accounts provide higher rates than Treasury bills. One-year T-bill rates are currently 0.24%, and shorter-term bills have lower rates.

Of course how long banks will be able to offer higher rates depends on their ability to invest this money, such as in new loans, at a profit. Part of what is going on is that some banks are trying to obtain funding that will be cheap over the long term, if not currently, since demand deposits and savings accounts are sticky once established. But if the flow into bank accounts pick up to an extent that the banks cannot profitably use the money, the relative attractiveness of the rates they offer will have to diminish.  

There does not seem to be much written about the macroeconomic effects of this.  I suspect that analysts looking at this are not sure what to make of it, just as economists, in general, are at sea about the likely course of the economy.

Deflation or inflation?  Recession, depression, or slow recovery?  The elaborate economic models of some forecasters are not of much guidance since no one has experienced the current mix of economic factors. Government policymakers cannot rely on models, and  policy will be the result of a combination of judgement and politics. Currently, politics appears to be clouding judgement.

1 comment:

  1. The lower returns on money market mutual funds may partially be explained by SEC regs that took effect recently to make the funds safer. Changes include dropping the average maturity from 90 days to 60 days; 10% of the securities have to mature every day, 30% within 7 days; a lower limit of tier-2 securities; and other technical changes.