Can anyone offer me a decent explanation of why, at this very moment, every major bank in the United States is offering a savings account with a higher interest rates than they give for certificates of deposit (CDs)? Go take a look. It makes no sense.

In a healthy economy, the CD should always have a higher rate. For those that don’t know, a certificate of deposit is a sort of “long term” savings account. The idea is that you deposit some amount in a bank for a fixed length of time (often three months, six months, or one to five years) and, in its simplest form, you are penalized if you withdraw from the CD account during this time period. The idea is that the bank has a guaranteed source of funds. This illiquidity is good for the bank, but inconvenient for you. To make this inconvenience worth your while, the bank should give you a higher rate.

But I can’t find any banks that are actually doing so, at least for CDs with a reasonable term length. Citibank, for example is advertising an “Ultimate Savings Account” with a rate of 1.01%. Meanwhile, their CD terms are much lower: 3-month 0.25%, 6-month 0.5%, 10-month 0.5%. At 12-months, you get the same rate as the savings account: 1.01%. Only at 18 months do they do better, and then not by much (1.1%). For three years, they’ll give you 1.5%. Other banks have much the same setup.

So, what the banks are saying with their behavior is that it is better for them if you have a savings account, rather than a CD with a term less than a year. (Or, put another way, they are saying “if you want a CD with a term less than a year, then we don’t really want your business”.) Why would this be? On the surface, it would seem that money locked in to them even for a short period would be better for them than money that can be withdrawn at any time. I can only think of a few possibilities this would not be so, most of which are unsatisfying:

  • Loss leader: Perhaps it isn’t that CD rates are too low, but that savings account rates are artificially high, with the idea that banks are inflating them to gain customers, with the intent of lowering the “teaser rate” drastically after some (short) period and hoping the customer doesn’t notice. It seems like if you make the assumption of classical economics that people are rational, this seems likely to fail. On the other hand, this classical assumption is almost always wrong, so maybe the bank knows they can get away with this kind of thing.
  • Overhead: It could be that the costs of offering, setting up and maintaining CD accounts are larger than they seem. For the current behavior to be rational, it would have to mean that only if a CD lives for 18 months does it become worth the extra effort for the bank, compared to a savings account. I find this hard to believe, but, on the other hand, about the only time I’ve talked with a human at a bank in the last few years was to do something with a CD, so maybe it’s true. If you look at the way various ladder strategies work, you can imagine that a higher cost for customer interaction is plausible.
  • Flexibility: Typically, rates of savings accounts are not fixed, while those of CDs are. This means that a bank that has lots of customers with savings accounts has a bit more flexibility than one where the customers all have CDs. That is, if things go bad, they can set the rate of the savings accounts to zero to control their costs, while the cost of the CDs would remain a constant drain. It seems to me that if this is really the reason, then these banks are in worse shape (or, at least, think they are) then we thought.
  • Contempt: It could just be that banks think their customers are too dumb to notice. Maybe they are even correct. For example, I opened a CD a number of years back at over 3%. As the term on this CD expired, I let it automatically renew. At some point during these renewals, the rate dwindled below 1%, yet I did not realize this until recently. I’d like to think not enough of the country is as dim as I was to make this a viable strategy for banks, but I’m probably wrong.

Maybe all of these ideas have some truth? Whatever the case, it is fairly baffling. I’d love to hear from someone who knows better.