Remember "disintermediation", the flow of money from one investment repository to another?

Well, there are signs, and incentives, for it to come back. This time, instead of having money leave banks and thrifts for mutual funds, we are likely to see money leaving fixed income mutual funds for bank and thrift CDs.

Why?

The yields on brokered Certificates of Deposit keep getting better and better. Not only are they significantly better than average CDs, they also beat comparable maturity Treasury obligations. As a consequence, they blow away the returns on most mutual funds. Here's the story.

Last week, while everyone was busy contemplating the merger of Old Media and New Media, the average yield on a brokered 5 year CD hit 7 percent--- 7.05 percent to be precise. Note that this is the average, not the highest yield available. With a little searching, you can find a slightly higher yield.

What does it all mean, beyond opportunity for yield investors?

Let's start with a little history.

Back in the late eighties, as Texas banks were leading the charge into oblivion, CD investors could reap something I called "the Texas Premium." It was a bit of extra yield, relative to the rest of the country, as Texas thrifts struggled to attract and retain deposits. In fact, the Texas Premium was only an exaggeration of conditions that regularly prevail in different regions of the country--- some areas are deposit importers and some are deposit exporters. Florida institutions, for instance, regularly offer lower yields than California institutions.

After the banking crisis, as thrifts disappeared and banks merged, CD yields dropped because the fastest way for a deposit institution to raise its equity relative to its deposits was to discourage depositors. So bankers discouraged us by offering miserable yields. CD yields were regularly lower than yields on comparable maturity Treasury obligations. That's when I started tracking something I call the DOG index.

Short for Deposit Opportunity Gap, the DOG measures the amount of interest income you'll give up by investing in average bank CDs instead of a portfolio of comparable Treasury obligations. On a portfolio of $50,000, the DOG was often as high as $500 a year.

Last week the DOG hit a record high, a stunning $626. CD rates were flat while Treasury yields continued to rise. (You can see the current DOG and its 13 week history as well as links to CD and Treasury sources.)

But something even more important has been happening. Brokered CD rates have been rising. Only a few years ago I was able to write that the highest yield CDs in the country only came close to Treasury yields. Now, yields on brokered CDs beat comparable maturity Treasury yields cold. The table below compares average bank CDs, Treasury obligations, and brokered CDs. As you can see, it's a sweep for brokered CDs.

Brokered CDs Win the Yield Contest

Instrument 3 months 6 months 1 year 2 years 5 years
Avg. Bank CDs 4.10% 4.59% 4.84% 5.10% 5.34%
Treasury Obligations 5.41 5.67 6.11 6.45 6.59
Brokered CDs 5.79 6.05 6.44 6.75 7.05

Source: www.banxquote.com

Now let's take it a step further.

Instead of simply listing CDs and Treasuries, as most information sources do, let's merge the CD and Treasury information with some data on the average yields and maturities of different categories of mutual funds. To do that, I made a profile of each Morningstar fixed income category and then rank ordered it with the CD and Treasury figures above. The results are shown in the table below, with brokered CD yields in bold type.

The Yield Pecking Order: January, 2000

Investment Yield Maturity in years
High Yield Bond funds

8.91

7.70

Multi-Sector Bond funds

7.45

9.70

5 year brokered CD

7.05

5.00

2 year brokered CD

6.75

2.00

5 year Treasury

6.59

5.00

2 year Treasury

6.45

2.00

1 year brokered CD

6.44

1.00

1 year Treasury

6.11

1.00

6 month brokered CD

6.05

0.50

General Bond funds-long

5.83

13.90

3 month brokered CD

5.79

0.25

General Bond funds-Short

5.75

4.10

General Bond funds-Ultra Short

5.75

1.70

6 month Treasury

5.67

0.50

General Bond funds-Intermediate

5.64

9.10

Government funds-long

5.52

14.60

3 month Treasury

5.41

0.25

5 year Bank CD

5.34

5.00

2 year Bank CD

5.10

2.00

International Bond funds

5.03

8.30

Government funds-Short

4.92

4.40

1 year Bank CD

4.84

1.00

Government funds-Intermediate

4.68

9.50

6 month Bank CD

4.59

0.50

3 month Bank CD

4.10

0.25

Sources: www.banxquote.com; Morningstar

What does the list tell us?

Lots. First, only two fund categories provide a higher yield than any brokered CD with maturity between 1 and 5 years. To get that higher yield you must not only accept the interest rate risk implied by the longer maturity, you must also accept lower credit quality.

That's not a very good trade-off.

Second, a simple 6-month brokered CD, yielding 6.05 percent, is now providing a higher yield than eight categories of fixed income mutual funds. A two-year brokered CD (6.75 percent) is now providing a higher yield than the average general bond fund (5.83 percent, 13.9 year average maturity) or short-term government bond fund (4.92 percent, 4.40 year average maturity).

Gaps like this will move billions.