While justifying the Administration’s $700 billion bailout proposal last week, Treasury Secretary Paulson testified in Congress that it would cover all financial institutions, specifically including credit unions on the list.
Most segments of the economy, including credit unions, could benefit if the program works. However, directly participating in this program could be a serious error for credit unions.
The reason: credit unions were not part of the problem and should not be tarred with the same brush as those who were. Instead credit unions have been and continue to be part of the solution.
Credit Unions Have Never Used Taxpayer Funds
Identifying credit unions as beneficiaries of a tax-funded bailout could seriously jeopardize their status as tax-exempt cooperatives.
Never in their history have credit unions asked for or received taxpayer funds. Not in 1909 when the first charter was issued, in 1934 when the Federal Credit Union Act was passed, in 1971 when the NCUSIF was established, in 1978 when the CLF was organized or in 1984 when the 1% funding solution for the NCUSIF was passed by Congress.
Cooperatives are established because market solutions do not always work or offer fair solutions to consumers. They provide a "middle way" between government funded or market-driven solutions.
Not Dependent on Market Expectations
As cooperatives, credit unions are not subject to the market-driven expectations for growth and earnings performance. There are no shares to be "shorted." Value is based on what is on the books, not an external share price. Cooperatives rely on members for their funding, not secondary markets or stock sales. Wholesale funding comes from the corporate network or the FHLB system, not commercial paper or Wall Street underwritten bonds.
Throughout the crisis, credit unions continue to do what they have always done—serve their members with competitive savings options and fair loan rates. Through June 2008, credit unions reported the highest six month loan origination in their history, a 40% increase in mortgage volume versus '07, and gains in market shares in autos, credit cards and mortgages.
Open for Business
Through every stage of the current crisis from the special Federal Reserve funding, to the Bear Stearns assisted merger, the takeover of Freddie and Fannie, the nationalization of AIG, and the failure and mergers of Countrywide, WAMU and Wachovia., credit unions continue to loan money and seek savings.
While not immune from the economic fallout, the credit union system has increased capital by over $2 billion in 2008 even in the face of increased chargeoffs and delinquencies. Credit union ROA has led all financial intermediaries for the last three quarters.
Common Sense in an Economic Revolution
As the mortgage and broader economic events have unfolded, we have characterized the situation as an economic revolution, not merely a cyclical downturn. Markets are fractured, firms are failing, delivery channels and secondary markets closed, and new solutions are being sought out.
In the first year of our country's political revolution against the English King, Tom Paine wrote a pamphlet called The Crisis, with the immortal opening line: "These are the times that try men’s souls."
Why did Paine use the word "souls" and not courage, or wisdom, or patience or resources? Sooner or later every revolution challenges its participants to be clear about who they believe they are and what they are doing.
This economic crisis can once again be a demonstration of the power of the cooperative model, but not if we take the King's schilling. At that point, we lose both the moral and political authority to differentiate our solutions from those who did create the problem.
Should the Treasury bailout, or some variation pass, there will be an opportunity to sell distressed securities and possibly delinquent mortgages to the government. But at what price?
Multiple Pricing Issues
The intent in buying troubled assets is to keep liquidity flowing in the financial system.
Three levels of “pricing” questions will be involved:
How will a fair price for illiquid or troubled assets be set? It is highly unlikely this will be book value. Therefore, for any credit union that participates, this solution will most likely convert an unrealized loss into a realized one. Can a credit union’s balance sheet absorb this?
What compensation will the government ask for when buying illiquid assets? Limits on executive compensation, warrants for stock purchases and other proposals suggest that the government will be looking for more than just any appreciation in value that holding these securities may bring.
What will be the regulatory reforms imposed to “promise the public” that there will be no more bailouts? These reforms could be draconian. They could range from a complete restructuring of federal regulation as proposed earlier by Treasury to specific constraints that would put credit unions in the same box as the institutions that caused the problem.
The bottom line on the bailout proposal is there appears to be no benefit and almost inevitable certainty that participation will put credit unions in the new regulatory framework as the institutions that brought about the crisis.
Helping Credit Unions in Trouble
In fact, credit unions are part of the solution and all data for the last year supports these efforts in responding to members’ needs.
So, if taxpayer funds are not the answer, how does the system help credit unions confronting liquidity or capital issues?
Credit unions have two resources not available to market-driven firms: patience and cooperative resources. Patience means that if problems are due to cycles in value, credit unions have leeway in riding out the down cycle—if the asset quality issues are contained.
Secondly, in extreme cases where capital is insufficient, credit unions can be funded by the NCUSIF. Credit union’s pooled insurance fund is a source for re-capitalization when other options such as mergers or sales are not feasible. Problems do not have to result in liquidation.
Finally corporate credit unions have multiple options beyond these because of their unique structure. Extending some of these options to the entire system should be one of the objectives for regulatory reform that will be enacted in response to the current crisis.
So why take the King’s schilling? Indeed, credit unions were created by government policy to meet needs when markets fail to do so.
The Credit Union Way
New regulatory legislation will not only be part of any bailout. It will also be a top priority for the new administration. Why? Because we know now who the new GSEs-- that is stockholder-owned companies that are too big to fail--will be. They are Citigroup, Bank of America and JP Morgan Chase. A couple more may be added to this list before the markets are settled.
So no one will want to repeat the Fannie-Freddie mistake of letting shareholders benefit but government taking the losses. These trillion dollar financial conglomerates will face a new regulatory attitude and structure.
Regulatory "Reform" Already Underway
Already some are predicting the end of the OTS and the thrift charter. OFEO now regulates the FHLB system, not the old five-person board.
It will be critical in this environment that credit unions have their legislative priorities clearly defined, if they are to stay clear of the new regulatory vortex that will be created in 2009. What should these priorities be?
Credit Union Regulatory Reform
Every initiative should focus on strengthening the credit union system’s ability to serve members in a cooperative structure. The changes that would make this more effective could include:
Membership capital accounts. Similar to USAA’s insurance model or Vanguard’s mutual funds which own their advisor, membership capital ties participation and ownership together in the member’s relationship.
Clarified Role of CLF. Make explicit, if necessary, the role of the CLF in providing liquidity to the system by promoting access to secondary markets with CLF involvement.
Enhanced transparency for members and a clearer process for capital accountability in the event of conversion.
Easier rules for banks and thrifts to convert to a credit union charter. Given the probable changes in bank regulation, the cooperative charter may become much more attractive.
Clearer standards to encourage the chartering of new credit unions as an Agency responsibility and priority.
Each of these key areas would significantly enhance the role of cooperatives as providers of economic resources to their members.
The core focus, however, should be to keep the cooperative model intact and separate from the market-driven model of banking. Additional ideas such as increasing CUSO investment limits or incentives for member savings could be included as long as they enhance the cooperative structure.
Why Cooperatives Matter
Cooperatives are especially important in times of market crisis. As hard as regulators and legislators will try to prevent future problems, these are an inevitable part of the market’s creative dynamic. A clear statement of this reality is an excerpt from Rudyard Kipling in 1919:
Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.
Cooperatives manage their copybooks for members, not for the Gods of the Market.