WSJ on Short-Term vs Long-Term CDs
The Wall Street Journal writes on "Short-Term or Long-Term CDs: Which Should You Buy?" They tell us, "Bank customers often opt for short-term certificates of deposit rather than higher-yielding long-term CDs because they are leery of potentially incurring early-withdrawal fees if they need their funds before the term is up. That is often a mistake. In many cases, according to new research, investors would be better off choosing longer-term CDs and paying an early-withdrawal fee if they need the money before the CD reaches maturity. That is because most banks -- intentionally or unintentionally -- have 'internal inconsistencies in their deposit pricing,' meaning that their interest rates on shorter-term CDs yield less than those on a longer-term CD, even with an early-withdrawal penalty, according to study co-author Francis A. Longstaff, a finance professor at UCLA." The Journal piece says, "To arrive at their findings, researchers analyzed data from S&P RateWatch, which tracks CD interest rates and early-withdrawal fees from more than 96,000 bank branches in the U.S. The team obtained weekly data from Jan. 5, 2001, to June 30, 2023, on CDs that would mature in six months, one year, two years, three years, four years and five years. The study found that in 52.4% of the CD term structures, there was at least one shorter-term CD whose interest rate was 'dominated' by a longer-term CD, meaning short-term investors would get proportionately lower returns, Longstaff says." The working paper, titled, "`Financial Sophistication and Bank Market Power," states, "We study the relation between bank funding costs and the financial sophistication of bank customers. In doing this, we make use of a natural experiment that allows us to identify banks that -- either intentionally or unintentionally -- price time deposits in a way that can result in financially unsophisticated customers essentially being shortchanged. We find that these banks have significantly lower deposit funding costs. These results provide evidence that having financially unsophisticated customers may provide banks with substantial market power and be an important component of the value of a bank's deposit franchise."
