When Ed Callahan went to NCUA in 1981, the Illinois Credit Union League presented him with a framed memento to hang in his DC Office. The sign read: "We don’t run credit unions."
At one reading, the sign merely summarized Ed's approach to deregulation: boards and managers were responsible for their institution's business decisions. In a different context, it also captures the fundamentally different skills required to be successful in the competitive market versus a government regulatory agency.
That difference was forgotten last Friday when NCUA put itself in charge of the two largest Corporates, with total assets of over $60 billion, through conservatorship. This action raises profound questions about the Agency's wisdom in taking this extraordinary step. All credit unions should be concerned.
Seven weeks ago the Agency stated that the uncertainty in investments in the Corporate network was a systemic problem. As described in a speech by Federal Reserve Chairman Bernanke on March 10: "The world is suffering through the worst financial crisis since the 1930's . . .Its fundamental causes remain in dispute."
This context and the accompanying logic of patient, longer-term cooperative solutions to avoid any forced sale was overturned when the Agency acted to conserve. There are at least three areas where the Agency’s actions are, at the least troubling, and at worst, creating a crisis where one did not exist.
How Did the NCUA Board Reach its Decision?
The logic presented by NCUA staff in its webinar on Monday, March 23rd, and in writing was that the system loss of $4.7 billion six weeks earlier had now been revised to $5.9 billion. This was due to a more comprehensive and thorough modeling of the investments, NCUA said with the PIMCO expertise frequently mentioned. Moreover, the "specific case" loss provision had gone from $1.0 billion to $5.0 billion, or 500% in this same period.
These dramatic changes over such a short time period should have been enough to cause the Board to question the data presented by staff. Even more fundamental, the determination of a "specific" number in establishing future credit losses in a dislocated market is impossible. The best minds on Wall Street, in Treasury and in think tanks and academia around the world are unable to do this. The outputs depend entirely on the future assumptions put into the model and the "scenarios" selected.
But in this case the Board, less than 6 weeks from having one set of “facts” presented to it and taking systemic action, now has another set of “facts” for securities losses extending out over ten years and, based on this “latest information,” decides unanimously to conserve two Corporates.
The impossibility of point estimates is acknowledged by NCUA in their $7 billion to $16 Billion range of loss projections presented in the webinar. However based on their selection of the "base case" outcome, they are asking credit unions to record losses on their income statements of almost $10 billion. None of these losses have yet occurred. However the Board is asking credit unions to write-off their entire 1% deposit in the NCUSIF and for shareholders in US Central and Wescorp to additionally write-off their entire MCS-PIC holdings. All this based on a change in a "point estimate" of at least 500% in six weeks for two of the Corporates.
Surely the Board must have seen that this kind of numerical accuracy is impossible and will change with the next set of input parameters, tomorrow, next month and next quarter. The staff said that they have contracted for three more PIMCO model runs. Secondly, this certain information was presented by the same staff who as recently as last July in public statements were assuring credit unions that they were in daily oversight of the Corporates and that the policy of holding through the dislocations was sound.
Unfortunately the data was also being presented as "honest" in contrast to the numbers developed by the Corporates. If the NCUA was so sure of their superior knowledge, why did they not present the information to the Corporates, their auditors and boards and then let the consequences fall where they should if there was dishonest data? Surely the Board must have been aware that if the staff was saying the Corporates were presenting self-serving information by selecting favorable assumptions, then how did the staff validate their own assumptions?
The Second Issue:
There is a fundamental difference in the skills and mind set need to run a market-based institution trying to succeed in a competitive economy and the capabilities that lead to success in a governmental career. This is not about domain knowledge but about leading teams, reading customer reactions, and understanding competitors versus creating programs and policies with formal authority from a statute.
As the regulator now becomes the regulated, how will it manage the inevitable conflicts in those two roles? How will the board of NCUA career employees decide between pricing to gain market share versus building capital; between investing in customer service and reducing expenses; between evaluating risk as viewed by an examiner versus need from a member credit union that has just seen 10% of its net worth eliminated by an external event? How does the CEO build a business plan-what are the objectives? How does he communicate and get reliable input from a market that has just had to write off over $1.0 billion because of an estimate whose details are unavailable to members?
The questions will go on. One of the most disconcerting points in NCUA's webinar was the repeated request, or was it a threat?, that credit unions need to continue to support the Corporates because if there were a liquidity crisis that caused a sale, then the expense would just go higher. With NCUA now in control, can they still blame credit unions if it is their leadership that is in charge of the outcomes? Or does NCUA even intend to "run" the credit union or just liquidate the assets as quickly as possible?
The Final Concern:
The government, the Treasury and all financial regulatory agencies have one overriding responsibility: to maintain public confidence in the areas of the economy they oversee. If actions undermine this fundamental trust, then no matter what safety and soundness rationale is provided, the NCUA or any regulatory agency has failed its most basic function.
In the Corporates, all of the fundamental cash flows, external borrowings, earnings and member confidence were showing very positive signs. Preliminary audit results were provided to the Agency by outside auditing firms. Plans were in place to pay down the legacy assets and to set up separate settlement solutions. NCUA has identified nothing they wanted to accomplish that was not possible through the LUA process in place—and that includes, if deemed necessary, management and board changes. However, the only logic NCUA presented is they wanted to be "in control."
NCUA's actions have led to an immediate write-off of almost $6 billion in the NCUSIF deposit and another $3 billion in MCS and PIC shares. Not a single loss in the portfolios has occurred, rather this is all based on estimates by recent model runs that show potential losses going from 2-10 years in the future.
The cooperative model provides options that other industries do not have because there is not private ownership or taxpayer interest to parse losses between. The ability to recognize losses as incurred and match expenses was and still is feasible.
Now having created greater book losses, increased apprehension, and diminished the trust, confidence and support that every government agency relies upon, the Agency is saying it must go to Congress to ask for governmental assistance to be housed in the NCUSIF. Not one dime has been spent, even the billion dollars transferred to US Central is still on the books.
But this could be a very fortuitous event. Perhaps Congress could ask to see how the Agency arrived at numbers so accurate for credit unions to request a specific line of credit (to be used as capital), a challenge so far eluding Treasury, the Federal Reserve, other financial regulators and every market participant, except PIMCO. The whole country should have the benefit of NCUA's process and models, not just credit unions. I think Congress would welcome that insight for the whole country.
Ed Callahan said it best:
"A single regulator is sooner or later bound to become a lazy or arrogant regulator. The best ideas will not bubble up; the regulated will not flourish."
-- pg 47, The Coaches Playbook