Supposedly, the Chinese character for "crisis" is a combination of the symbols for "danger" and "opportunity." When it comes to Wall Street behavior in crisis, though, this famous Japanese haiku nails it:
Their hair is on fire
Yet they run around the lake.
Quick! Take their wallets!
In the current credit crunch, the supposedly sober and staid credit markets have done some rather predictably silly things. Fortunately, you can profit from those things.
Let's start with the easiest one: high-yielding bank CDs from troubled mortgage lenders. Normally, you should be wary when any institution offers you interest rates that seem too good to be true.
Still, the subprime lending scandal has prompted some banks to kick up the interest rates on their money-market accounts and CDs a notch. Thanks to the credit crunch, you can enjoy far juicier rates on CDs and money-market accounts than you could just a week ago.
Why? In short, they need the money.
Let's say that a bank made many loans to subprime borrowers — by definition, borrowers with shaky credit who are more likely to default.
These loans typically carried low initial rates for two years, then revert to a crushingly high rate for the next 28 years. In some cases, the bank would lend the borrower both the mortgage and the down payment. The borrowers had expected to refinance before the loan became a problem. And the bank planned to sell the loan to someone else just as soon as the ink was dry on the mortgage note.
Unfortunately, home prices fell, and subprime mortgage delinquencies started to rise. Suddenly, subprime lenders had a big problem: To lend money, you need money. But the flow of new money to subprime lenders came to a halt. Investors didn't want to buy subprime loans any more. Even worse, short-term cash — vital to any company — dried up in the money market.
Banks raise the rates they pay depositors to attract new money. In the case of some banks with a heavy subprime lending business, they push up rates quite a bit. Countrywide, for example, is offering 5.25% on its money-market savings account, provided you plunk down $50,000. Washington Mutual offers 5.5% on its six-month CD; the minimum deposit is just $1,000. "As long as you're within the comfortable confines of federal deposit insurance, that additional return is pure gravy," says Greg McBride, senior financial analyst for Bankrate.com.
Those confines are indeed fairly comfortable: $100,000 in insurance per person, per bank; $250,000 for individual retirement accounts. You can title deposits differently to expand your Federal Deposit Insurance Corp. coverage. An account in your name and an account held jointly by you and your spouse would each be insured to $100,000 at the same bank. For a rundown on deposit insurance limits: www.fdic.gov.
If you suspect interest rates will fall, as many economists do, then this is a good time to lock in current rates. "If you're looking to diversify your portfolio or generate interest income, these long-term CDs look mighty appealing as we stare at coming Fed rate cuts," McBride says.
If you're in a high income-tax bracket and are willing to take a bit more risk, Wall Street has another gift for you: municipal bonds. Interest from these long-term IOUs issued by municipal entities are free from federal income tax. (If you live in the state where they're issued, the income is free from state taxes, as well.)
Normally, munis pay lower interest rates than comparable Treasuries do because their interest is free from federal taxes. In a typical market, a top-rated muni would yield about 15% less than a Treasury security that matured at the same time. If a 10-year T-note yielded 5%, for example, you could expect a 10-year muni to yield 4.25%.
Thanks to the terror in the bond market, traders are treating all bonds (except Treasuries) like an annoyed cobra. Currently, high-rated 10-year munis yield 4.33%, vs. 4.63% for a 10-year T-note. Someone in the 28% tax bracket would have to earn 6.01% to receive the after-tax equivalent of 4.33%.
Why the higher yields? The markets run on fear and greed, says Ron Fielding, manager of Rochester National Municipal fund. "It went into fear mode, big-time," he says. At the height of the subprime meltdown, some top-rated munis yielded more than Treasuries. "It's very unusual and highly nonsensical on a long-term basis," Fielding says.
As you can see from the chart, you can also lose money in muni funds, so if you can't stand the thought of a loss, stick with CDs instead. Still, for those in high tax brackets — and taxes are unlikely to go lower — muni bonds might translate into a good value.
John Waggoner is a personal finance columnist for USA TODAY. His Investing column appears Fridays. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.
