by Calculated Risk on 2/20/2009 10:07:00 AM

I frequently receive questions about what happens to FDIC insured CDs when a bank fails.

Tom Petruno at the LA Times explains: If your bank is bought, your CD yields could be slashed

Late last year, struggling [Culver City-based Alliance Bank] had been offering yields of 4% or higher on one-year certificates of deposit -- well above market averages -- as it sought to pull in cash to stay alive.
...
[Alliance] was seized by the Federal Deposit Insurance Corp. on Feb. 6, and was sold to California Bank & Trust of San Diego.
...
California Bank & Trust didn’t pay those kind of yields, and won’t now: The bank has sent letters to Alliance customers telling them that the annualized yields on their CDs will be unilaterally reduced to 1.4%.

If depositors don’t like that yield they’re free to cash out, with interest earned to date and without an early-withdrawal penalty ...

The acquiring bank has the option of paying the higher yield, or they could lower the yield, and give the borrower the option of accepting the new rate or withdrawing their money without penalty. Note that the CD investor does receive the higher yield up to the day the bank is seized.