The American banking system evolved over two centuries. States initially regulated banks and guaranteed depositor funds. Panics, called recessions today, throughout the 19th and early 20th centuries caused economic turmoil that resulted in bank failures. A 1921 economic downturn followed by years of agricultural difficulties decimated state banking insurance funds. By 1930, only Texas fully compensated depositors of failed banks. The federal government stepped in to build stability into the chaotic banking system. The Federal Deposit Insurance Corporation, FDIC, was established to guarantee depositor accounts in 1933.
Insured Certificates of Deposit
Certificates of Deposit are insured, theoretically riskless investments. The FDIC will reimburse the CD owner for the value of the certificate plus interest due should the bank issuing the paper fail. Banks actively market their CDs because they require funds to operate, lending money to customers for everything from auto loans to business start-ups. CDs require investors to lock in an interest rate for a specific period of time; the funds usually cannot be withdrawn prematurely without a penalty. These funds are then loaned to bank customers.
Introduction of CDs in the 1960s
Banks began offering CDs in the 1960s. A clue to average interest rates before the 1960s can be determined from Treasury bill rates. Six-month Treasury bill interest rates were under one percent from 1934 though 1947. The average rate in 1948 climbed to 1.05%. Rates fluctuated from approximately 1.50% to 3.50% from 1948 until 1964. The Treasury bill rate averaged 3.55% in 1964. Six-month Certificate of Deposit rates, usually averaging about 50 to 75 basis points higher than Treasury securities, averaged 4.03% in 1964. A basis point is one hundredth of a percent (.01%). Adding 50 basis points (.50) to the six-month Treasury rate provides an idea of what CD rates would have been from 1934 until 1964.
The Close of the 20th Century
CD rates increased rapidly after 1969. The Vietnam War and inflation dictated higher rates for the next 20 years. The government financed the war by increasing the money supply; it printed money. Prices of consumer goods and commodities soared. President Nixon attempted to stabilize the economy by raising interest rates. Rates averaged as high as 12.90% in 1980 for a six-month CD. Some banks offered well above the average rate as they competed to attract dollars. By the early 1990s, rates began retreating. Recession marked the early years of the last decade of the 20th century; the latter part of the decade experienced prosperity and a bullish stock market. CD rates ranged from four to six percent throughout most of the 1990s.
The Twenty-first Century
The year 2000 ushered in the beginning of the worst recession and bear stock market since the Depression. The events of Sept. 11, 2001, followed by the Afghanistan and Iraq wars, added to the economic uncertainty of the era. The Federal Reserve tried to stimulate the economy by lowering interest rates, making loans to businesses and consumers more affordable.CD rates dropped to 1.81% in 2001, increased to 3.73% in 2005 and 5.24% in 2006, only to decrease to 3.14% in 2008 and plunge to .87% by 2009. Rates remained historically low throughout 2010. The low rates of the past couple of years mirror the low rates offered on Treasury instruments during the Depression and World War II years. When the economy rebounds, as it did in the 1950s, CD rates should improve.
Meryl Baer worked at a financial firm for 15 years, researching investments and writing newsletters and marketing materials. She also worked at two business schools as an English/business writing instructor, department head and placement director. Baer holds a master's degree in American studies from Pennsylvania State University and a master's degree in business administration from Robert Morris University.