Tuesday, April 12, 2011

Kelly Campbell, Government Bailouts and Pure Arbitrage

The other day I was so smitten with Kelly Campbell's discussion of mortgages, I investigated his other great advice.  In particular, he gives three reasons CDs stink.  I wish I could say this got me thinking, but it didn't.  I only observed that his three reasons are all the same: Certificate of deposit rates are low, you barely earn anything and they might rise in the future.

That doesn't mean they stink.  So, I went looking for a good example of a CD.  That's when I found the arbitrage.  For this, I owe Kelly thanks.

You and I own Ally Bank (f/k/a GMAC.)  Ally has great commercials.  The Feds took over when the financing arm of the old General Motors went bust.  We both own it as taxpayers, re-branded as Ally.  Unfortunately, I happen to own ever so slightly more due to an investment through my old employer.  I say ever so slightly because the equity owners were diluted so massively by the government bailout.

As owners, we should all be pleased that Ally has filed for an IPO.  Let's hope the bankers do a great job selling the stock.  But, I'm a little concerned about how Ally funds itself.

Ally offers the usual line-up of deposit products to attract cash.  Remember, banks make money by attracting deposits from savers and lending to borrowers, taking a spread.  Potentially uniquely, Ally attracts deposits by offering five year CDs with an early termination penalty of two months interest.  So, Ally will take your FDIC guaranteed deposit of $250,000, and pay you (today) 2.37% interest, fixed for five years.  However, you can close the account any time you please, only forgoing two months' interest.  That's free money.

What's the problem?  Ally may look like it has a chunk of stable, longer term deposits, when in fact it doesn't.  It has deposits that could be long term, but probably aren't, from people smarter than me who have been engaged in this transaction for a long time.  When short term rates rise, these deposits flee.

So, as Ally shareholders, what should we do?  I for one have just opened my account.  I'll get my too high, riskless return on my cash...and maybe contribute slightly to the fiction of Ally's strong balance sheet, ever so slightly improving the IPO price!