Why do FDIC insured CDs yield more than treasuries?

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Kelly
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Why do FDIC insured CDs yield more than treasuries?

Post by Kelly » Thu Nov 26, 2015 5:54 pm

Folks,

A treasury maturing in one year yields 0.48% but Ally bank has a one year FDIC insured CD yielding 1.05%. Unless I'm missing something the risk is the same: none.

My guess is that there's simply much more institutional money flowing into treasuries pushing the yield down. If that is the reason, why would an individual investor ever prefer nominal treasuries over CDs? The question assumes that their CD amount is below the FDIC limit.

Many thanks for any insight.

Kelly

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by grok87 » Thu Nov 26, 2015 6:01 pm

Kelly wrote:Folks,

A treasury maturing in one year yields 0.48% but Ally bank has a one year FDIC insured CD yielding 1.05%. Unless I'm missing something the risk is the same: none.

My guess is that there's simply much more institutional money flowing into treasuries pushing the yield down. If that is the reason, why would an individual investor ever prefer nominal treasuries over CDs? The question assumes that their CD amount is below the FDIC limit.

Many thanks for any insight.

Kelly
Hi Kelly,
Often CDs are indeed preferable. But be aware of (at least) 2 things:

1) If in a taxable account, any state income taxes would apply to CDs but not to treasuries.

2) You may or may not be able to withdraw early from a CD. please read the fine print and be aware that it is often ambiguous. Many banks reserve the right to deny early withdrawals. Their fine print may say something ambiguous like: "in the case of an early withdrawal a penalty of 6 months interest will apply". but then buried in some other clause in a totally different place it states that the actual ability to do an early withdrawal is subject to the bank's approval.

3) you can always get your money back quickly and easily with a treasury by selling it.
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JoMoney
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by JoMoney » Thu Nov 26, 2015 6:06 pm

Banks compete for consumer deposits.
Treasuries have buyers that (for a variety of reasons) can't use CD's.

The risks aren't exactly the same either. While it's generally assumed that a CD can be redeemed before it matures by paying some penalty fee, there is a possibility that an early out may not be honored, the bank could go under, and the money could be locked in for longer than you may have wished. Treasuries offer a liquid market where they can be sold (albeit possibly at a loss) at any time.
There's also some nit-picking that could be done about the quality of FDIC insurance, which has been interpreted as being backed by the full faith and credit of the U.S. government, as opposed to a treasury debt which is explicitly backed by the full faith and credit of the U.S. government.
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Dandy » Fri Nov 27, 2015 2:13 pm

Treasuries are often bought by foreign investors (especially when geo politics are bad), foreign governments, large institutions, pension funds, and other large institutional investors -- none of them can effectively buy CDs. When times are tough and there is a flight to quality these investors buy even more Treasuries and drive up the price and drive down the yield.

Banks offer have a wide variance in rates they offer on CDs depending on their need for assets and/or new customers. You can get a 1 year CD at Bogota Savings in NJ for 1.30% or Bank of America for 0.07%. A one year Treasury goes for about 0.64%

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Fri Nov 27, 2015 2:29 pm

As others have posted, various factors are involved.

One factor, for directly issued CDs from banks and Certificates from Credit Unions, is that usually such CDs/certificates automatically renew and usually post interest to the CD. This tends to keep the funds in the bank or credit union for a longer (sometimes much longer) than the original term of the CD/certificate. That factor motivates the bank or credit union to offer slightly higher rates to attract more funds.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Geologist » Fri Nov 27, 2015 2:52 pm

It also has not always been true that CD's yield more than treasuries. My credit union has reasonably competitive CD rates, but a dozen or so years ago, their rates were somewhat lower than Treasuries, at least for maturities longer than 2 years. With the state income tax advantage of Treasuries, that made them preferable. This situation has been gone for some years, but it could return in the future.

You also have to take into account that even for individual investors there is the annoyance of opening accounts at banks hither and yon to capture whichever one is offering the best rate when you want to buy a CD. Even with the Internet, this is not zero.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Fri Nov 27, 2015 3:47 pm

JoMoney wrote:Banks compete for consumer deposits.
Treasuries have buyers that (for a variety of reasons) can't use CD's.
The risks aren't exactly the same either. While it's generally assumed that a CD can be redeemed before it matures by paying some penalty fee, there is a possibility that an early out may not be honored, the bank could go under, and the money could be locked in for longer than you may have wished. Treasuries offer a liquid market where they can be sold (albeit possibly at a loss) at any time.
There's also some nit-picking that could be done about the quality of FDIC insurance, which has been interpreted as being backed by the full faith and credit of the U.S. government, as opposed to a treasury debt which is explicitly backed by the full faith and credit of the U.S. government.
1. Certainly Treasuries offer excellent liquidity and a low bid-ask spread - much better than brokered CDs, for example.

2. Yes - read the "fine print" on direct issue CDs. While most banks and credit unions allow early withdrawal (for a penalty), not all do and there is no requirement to do so.

3. Yes - all CDs (whether bank, credit union, direct issue or brokered) have "call risk" if the institution fails or is merged into another institution.

4. I am 100% convinced of the "full faith and credit" backing of FDIC and NCUA and regard "nit picking" as that of conspiracy theorists (much like alien invasions, etc.)

5. I do not think there is any risk of your money being locked up longer than the original term of the CD, except a few days or a few weeks in the case where the FDIC or NCUA take over the bank or credit union when it fails.

Let me also add the opinion that it is prudent whenever purchasing any CD from a bank or credit union that the buyer should independently verify federal insurance (FDIC or NCUA) and not rely on the sign on the door or on the web site. Go to the NCUA or FDIC web site and look up the bank or credit union.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by nisiprius » Fri Nov 27, 2015 4:00 pm

dm200 wrote:...2. Yes - read the "fine print" on direct issue CDs. While most banks and credit unions allow early withdrawal (for a penalty), not all do and there is no requirement to do so,,,
And--this always seems to me like a Catch-22--sometimes the terms and conditions give them the right to change the terms and conditions, so look for that as well. It will say something to the effect that they will give you X days notice, within which perhaps you can cash out the CD with no withdrawal penalty--but you need to be ready to react when you get the envelope in the mail. Allan Roth wrote a column about Ally actually changing the terms and conditions on their CDs to include the words "If we consent to the redemption..." This puts Ally into the same awkward category as many banks, which have the right to deny early withdrawal but "never" exercise that right.

It's not a topic on which you can learn much from banks, and I think the reason is that, at least in normal times, a bank that is in good shape will have a policy of always granting early withdrawal--but wants to be ready to change the policy and play hardball if they were on the ropes and needed to stop any withdrawals they could possibly stop.
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by knpstr » Fri Nov 27, 2015 4:30 pm

Ally's savings accounts yield 1% no need for a CD!
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by mjb » Fri Nov 27, 2015 5:07 pm

As others have stated, this is in part due to the fact that not everyone can buy CD's. From a historic basis, usually 3 year and shorter CD's are a little better than equivalent treasuries. 5 year tends to be break even.

Treasuries are far more liquid and don't have early redemption penalties.

As others have mentioned, FDIC doesn't mean perfectly protected. If there are enough banks that fail, the FDIC fund only has so much. It could take a while to get back all your money as the FDIC restructures the bank. The U.S. can effectively print money (not quite true, but close enough for this talk).

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by sciliz » Fri Nov 27, 2015 5:36 pm

I appreciate the other responses about practical advantages. I will say, that *specifically* with Ally, the amount of interest forfeited if you break a CD early is not awful, and I had no trouble doing it when I'd put my E-fund there in a ladder. Which, of course, doesn't mean much about what *could* happen.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Johno » Fri Nov 27, 2015 6:12 pm

mjb wrote:1. As others have stated, this is in part due to the fact that not everyone can buy CD's. From a historic basis, usually 3 year and shorter CD's are a little better than equivalent treasuries. 5 year tends to be break even.

2. Treasuries are far more liquid and don't have early redemption penalties.

3. As others have mentioned, FDIC doesn't mean perfectly protected. If there are enough banks that fail, the FDIC fund only has so much. It could take a while to get back all your money as the FDIC restructures the bank. The U.S. can effectively print money (not quite true, but close enough for this talk).
1. The important thing for investors to understand IMO is that *the best yielding* CD's currently yield considerably more than treasuries for trivially if any more risk, *if and where (2) the investor doesn't need instant liquidity*, but most people don't for most of their fixed income allocation.

This is illustrated I think by looking at the list of best CD rates on bankrate.com, say. The 5yr note yields 1.65 (as of 11/27). The best CD on bankrate is 2.25 (three way tie between Synchrony, CIT and KS State Bank, it's possible one of these might offer some special bonus). But the 17th best rate on that site is Luana Savings at 1.66. Are we to suppose there's some risk reason that fully explains that big difference between mediocre CD rate and best, forget for a moment treasuries? Basically, no. It mainly reflects price insensitivity of retail depositors where professional traders cannot arbitrage out such an inefficiency. We can't automatically say the 2.25 CD is a 60 bp better deal than the treasury* but it's clear that CD rates vary among themselves by a lot for no really good reason and it seems implausible to say Luana's deal is 59 bps worse than a treasury once accounting for 'all the other risks', which would be the implication if we claimed that CIT's/Synchrony's deal is really only equal to the treasury. It's pretty clearly better, where instant liquidity isn't needed**.

3. The 'credit' risk of a CD was correctly characterized as a possible contingent call if the bank fails. You'll get back your principal virtually as surely as a treasury, but you might have to reinvest it for the remaining term a lower rate. But not necessarily, and it's pretty unlikely a given bank in reasonable shape will fail in 5 yrs, and failing banks are often just bought out in which case nothing might happen to your CD anyway. This risk can't IMO be plausibly be valued at more than a handful of bps.

OTOH the implied idea that principal is at risk because 'there's only so much funds in the FDIC' is not correct. Whether the US govt would be more committed to paying off treasuries or back stopping the FDIC is actually not clear. It could even be argued the other way around. In an extreme situation where the govt found the path of least resistance to hair cut 'wealthy' treasury holders rather than cause hyper inflation by unlimited money printing (as other govts have done on domestic currency debt in the past), banks might still pay off CD's without needing the govt backstop, which might anyway remain because CD depositors are generally less lucrative political targets to absorb losses. And just as it was mentioned banks might be able to change terms and conditions, governments can change their 'terms and conditions' too. I would just leave it as 'very small difference in credit quality' between (govt insured) CD's and treasuries

*though it's not actually clear it's less than 60: the CD lacks the treasury's liquidity, then again it contains a put option that might be worth 25bp or more: it's fair to debate if a bank might in some circumstances be able to renege on that option, but you don't own any such option on a treasury.
**and as indirectly alluded to, if you put 95% of the money in a 1.1% savings account you have instant liquidity, and use the other 5% to back a position in treasury futures, also instant liquidity, and get a return of treasury-repo, but repo more like .25% at most so you net ~80 bps more that way than owning the cash treasury (underlying the futures contract) without giving up liquidity, and the tax characteristics can be superior also, though you do take credit risk to the broker on the ~1% in actual cash margin at any given time. It's an indirect proof, even if you don't actually do the trade, than the 'FDIC arb' does in fact have an element of 'free lunch': 'no free lunchs' only applies where professional traders can arbitrage them away, here they can't.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by jalbert » Fri Nov 27, 2015 6:49 pm

Banks also usually have fine print stating that the bank reserves the right to ask for 30 day's notice in writing to request a withdrawal.

The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.

-jalbert

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by grok87 » Fri Nov 27, 2015 7:15 pm

jalbert wrote:Banks also usually have fine print stating that the bank reserves the right to ask for 30 day's notice in writing to request a withdrawal.

The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.

-jalbert
actually i'm pretty sure most banks reserve the right to deny early withdrawals.
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by burt » Fri Nov 27, 2015 7:24 pm

nisiprius wrote:
dm200 wrote:...2. Yes - read the "fine print" on direct issue CDs. While most banks and credit unions allow early withdrawal (for a penalty), not all do and there is no requirement to do so,,,
And--this always seems to me like a Catch-22--sometimes the terms and conditions give them the right to change the terms and conditions, so look for that as well. It will say something to the effect that they will give you X days notice, within which perhaps you can cash out the CD with no withdrawal penalty--but you need to be ready to react when you get the envelope in the mail. Allan Roth wrote a column about Ally actually changing the terms and conditions on their CDs to include the words "If we consent to the redemption..." This puts Ally into the same awkward category as many banks, which have the right to deny early withdrawal but "never" exercise that right.

It's not a topic on which you can learn much from banks, and I think the reason is that, at least in normal times, a bank that is in good shape will have a policy of always granting early withdrawal--but wants to be ready to change the policy and play hardball if they were on the ropes and needed to stop any withdrawals they could possibly stop.
I’m reading “The Great Depression: A Diary.”

“Mr. Roth is horrified when the local banks fail (“I still cannot believe that the Dollar Bank — the Gibraltar of Youngstown — has closed its doors”) and points out that even after the banks reopen, customers aren’t allowed to withdraw more than a small fraction of their savings. He explains how entrepreneurs with money buy up people’s frozen passbook accounts for 50 cents on the dollar and how barter and scrip come to replace the money people no longer have.”

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Dandy » Fri Nov 27, 2015 8:08 pm

“Mr. Roth is horrified when the local banks fail (“I still cannot believe that the Dollar Bank — the Gibraltar of Youngstown — has closed its doors”) and points out that even after the banks reopen, customers aren’t allowed to withdraw more than a small fraction of their savings. He explains how entrepreneurs with money buy up people’s frozen passbook accounts for 50 cents on the dollar and how barter and scrip come to replace the money people no longer have.”


Hopefully, everyone realizes the Great Depression banks failed without the benefit of FDIC which was created because of the Great Depression bank failures. We kind of take that level of safety for granted. But in those days it was pretty much the bank or the cookie jar and neither were very safe.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Johno » Fri Nov 27, 2015 9:10 pm

jalbert wrote: The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.
A bond fund which maintains a constant maturity has different term risk over time than a single treasury, or a single CD. The constant duration can also lose more money if rates go up than you'd lose with a single instrument whose duration is decreasing over time, again be it a treasury or CD. That's not a difference intrinsic to CD's v treasuries. By the same token one can construct a ladder of CD's which stays at a relatively constant maturity, or again one can get the 'FDIC premium' a different way than CD's, ie by putting 95% of the money in best yielding bank account at 1.1% and use the other 5% to back a rolling long position in treasury futures earning treasury minus repo. That also maintains ~constant duration like a treasury bond fund but yields around 80bps more because the best FDIC insured zero duration rate* is so much higher than the repo rate.

It's IMO confusing the situation to compare positions with different duration characteristics then attribute those differences to 'treasury v CD'.

On break option again we're considering the possibility banks might renege on the options in extreme cases (though most fine print does not in fact say they can, the idea there is they would despite it not saying so) but there's no such option at all on a treasury. So it's still an advantage for a CD, and the inefficiency of the retail depositor market would again aid those paying attention. It's not plausible to believe as individual you can beat professional rate and option traders to the draw on anything, but it is plausible to believe that if there's a wave of CD breaks by retail you can be among the earlier ones if you're paying attention. It's like putting on your sneakers as the bear approaches and your friend says 'you'll never outrun a bear!', and you say 'I only have to outrun you'. :D

*in a market of price insensitive retail depositors where FDIC ins 1.1% savings accounts can exist alongside FDIC ins 0.02% saving accounts, at latter rate the idea doesn't work.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by William Million » Fri Nov 27, 2015 9:23 pm

In theory, CDs should not yield more than treasuries. But for several years, that has been the case. As to why, there are many theories. Bottom line is CDs are a hassle to maintain, but currently a good deal.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by small_index » Fri Nov 27, 2015 9:52 pm

...
Last edited by small_index on Sat Dec 12, 2015 1:09 am, edited 1 time in total.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by jalbert » Fri Nov 27, 2015 10:31 pm

grok87 wrote:
jalbert wrote:Banks also usually have fine print stating that the bank reserves the right to ask for 30 day's notice in writing to request a withdrawal.

The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.

-jalbert
actually i'm pretty sure most banks reserve the right to deny early withdrawals.
Yes. I think the right to request 30-day's written notice to get the funds is usually in the fine print for all types of accounts.

-jalbert
Last edited by jalbert on Fri Nov 27, 2015 10:34 pm, edited 1 time in total.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Fri Nov 27, 2015 10:33 pm

The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.
Actually when comparing CDs to the same maturity Treasuries, it is the identical issue.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Fri Nov 27, 2015 10:41 pm

and it's pretty unlikely a given bank in reasonable shape will fail in 5 yrs, and failing banks are often just bought out in which case nothing might happen to your CD anyway. This risk can't IMO be plausibly be valued at more than a handful of bps.
The failure rate of banks and credit unions is now very, very low (but not zero). For a few years, the failure rate of both banks and credit unions was (relatively speaking) much higher. Even in the case of a merger/takeover (especially if assisted by the FDIC), existing CDs at the "new" bank may be redeemed early or the rate lowered. I agree, though, that today this is rare.

A few years ago, the organization I manage had just over $500,000 in FDIC insured CDs at three banks in Puerto Rico - and they all failed on the same day. We received the full amount in a week or so from the FDIC (Vanguard brokered CDs), but we then needed to reinvest that $500,000 and could not get the same rate of the CDs in the failed banks.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by jalbert » Fri Nov 27, 2015 10:51 pm

dm200 wrote:
The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.
Actually when comparing CDs to the same maturity Treasuries, it is the identical issue.
If rates fall, you can sell a treasury bond at a premium and re-invest the larger principal in a different treasury bond at the lower rate. You maintain the same coupon stream in absolute terms, but you then capture the higher principal when the bond matures. CDs do not have this option-- direct CDs will be withdrawn early at (par - penalty) and brokered CDs are not liquid enough to make it work. If you hold a bond or CD to maturity and rates have fallen, you are reimbursed at par despite the lower rates.

The liquidity of treasuries offers much more control of when to roll the portfolio in this manner than a CD ladder.

-jalbert

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Johno » Sat Nov 28, 2015 11:33 am

jalbert wrote:
dm200 wrote:
The biggest risk of CDs is often not considered: it is them maturing when rates are low. A treasury bond fund can roll the portfolio to capture the upside of falling rates (and also to arbitrage an aging bond's rate against the yield curve), but CDs mature when they mature and have no mechanism to capture the upside of falling rates orher than the fixed rate of interest they yield.
Actually when comparing CDs to the same maturity Treasuries, it is the identical issue.
If rates fall, you can sell a treasury bond at a premium and re-invest the larger principal in a different treasury bond at the lower rate. You maintain the same coupon stream in absolute terms, but you then capture the higher principal when the bond matures. CDs do not have this option-- direct CDs will be withdrawn early at (par - penalty) and brokered CDs are not liquid enough to make it work. If you hold a bond or CD to maturity and rates have fallen, you are reimbursed at par despite the lower rates.

The liquidity of treasuries offers much more control of when to roll the portfolio in this manner than a CD ladder.
You don't specify what's 'different' about the second treasury. If it's the same final maturity as the first treasury, you accomplish exactly nothing (pre tax) by realizing a gain on the first to get a lower coupon on the second, those two things offset. If instead you mean the second treasury has a later maturity date than the first, this is a different duration position than holding a single CD *or* treasury to maturity, so again it's confusing the issue in the question 'Why do [best rate] FDIC insured CD's yield more than treasuries?" by considering a different duration strategy then attributing the difference to some intrinsic difference between treasuries and CD's. Again if one had a ladder of CD's the effect of yield changes (or non changes, 'roll yield') over time would be the same as a ladder of treasuries with same center point, but best CD's yield relatively a lot, not a little, more.

Or once again consider what's illustrated by the comparison of 'rolling' cash treasuries to a ~constant maturity v. being long treasury futures and putting ~95% of cash you don't need then to buy the cash treasuries into 1.1% bank account instead. The net of treasury minus repo return of the futures plus 1.1% on 95% of the cash (assuming zero for the 5%) will come out around 80 bps higher than the cash treasury return, with same 'roll effect', same 'option' (it's not really an option properly speaking) to maintain a ~constant maturity by rolling from one futures contract to the next. This comparison actually illustrates the answer to the question "Why do FDIC insured CD's yield more than treasuries?", the main answer being an inefficient, price insensitive retail deposit market where the price conscious investor can simply get more return for the same risk by picking the FDIC instruments with highest spread to the treasury curve, whereas the very efficient treasury market is completely arbed out by institutions not allowed into the FDIC deposit market. Your point in contrast with due respect is mainly a tangent to the question, saying how a *different duration exposure* in treasuries over time gives a different return. That applies, just as dm 200 said, equally when considering 'rolling' treasury issues to a constant maturity v. holding a single treasury issue to maturity.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by jalbert » Sat Nov 28, 2015 7:00 pm

You don't specify what's 'different' about the second treasury. If it's the same final maturity as the first treasury, you accomplish exactly nothing (pre tax) by realizing a gain on the first to get a lower coupon on the second, those two things offset
No difference. If there are say 3 years left on a treasury when rates fall, and you sell it and buy a second one with higher principal and lower coupon rate, and 3 years left to maturity, then in the absence of taxes on the sale, the future coupon payments offset in absolute terms as you suggest. But 3 years later, you get back more principal with the second bond when the bonds mature. The original bond will return principal at par at maturity regardless of the lower rates, just like a CD would. Bond portfolio managers roll their portfolios in this way as a standard practice, both to capture appreciation from falling rates and to arbitrage rates on aging bonds against the yield curve. Management of a large bond fund is significantly more sophisticated than managing a CD ladder.

-jalbert

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Johno » Sun Nov 29, 2015 1:14 pm

jalbert wrote:
You don't specify what's 'different' about the second treasury. If it's the same final maturity as the first treasury, you accomplish exactly nothing (pre tax) by realizing a gain on the first to get a lower coupon on the second, those two things offset
No difference. If there are say 3 years left on a treasury when rates fall, and you sell it and buy a second one with higher principal and lower coupon rate, and 3 years left to maturity, then in the absence of taxes on the sale, the future coupon payments offset in absolute terms as you suggest. But 3 years later, you get back more principal with the second bond when the bonds mature. The original bond will return principal at par at maturity regardless of the lower rates, just like a CD would. Bond portfolio managers roll their portfolios in this way as a standard practice, both to capture appreciation from falling rates and to arbitrage rates on aging bonds against the yield curve. Management of a large bond fund is significantly more sophisticated than managing a CD ladder.
You have a misunderstanding then. If you sell any treasury with 3 yrs left and buy any other treasury which also has 3 yrs left you gain essentially nothing. Treasuries maturing in 3 yrs are all priced virtually the same give or take quite small liquidity or tax differences among treasury issues. Any significant arbitrage, which means buying and selling things of the essentially same intrinsic value for different prices, is gone even for fund managers let alone individuals.

What you mean is that bond funds might buy a treasury with 5 yrs to maturity, sell it when it gets to 4 yrs to maturity, and simultaneously buy another new treasury with *5yrs* to maturity, more than the old bond had *when sold*, not the same. They do this basically to keep the maturity of the fund constant. It *may* create a return higher than the yield on 5 yr treasuries if there's a term premium, ie if the realized 4 yr spot rate one yr after buying a 5yr bond is less than the 1 yr forward 4 yr rate at the time the bond was originally purchased. That's also sometimes called 'roll yield'. It is not an arbitrage. It is a potential advantage of keeping a constant maturity, but that also involves a risk (compared to shrinking maturity of a single instrument) and more relevant to this discussion, it's nothing special about cash treasuries. You get exactly that same effect by putting 95% of cash in 1.1% bank account and using the other 5% to go long 5 yr note (let's say) futures, rolling to the next contract every 3 months. But you also get ~80bps more yield...because in the inefficient FDIC ins depo market the max zero duration ~credit risk free rate is 1.1% (though worst deposit rates are nearly zero), but the professional market treasury repo rate (ie ~implied financing rate in the futures price) is at most ~.25%. And the best 5yr CD rates are pretty much consistent with the best deposit rates: around 60 bps higher than the treasury curve in raw terms, but the CD includes a put option worth around 25bps so, option adjusted, it's same 80 bp ballpark range at zero years and 5 yrs.

Again it's just confusing oneself to focus on bond fund roll yield effects. The exact same thing can be done via FDIC deposits retaining very similar spread of best CD's, and actually a different form of the same thing will be realized eventually with a CD ladder of constant maturity.

"Why do [*best*, not all] insured [savings accounts and] CD's yield [quite a lot] more than treasuries?" Mainly because the retail deposit market is inefficient and thus much higher CD/bank acct rates co-exist with much lower ones for no real risk reason. In contrast value among treasury issues is virtually 100% consistent, any discrepancy is almost instantly arbed away by institutional traders. Thus, and it's manifest in today's market, individual investors choosing the *best* CD or bank account rates can in fact enjoy arbitrage profit relative to the treasury curve, risk for risk. If liquidity is absolutely needed, it's the bank acct/futures method, if not and the put option is attractive, 5 yr direct CD's. Or a mix. The choice is also subject to individual tax issues, but again those might also be most favorable for bank acct/futures, depending.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Kevin M » Sun Nov 29, 2015 3:47 pm

Perhaps best to start by considering brokered CDs vs. Treasuries.

As others have noted, rates vary widely, and explanations for this have been offered, but I don't care much about this. I care mostly about the best rates. So I'd rephrase the question as why are best rates of brokered CDs higher than Treasuries of same maturities?

The next question that comes to mind is why institutional investors don't prefer higher yielding brokered CDs to Treasuries, thus driving the prices/yields to be more similar to Treasuries, as with any other arbitrage opportunity.

One answer is that the amounts they invest are too large to take advantage of FDIC insurance, so the CDs are not essentially risk-free to them as they are to retail investors. So they price them on the basis of the perceived risk of bank default relative to perceived risk of US government default.

Another part of the answer might be that the higher-yielding CDs are not offered in sufficient quantity for the institutional investors to mess around with. If you're looking for somewhere safe to park a billion dollars, it isn't worth messing around with a million dollars here and a million dollars there.

Looking secondary market CDs offered by Fidelity of about 5-year maturity, with yields higher than Treasury 5-year yield of 1.64%, I find 18 offerings. The largest single quantity I see is 898 (so $898,000) for Discover Bank maturing 10/15/2020 at 2.17%. Not even a million bucks worth.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by itstoomuch » Sun Nov 29, 2015 4:45 pm

I read/told that branch banking is not so much as getting demand deposits/CDs but getting the loans. And is the loans that make money for the bank. :oops:
The bonus in higher CD rates is from adding the cost of alternstive advertising to the CD rates.
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Kevin M » Mon Nov 30, 2015 3:44 pm

itstoomuch wrote:I read/told that branch banking is not so much as getting demand deposits/CDs but getting the loans. And is the loans that make money for the bank.
Of course they make money off the loans, but they need the deposits to fund the loans.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Mon Nov 30, 2015 4:46 pm

Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by grok87 » Mon Nov 30, 2015 7:44 pm

dm200 wrote:Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.
penfed might be one to watch tomorrow. or jan 1
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by Kevin M » Mon Nov 30, 2015 9:56 pm

grok87 wrote:
dm200 wrote:Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.
penfed might be one to watch tomorrow. or jan 1
Yeah, we were all watching last year, and unfortunately they didn't come through like they did the year before. Fingers crossed though. They have really fallen completely out of the picture as far as competitive 5-year CD rates go, and their new early withdrawal penalties also are quite severe and noncompetitive.

Also, 5-year Treasury rate is higher than it was a year ago, and about the same as it was five years ago, so no rate increase to respond to yet.

I can guarantee my money will be flowing out of PenFed when my CDs there mature, unless they come out with a really nice special at the right time.

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by itstoomuch » Tue Dec 01, 2015 12:54 am

dm200 wrote:Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.
We really need a new popcorn popper than taxable CD interest. :annoyed We really do. :greedy
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by JoMoney » Tue Dec 01, 2015 3:59 am

itstoomuch wrote:
dm200 wrote:Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.
We really need a new popcorn popper than taxable CD interest. :annoyed We really do. :greedy
Might be a ways off from those kinds of "specials", from what I've read, the days when banks gave out toasters and appliances for opening accounts was something banks did to sweeten the deal because the maximum interest rates they were allowed to offer was being regulated by the government.
There was a time when new U.S. treasuries would go to auction and not find buyers at the interest rates they were offered at. By limiting what banks were allowed to offer on interest, it made treasuries look more appealing.
With the Fed's current policies, the treasury hasn't had any problems finding a buyer to finance government spending even with interest rates at next to nothing.
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by ursugardaddy » Tue Dec 01, 2015 4:17 am

Who really knows? The FEDS and system is crazy....

My wife and I have I- bonds which are a tax-deferred investment that is guaranteed to keep up with inflation... I bonds are inflation-protected savings bonds issued by the U.S. government and backed by the government. As long as my emergency money is insured, I am okay and happy

https://www.treasurydirect.gov

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Re: Why do FDIC insured CDs yield more than treasuries?

Post by itstoomuch » Tue Dec 01, 2015 11:52 am

itstoomuch wrote:
dm200 wrote:Being in this sort of business, I can say that, at least some and probably many, credit unions and banks are concerned that when interest rates rise, funds may or will flow out of low yielding accounts. Watch for "specials" offered to keep funds in the bank or credit union, when such "specials" fit your situation.
We really need a new popcorn popper than taxable CD interest. :annoyed We really do. :greedy
Perhaps the reason the financial retailers no longer use frivolous appliances is because the appliances cost them (CU, Banks) more than the miniscule interest they pay for the use of your money. :twisted:
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Re: Why do FDIC insured CDs yield more than treasuries?

Post by dm200 » Tue Dec 01, 2015 3:19 pm

Perhaps the reason the financial retailers no longer use frivolous appliances is because the appliances cost them (CU, Banks) more than the miniscule interest they pay for the use of your money. :twisted:
Some (many) of us older folks remember the highly restricted (by federal laws and regulations) rates of interest that banks, S&Ls and credit unions were allowed to pay. There was little or no rate competition for savings deposits between banks, for example. Every single bank, for example, could only pay that cap (which varied and increased over the years). Long before the "Truth In Savings" laws and regulations (that standardized the calculations and disclosures on accounts) and without being able to pay a higher interest rate than the bank (or S&L - S&Ls did have a higher cap than banks, but it was the same for all federally insured S&Ls ) down the street, banks and S&Ls (and to a somewhat lesser extent credit unions) used other methods to attract or retain deposits.

One technique was more frequent compounding of the deposits. Monthly yielded slightly more than quarterly, then daily yielded slightly more than monthly. I think some even went to "continuous" compounding where the interest was compounded to fractions of a second. They, of course, had signs and TV ads. They could also compete (Can't recall if there were any restrictions or limits) by giving away toasters, and the like. I believe giving away toasters and the like, especially if highly promoted, were often successful. It is my opinion that the decline or demise of banks and credit unions giving away toaster, etc. was primarily due to the fact that those rate caps are now a thing of the past and banks and credit unions can (and do) attract deposits by increasing rates.

Some states (such as Maryland, where I was employed at the time, although I lived in Virginia) allowed state chartered S&Ls to choose private (or perhaps state sanctioned) deposit insurance. if a state chartered S&L in Maryland chose federal (FSLIC) deposit insurance, they were capped at something like 5.00% interest, while a state charter S&L that chose the private (NOT FSLIC) deposit insurance could pay something like 6.00% (This was in the 1970's). I had a "passbook" savings account at one of these. They claimed (and made a big deal of it) that this private/state deposit insurance was very, very safe. BUT - they went even further and claimed (or certainly implied) that the backing of this private/state insurance was even stronger than the federal FSLIC. They cited the ratio of the money in the insurance fund to total insured deposits and the private/state fund ratio was much higher.

Fortunately for me, I had closed out that privately insured Maryland S&L account when it all hit the fan and folks with deposits in these S&Ls (and some credit unions) had to wait years to get their money.

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