The Financial Crisis, Great Recession, Deposit Rates, Unemployment Rate and the Federal Reserve

Everyone who has opened a savings account, money market account, or a certificate of deposit account over the past 6 years has seen how low interest rates have fallen. If you had a long term certificate of deposit mature recently, you've been shocked by how low CD rates are on both short and long term CDs. This long cycle of low interest rates was started by the financial crisis of 2007 and the Great Recession that followed in 2008.

Housing Bubble Bursting Sends Federal Funds Rate to 0.00%

The cycle of events started with the housing bubble bursting which brought on the crisis with the mortgage-backed securities market. This caused ripples throughout the brokerage industry, Lehman Brothers failed, Bear Stearns was about to fail but the government stepped in and negotiated a deal to have JPMorgan buy Bear Stearns for $1.

Merrill Lynch was also about to collapse and was bought by Bank of America, with a nod from the government. Goldman Sachs and Morgan Stanley became commercial banks to be able to raise deposits and receive government assistance trough TARP. The Federal Reserve decreased the federal funds rate from 5.25 percent at the start of the housing bust in June of 2006, to 0.00 percent to 0.25 percent by December 2008.

Current Federal Funds Rate Suppress Deposit Rates

The current fed funds rate is still in a range of 0.00 percent to 0.25 percent. As a result of a 0.00 percent fed funds rate, FDIC average savings rates and money market rates are in the single digits. Average 1 year CD rates reported by MonitorBankRates are at 0.67 percent this week.

These rates are significantly lower than rates were just before the financial crisis hit and the Fed had to lower interest rates to record lows. In 2006, you could easily find savings rates and money market rates around 3.00 percent. Most banks were offering 1 year CD rates slightly higher in the 3.5 percent range.

Just before the financial crisis hit, there were some banks that realized their balance sheet was in trouble and needed to raise more deposits. They did this by offering rates that were much higher than prevailing rates. Remember Washington Mutual Bank? Back in August 2008 they were offering a whopping 5 percent 13 month CD rate.

That high CD rate still didn't help Washington Mutual Bank survive. In September 2008, WaMu was seized by the Office of Thrift Supervision and placed into receivership with the FDIC.

Deposit Rates Restricted by the FDIC

The practice of offering deposit rates much higher than most other bank CD rates was put to an end by the FDIC. Part 337.6 of the FDIC Rules and Regulations states that interest rate restrictions will be placed on "less than well capitalized institutions."

Any financial institution that is less than well capitalized can only offer deposit rates that are 75 basis points, 0.75 percent, higher than the average rates posted by the FDIC. Average rates are updated weekly in the FDIC's Weekly National Rates and Rate Caps.

Unemployment Rate, Inflation Rate and the Fed Funds Rate

The Federal Open Market Committee has stated over the past couple of years that the current targeted level for the federal funds rate, 0.00 percent to 0.25 percent, will remain at that level until the U.S. unemployment rate falls below 6.5 percent. In past meeting minutes released by the FOMC, they stated they believe the rate will fall below 6.5 percent sometime in 2015.

In the released July meeting minutes, the Fed didn't mention the timeframe of mid to late 2015 when they believed the unemployment rate would likely fall to 6.5 percent. Could this mean the Fed believes the rate will fall to 6.5 percent before 2015 or did they not want to tie the rate to when they will increase the fed funds rate?  With the current unemployment rate at 7.4 percent, hopefully we could see the 6.5 percent unemployment level closer to the first quarter of 2014.

When Will Deposit Rates Go Higher?

If the unemployment rate falls to 6.5 percent during the first three months of 2014 and the Fed increases the fed funds rate, we could see deposit rates move higher soon after. The fed's current interest rate policy, zero percent fed funds rate, is so accommodating just to get a neutral stance that the Fed will have to quickly increase the rate.

A more neutral level would be a fed funds rate of 1.00 percent to 1.50 percent, which would cause bank CD rates and other deposit rates to move higher. 1 year CD rates would move to a range of 2.00 percent to 2.25 percent. Savings rates and money market rates would also move to the 2.00 percent range.

Of course anything can happen to economic growth that would delay interest rates moving higher. However, I believe that the scenario of higher interest rates in the first 6 months of 2014 is quite likely.