Want Higher CD Rates? Try Troubled Banks!

Cash investors can put their money in U.S. Treasuries or passbook savings accounts to earn less than 1 percent annually. Another alternative is to open a CD with a cash-poor bank, and log returns in excess of 3.5 percent.

The only reason that Rod Tidwell stuck with his agent in Jerry Maguire was because Jerry promised to show him the money. The same dynamic is happening right now in the banking industry, as troubled banks are promising fat yields to keep their old customers and attract new ones.

Cash deprivation

The run on cash in this country is creating opportunity for depositors, even as it continues to cause problems for financial institutions. Banks are eager to build up their cash reserves, but a credit freeze and rising loan defaults are sending them two steps back for every one step forward. The cash need is particularly dire for institutions that have less-than-conservative capital structures. You can call them troubled banks, bad apples, or just unlucky. Whatever the case, they need cash and lots of it.

If there were no credit or mortgage lending crisis, these banks would replenish their cash by borrowing from other banks, and by receiving scheduled loan repayments. The banks that make mortgage loans for resale would also have a regular supply of liquidity from mortgage investors. Unfortunately, none of these sources are reliable right now. That's why banks are stumbling over each other to get to the money that's in your wallet.

Show me the money

Banks used to compete for your business by offering freebies, like toasters or clock radios. Now, they'd rather give you a high rate on your CD. For the bank, the CD is reliable; the bank knows how long your money's going to be there, and is aware of the small likelihood that you'll withdraw your funds early.

It's not coincidental that some of the weaker banks are offering the highest CD rates; after all, they're the ones in the greatest need.  During the first week of December, UmbrellaBank.com was offering a 4.10 APY on 12-month time deposits. Under BankRate.com's Safe & Sound Ratings system, UmbrellaBank.com has the lowest financial strength rating-one star. Imperial Capital Bank, ranked with one star, and Wachovia Bank, ranked with two, are both pushing 12-month CDs at 4 percent APY.  These are not jumbo CD rates-the minimum deposit on all three is $2,000 or less.

By comparison, Wells Fargo's 12-month CD was paying a 1.45 percent APY.

Risk and reward

Normally, a higher yield investment comes with a proportionately higher risk. But that's not really the case with federally-insured CDs. As long as you keep your deposits within the stated limits of FDIC or the National Credit Union Share Insurance Fund (NCUSIF) insurance, you're safe from loss. If your bank goes under, the insuring entity guarantees to return your principal and accrued interest up to the insurance limit. In other words, if the bank can't fulfill the Jerry Maguire promise, the FDIC or the NCUSIF will.