In a financial crisis, the most important factor in stabilizing an institution, a whole industry, or markets generally is liquidity. Liquidity is the capability of individuals and institutions to withdraw their deposits or other assets at par. Without that assurance, panic can ensure, forced sales of assets cause values to decline, and losses lead to insolvency.
We have just seen such events unfold in exactly this fashion. It is called the Great Recession.
After years of effort, credit unions in 1977 passed legislation to establish an industry-owned and -funded Central Liquidity Facility. In some respects, the facility was modeled after the Federal Reserve. But there were significant differences in operations -- the Facility was a cooperative innovation in both its capital structure and operations via the corporate network of agents and a group agent.
Congressional intent was clear in CLF’s establishing legislation. The specific purposes were listed in Section 301 of the Federal Credit Union Act:
Congress finds that the establishment of a National Credit Union Central Liquidity Facility is needed to improve general financial stability by meeting the liquidity needs of credit unions and thereby encourage savings, support consumer and mortgage lending, and provide basic financial resources to all segments of the economy.
Remarks by Congressman Fernand St. Germain when he and Henry S. Reuss, Chairman of the House Committee on Banking, Finance and Urban Affairs, introduced the CLF legislation, were specific in their intent to establish a separate cooperative system of liquidity:
The traditional sources of external liquidity for credit unions have been commercial banks, central credit unions and other credit unions. In many cases the reliability of these sources is easily threatened as was the case during the more recent credit crunch periods when competition for funds was intense. At such times commercial banks, credit unions and all other financial institutions suffer the same liquidity pressures. . . .
The CLF as proposed by this legislation would offer credit unions a reliable source of liquidity, which will greatly enhance the existing system of corporate central credit unions. If the existing system of corporate central credit unions fails to supply the capital needed at reasonable rates, credit unions will be able to call upon the CLF for their needs. The CLF will have at its disposal a spectrum of approaches . . . . The mere existence of the CLF as an alternative source of liquidity will greatly enhance the credit unions’ bargaining position in dealing with local money sources.
The legislative record has many other references showing that Congress intended the CLF to serve the same purpose as the Federal Reserve’s discount window serves for commercial banks and the FHLB Board serves for savings and loans. (Sen. Rep. No. 95-1273 at 5-6 (1978))
When the CLF legislation was finally passed, Congressman St. Germain added a discussion of the CLF in the Extension of Remarks section of the Congressional Record on October 14, 1978, saying in part:
“The committee believes the facility should be available to enhance the Federal government’s ability to improve the economic well being . . . . To assure the facility is able to contribute to the nation’s economic well-being by stimulating consumer lending when it is in the national interest, your committee expects the non-expansionary provision not to apply . . . .”
The CLF during the Great Recession: Missing in Action
Given this legislative history, what was the role of the CLF during the worst financial crisis since the Facility was established? A polite appraisal might describe the CLF as Missing in Action; a more appropriate phrase might be derelict of duty. Here’s why.
At the peak of the crisis, credit unions, Congress, and the NCUA were successful in raising the CLF’s borrowing authority from the $1.5 billion initially appropriated to the full 12 times subscribed capital, or $41.5 billion. Thereafter, both natural person credit unions and corporates made multiple inquiries and proposals for CLF assistance.
But despite a clear legislative history and precedents, NCUA said it would not lend to corporates. And the natural person efforts were so distorted as to become meaningless in practice.
Astonishingly, however, the Federal Reserve did not have any problems with credit union borrowing. In October 2008, 13 credit unions, including two corporates, made 88 draws for $34.7 billion. Most, but not all, of the loans were overnight or for seven days. In the following month, 12 credit unions made 94 short-term draws for $96.9 billion. Overnight amounts ranged from a high of $6.0 billion to a low of $25,000.
The Federal Reserve lends only on a secured basis so it is assured it will get its money back. The Fed was responsive not only to individual institutions but also to putting liquidity into markets at a time of extreme uncertainty. The Federal Reserve responded to the institutions that the CLF was funded by and designed to serve, but did not.
The CLF’s efforts at lending in late 2008 via SIP and CU HARP were so poorly designed that they were ineffective for both credit unions and corporates. In March 2009, after the liquidity crisis had significantly abated, then the CLF made two loans of $5 billion each to WesCorp and US Central, an action the Agency had previously declined to make.
A Reformed CLF
The current management structure of the CLF does not meet Congress’s purpose for the CLF when the legislation was passed. Currently, credit unions have funded over $1.9 billion of CLF capital stock, but there is neither a clear ownership structure nor an operational capability of serving multiple credit unions quickly.
A reformed CLF would have the following characteristics:
- The CLF would be separated from the NCUA and run as a separate mixed-government ownership corporation, and with its own budget;
- The Board would consist of credit union representatives elected by members, similar to the FHLB, plus ex officio representations from state and federal regulators;
- The CLF would rely on the distribution and underwriting capabilities of the corporate network for extensions of credit;
- The CLF would continue to rely on the Federal Financing Bank and Congressional appropriation for its liquidity lending role;
- With its members, the CLF would develop capabilities to aggregate credit union loans for secondary market sale, setting standard underwriting and servicing requirements. Such sales would include performance “guarantees” as necessary to ensure competitive pricing for credit union access to the market; and
- The CLF would have independent audits and be subject to normal governance processes (reporting, annual meetings) required by the owners to ensure responsiveness and compliance with public policy requirements.
How to Make the Transition
The CLF, of course, already exists; it is fully capitalized with retained earnings and has a line of credit for funding. Two initial steps to enact the above reforms are:
- Members request redemption of all current shares until a new operating structure is in place; and
- Stakeholders write legislation to establish an independent, cooperatively owned CLF with explicit oversight in order to serve the original Congressional intent for the Facility.
Between the CLF’s creation and the Great Recession, the CLF lost its ability to respond as designed. This is not a management issue, but a structural flaw that can be corrected. When a crisis occurs, a reliable source of liquidity is the difference between a problem and a disaster. The Federal Reserve was able to act; the CLF was not. Now is the time to correct this flaw.