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Low interest rates have been hell on savers—and heaven for banks. How heavenly? Try $56 billion. That's the amount U.S. banks booked in extra interest income in the two years after the Federal Reserve started cutting rates in September 2007, according to calculations done for Bloomberg BusinessWeek by researcher SNL Financial (OFG).
Banks are getting a pretty sweet deal for nearly blowing up the financial system. Not only did the Fed ratchet down rates to save them, but wary depositors rushed to the comfort of their government-backed accounts. Banks have been able to use those ultra-cheap funds to make lucrative loans and investments since longer-term interest rates have remained relatively high. It's a hidden subsidy that may be as important to the bank bailout as the Troubled Asset Relief Program and the bond guarantees from the Federal Deposit Insurance Corp.
The problem, says Joseph R. Mason, a finance professor at Louisiana State University in Baton Rouge, is that savers are bearing the cost, and they won't be getting their money back. "We are all funding the bailouts, whether we want to or not, both as taxpayers and depositors," he says. As the Fed lowered short-term interest rates to near zero, banks sliced the rates they offered on savings accounts, certificates of deposit, and the like. The average rate paid to depositors dropped from 4.23% in September 2007 to 1.55% in September 2009, according to Dan Geller, executive vice-president of Market Rates Insight, a data firm.
Offering minuscule rates didn't prevent the banks from sweeping up deposits. With the stock and bond markets in turmoil, savers funneled $534 billion into federally insured accounts from June 2008 through June 2009, boosting the total by 7.6%, according to the FDIC.
Banks are making a nice profit on the funds, helping them offset bad loans. Rates on 30-year fixed-rate mortgages declined only 1.24 percentage points during the two years, or less than half the 2.88-point decline in rates paid on a six-month CD, notes Bankrate.com (RATE). Thanks to such widened gaps, Citigroup (C) banked extra net interest income of $13.7 billion in the two-year period, according to estimates in its financial reports that include businesses outside its regulated banks. "The banks are making more money than they have ever made" on the difference between their borrowing and lending, says David Bianco, equity strategist at Bank of America Merrill Lynch (BAC).
The good times (for banks) will last as long as the Fed keeps rates low—and that could be quite a while. Economists surveyed by Bloomberg believe the Fed won't start raising rates before November, and most expect the Fed to move cautiously as long as unemployment remains high. The low short-term rates, combined with diminishing loan losses, could provide a big boost to banks' bottom lines. If you really get the Fed to hold rates steady, says Bianco, "you could get explosive bank earnings growth in 2010."