One of the most important credit union innovations was the 1984 financial redesign of the NCUA managed insurance fund. Previously, NCUA’s share insurance fund had been structured on the premium insurance model of the FDIC and FSLIC. Both of those funds, created during the Depression had a 40-year premium head start on the NCUSIF, which was founded in 1971. Through the 1970s, NCUSIF was progressively rolled out to state chartered credit unions, which had created their own system of funds beginning in the 1960s.
When the 1978-1982 economic crisis of double-digit inflation and unemployment arose, the public policy response for financial institutions was deregulation. The structure of the FDIC and FSLIC was not changed to correspond to the new reality that market performance, not regulations, would determine the future of banks, S&Ls and credit unions. Both the FDIC and FSLIC subsequently failed and were bailed out by new legislation -- in the case of FSLIC, government funding.
The path of the NCUSIF was different. Credit union actions in 1984 reinvented the NCUSIF, but not as an insurance fund like FDIC to be funded with premiums. Rather the NCUSIF, modeled after the experience of state cooperative funds, was funded with a 1% of insured shares deposit as the primary source of capital.
The experience of the 1981-1984 economic slump revealed that a premium approach to funding the NCUSIF would not be adequate in a general economic decline. The purpose of the NCUSIF was to resolve problems, not expense them away. As the only source of collective capital, the new structure enabled the NCUSIF to use its section 208 assistance authority to inject capital into turnaround situations to enhance recovery strategies. In fact, the percentage of Code 4 and 5 natural person credit union assets has never been greater than during 1984-1987, and yet no premiums were required to steer through this period of system problems.
This collective capital approach of the NCUSIF not only minimized losses, but also became a source of system-wide confidence. In an economic or financial crisis, failure is not an actuarial or insurance event. Unlike auto, life, or homeowner’s insurance, deposit insurance’s actuarial assumptions are not valid when external factors create a series of interrelated failures that lead to a systemic collapse. Their projections may be adequate for random unconnected events, which an insurer can “payout” and then move on. In an economic downturn, however, resolving problems en masse can be the same as “selling at the bottom” during a market decline and saddling thus future years with these losses.
The FDIC has been insolvent, reporting negative net worth since June 2009, with a negative $7.4 billion at December 2010. With this model, both an explicit government guarantee and pre-assessments of projected premiums of up to three years to raise cash are critical to keep the fund operating.
Moreover, the FDIC was not even the primary source of assistance to its largest insured institutions. That was the U. S. Treasury in the form of the TARP program, which injected over $220 billion into the banking sector. This was an amount over four times FDIC’s balance sheet at the beginning of the crisis.
Recent NCUSIF Actions
If the NCUSIF cooperative capital structure is the more adaptable financial model for credit unions than the FDIC’s premium-financed fund, why is any change necessary? The reason is that the NCUSIF has not been managed as designed in three critical respects:
208 assistance, authorized to natural person credit unions by the FCU Act, has been lacking. Credit unions instead have been told to downsize, that is, to fit their balance sheet to whatever capital they have. This interpretation of PCA (prompt corrective action) is contrary to the FCU Act’s section 216, which directs that PCA be implemented with the unique characteristics of credit unions in mind (see section in sidebar). Throughout the worst financial and credit crisis in a generation, the collective capital of the credit unions was kept locked away in sterile deposits at the U. S. Treasury instead of providing credit unions recovery assistance.
The NCUSIF has overcharged credit unions for premiums, which it has based on projections with no objectively verifiable modeling. For example, in fall of 2009, the staff gave the Board projected losses on natural person credit unions for 2010 of $450 million to $1.6 billion. The actual numbers for 2010 to the NCUSIF were $35.5 million for losses due to economic factors plus $188 million for St Paul Croatian FCU’s failure. This federally chartered credit union had reported net worth of $31.6 million one month prior to its conservatorship. The total loss would thus exceed $219.6 million, or 87.5% of total assets, a failure, not because of economic circumstances, but because of some grand theft undetected by examiners.
For 2010, NCUA charged credit unions a premium $ 929.5million, which funded a reserve for losses of $1.3 billion at December 31, an amount 37 times the actual losses from economic events in 2010!
This 2010 premium was an expense for every credit union, reducing their net worth, as well as their ability to lend and grow. Moreover, it transferred cash resources for loans to the NCUSIF, which by law must redeposit the funds in the U. S. Treasury, thus limiting the ability of credit unions to expand their loan portfolios.
The NCUA’s reporting has not been transparent , timely, or responsive to the fund’s owners, which is the credit union community. The fund is a cooperative, owned by credit unions and funded with a withdrawable 1% of insured shares deposit. The NCUA has not met its statutory reporting requirements of an April 1 annual financial report nor the reporting that good governance principles would require of any organization, public or private.
What must be Done
Reform of the NCUSIF would first separate, by legislation if necessary, the insurance and the regulatory responsibilities into separate organizations. Today the insurance fund is used as a fig leaf for regulatory failures. There is an inherent conflict when the regulator claims to be acting to “protect the fund” while at the same time its own regulatory shortcomings are an integral part of the problem.
This separate cooperative insurance/capital fund would be governed by a Board elected by the insured much the way private insurance firms are structured today but with ex officio representatives from state and federal regulatory agencies.
The fund’s purpose would be as a source of collective capital and problem resolution when the chartering-supervision authority deemed a situation beyond regulatory redemption.
The fund would have its own operating staff but rely for examinations in the first instance on the primary regulator, whether state or federal.
Moreover, if legislation is required for this change, another vital change would be to give a credit union the right to select FDIC insurance coverage versus the cooperative model. Although the coverages are similar, the choice would highlight the difference in the two models, create competition among insurers, and give credit unions a real choice of how they want to pay for their share insurance.
Restoring Power of the Cooperative Model
The $10 billion in the NCUSIF is a collective resource that should be a major advantage of the credit union charter. Instead the funds sit idle at the U. S. Treasury. These credit union member funds are assembled, just like funds in the credit unions, to benefit all members. Instead they have been used as an in-house treasury by the NCUA board. Rather than acting as trustees for the members, NCUA has used funds to bury its own examination and supervisory shortcomings. It has assessed the maximum premiums possible without any verifiable loss model, even refusing to disclose the basis for its loss projections.
Because of the lack of institutional capital options, credit unions created a collective resource in their insurance funds. To regain this cooperative advantage, the NCUSIF must be placed under cooperative governance. Without this participation and representation, the fund becomes just another government program and a tax on credit unions.