Banking, Personal Finance 

Remember Certificates of Deposit During Fed Rate Cuts

If you think interest rates are falling, put some of your savings into a CD. Since last August (2007), the Federal Reserve, haunted by the spectre of a slowing economy, had been hacking and slashing the Federal Funds and Discount rates. During that run, and until just recently, the prevailing attitude on Wall Street was that the Fed was going to continue cutting the rate until the threat of future inflation balanced out the threat of a recession. With this last twenty five basis point cut at the end of April, the prevailing attitude changed. Analysts now believe the Fed will stand pat and potentially even raise rates in the future.

During those rate cuts, all of the high interest online banks dropped their savings account interest rates dramatically. Since January of this year, the interest rate on E*Trade’s online savings account fell from 4.95% to 3.01% (only to increase, just recently, to 3.15%). ING Direct account holders saw their rates fall from 4.10% to their current rate of 3.00%. If you were able to purchase a CD at the prevailing higher yield online savings account rates for even a year, you’d be sitting pretty on those funds right now and that’s why CDs become popular during a falling interest rate environment.

This is where you say: “Jim, I’m not an idiot, I know that if the rates are going lower then I want to lock in good rates.” Yes, you are not an idiot but the point is I didn’t lock in any funds in CDs, except for my laddered emergency fund, because I didn’t recognize that I should have (or at least should have considered it). It wasn’t an error of judgment but one of ignorance.

Everyone knew rates were going to be cut but not everyone realized they should’ve considered putting a little bit away in certificates of deposit. (I can confidently say that because I know I didn’t) So, the next time you think rates are going to stagnate or fall, lock a little away in CDs.

 Personal Finance 

All About Rates: Fed Rate, Prime Rate, LIBOR and COFI

The Fed did what everyone expected this past week, cutting the federal funds rate by 75 basis points to 2.25%, a little less than what the market wanted (they wanted a full 100 basis point cut down to 2%). The federal funds rate has gotten a lot of press lately and many people have started to understand how the Fed Rate personally affects them. Some have been confused between the federal funds rate and the federal discount rate, which I tried to explain in the past, and wanted to learn why the fed rate affected the stock market, but overall I think it’s relatively well understood. The other popular rates that aren’t as well understood are the Prime Rate, the London Interbank Offered Rate (LIBOR), and the 11th District Cost of Funds Index (COFI).

Prime Rate

What is it? The prime rate is a generic term but in the US it primarily refers to the the Wall Street Journal Prime Rate. It is “the base rate on corporate loans posted by at least 75% of the nation’s 30 largest banks.” [Source: Wikipedia] Usually you can expect the rate to be about 3% higher than the Federal Funds rate so when the Fed drops its rates, you can expect the Prime Rate to fall as well (but not always). WSJ prints this rate about once a month.
Why does it matter? The Prime Rate is often the rate you see associated with credit cards, car notes, and all other types of consumer debt. For example, a card may have their variable purchase and balance transfer APR pegged to the Prime Rate plus 4.99%, so that rate will be the Federal Funds rate plus around 8.99%. Since the Fed cut the rate by 75 basis points, you should expect a similar fall in your interest rates. The Prime Rate is published by WSJ so it will lag the Fed by a little bit, so you might not see the lower rate for a little while.

London Interbank Offered Rate (LIBOR)

What is it? The LIBOR is “a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market (or interbank market).” [Source: Wikipedia] In other words, it’s the Fed funds rate in London. Some other notable differences are that it’s a daily rate, announced after 11 AM by the British Bankers Association, and is an average of rates on inter-bank loans of up to 1 year with contributor banks. It’s a lot like taking a snapshot of the crowd at a sporting event, you get close but it’s obviously a continually moving target. Another difference between the two rates is that with the Fed funds rate you’re talking about the target that the Fed is trying to hit by adding liquidity. With the LIBOR, it’s the actual rate being charged and not a target. While it is an academic difference, it’s a difference nonetheless.
Why does it matter? Some adjustable rate mortgages are actually linked to the LIBOR, such as LIBOR + 2.75% or LIBOR + 2.0%; so when the LIBOR moves around, it can affect what your ARM is adjusted to.

11th District Cost of Funds Index (COFI)

What is it? Last but not least, we have the 11th District Cost of Funds Index (COFI), an index I never heard of before researching this article. The COFI is a little more complicated and is “computed from the actual interest expenses reported for a given month by the Arizona, California, and Nevada savings institution members of the Federal Home Loan Bank of San Francisco (Bank) that satisfy the Bank’s criteria for inclusion in the COFI (COFI Reporting Members).” [Source: FHLBank San Francisco] Like the Prime Rate, this rate is reported on a monthly basis but two months behind (so the January value is reported in March).
Why does it matter? Again, it’s an index used to adjust mortgages and other loans and it’s popular because it lags the market and is a stable measure. This means that it’s good when the rates are increasing, since it lags, but not as good when the rates are falling, since it lags. The reason why its stable is because it includes more factors such as loans from savings and checking accounts, CDs, etc.

Hope that clarifies things just a little bit more…

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