Wanted: A New Governance Model For The Central Liquidity Facility

The CLF contains $2 billion of credit union capital. What kind of governance model for the CLF would allow credit unions to never depend on the kindness of strangers?


In a March 29, 1985, letter to President Ronald Reagan, which included NCUA’s 1984 annual report, The NCUA Chairman singled out the accomplishments of the Central Liquidity Facility.

“The central bank for credit unions was voluntarily capitalized,” the Chairman said. “Now every credit union has access to a government-managed lender particularly sensitive to its needs and prepared to meet any unexpected liquidity crisis.”

The first item in the report’s highlights describes how this happened: “NCUA Central Liquidity Facility is fully capitalized under a history-making agreement between the CLF and U.S. Central. More than 18,000 natural person credit unions now belong to the CLF either directly or through the corporate credit union system and have access to a permanent source of backup liquidity.”

Fully Capitalized, But Non Operational

The CLF is still fully capitalized today. According to the Dec. 31, 2011, annual audit, credit unions have $2.060 billion in capital in the CLF. That amount exceeds the entire natural person credit union investment in the corporate network by almost $500 million. Yet, there are no members, no corporate distribution system, and no information about how the facility is supposed to function. Its credit union-owned capital and $26 million in retained earnings are up for grabs (2011 CLF annual audit, page 4. Page numbers reference the specifc page of the audit, not the pdf document).

Moreover, the corporate agents play, at best, a partial role today compared to 1984. In the December 2011 call report filings, 1,678 credit unions reported no paid-in or membership capital shares in a corporate. These credit unions comprise 23% of the system and are responsible for 39% of the industry’s total assets.  

25 Years Of A Cooperatively Designed Solution Gone

Today’s $2.0 billion in capital is the result of credit unions voluntarily subscribing to the CLF. As described in the CLF’s 1984 annual report, the CLF was designed as a partnership between the fund and the corporate credit union network. Each natural person credit union contributed membership capital to their corporate credit union. The corporate, in turn, sent a membership capital contribution to U.S. Central, whose authority as the membership agent for all corporates not already members of the CLF was accepted on Oct. 4, 1983. U.S. Central sent this contribution — which totaled one-quarter of 1% of natural person credit unions’ shares — to the CLF as funding. The funding enabled the CLF to draw upon its full borrowing authority and gave 100% of credit unions access. (Click here for a history of the CLF.)

This design ensured the CLF could support itself and not have to build an expensive infrastructure, like the Federal Home Loan Bank system, to reach its members. The CLF’s capital came from credit unions, not government funds.

The CLF stock subscription has always been voluntary, never mandatory, and according to NCUA 2011 annual audit, the capital stock is “redeemable upon demand by the members,” (2011 CLF annual audit, page 14, footnote 8). However, since NCUA conserved U.S. Central in 2009, it is unclear if credit unions still have the ability to redeem their capital.

Changing The Cooperative Agreement Without Consultation

U.S. Central managed this cooperative solution on behalf of the corporate network, and the NCUA board reaffirmed the solution annually until 2009. In 2009, NCUA unilaterally changed the terms of the 25-year funding arrangement between U.S. Central and the corporate system. The CLF’s independent auditor, Deloitte, issued its opinion as of December 2008, stating the CLF was insolvent due to the failure of U.S. Central. The auditor understood the CLF’s capital was a portion of the membership capital shares that were extinguished by NCUA’s OTTI loss provisions for U.S. Central’s investments.

That 2008 opinion, released June 10, 2010, more than 18 months after December 2008, would have meant the CLF capital was gone and the CLF’s borrowing authority non-existent, so NCUA changed auditors. The new auditor, KPMG, reversed that finding in the 2009 annual audit, which restored CLF’s solvency and its credit union capital in “conformity with U.S. generally accepted accounting principles,” (NCUA 2009 annual audit, page 1).

In the past two years, NCUA has transferred $258 million from U.S. Central’s books ($139 million in 2010 and $119 million in 2011) to the CLF’s capital account. “Subscriptions are adjusted annually to reflect changes in the member credit unions’ paid-in and unimpaired capital and surplus,” (2011 CLF annual audit, page 14, footnote 9). U.S. Central is supposedly insolvent, yet NCUA does not explain from what U.S. Central account it transferred these funds. And as NCUA never notified or consulted the members of U.S. Central or credit unions about this transfer, they could not provide authority for the transfer.

In the 2011 CLF annual audit (page 15, footnote 9), NCUA states the five bridge corporates chartered by U.S. Central were “chartered private enterprises to purchase selected assets, including CLF capital stock held by USC.” But why would corporates have to purchase stock in the already-funded CLF?

A Series Of NCUA Intentions

Since 2009, NCUA has issued a series of statements indicating the CLF’s future was always a part of its plan for the corporate network.  

  • NCUA plans to discuss the future of the emergency loan fund with credit union groups over the coming months before determining a new ownership structure, said CLF President Owen Cole during an August 2009 webinar (Credit Union Journal, Aug. 11, 2009).
  • The NCUA board will consider a proposal in the “near future,” said John McKechnie, NCUA director of public and congressional affairs (Credit Union Times, Aug. 12, 2009).
  • CLF has a plan for the transfer of ownership of the capital stock to member credit unions when USC Bridge ultimately winds down (NCUA 2010 annual audit, footnote 7). No such plan has been published.

In the 2011 CLF annual audit (page 15, footnote 9) the latest intention is stated: “As part of the Corporate System Resolution Program the NCUA Board had been actively pursuing a credit union system-led resolution to the Bridge corporates to facilitate a number of transitions, including a CLF agent-member structure.  As of Dec. 31, 2011, neither USC’s members nor NCUA was able to secure a transition of USC’s products and services to a successor entity. … Accordingly, it is likely that USC Bridge would discontinue its role as the agent group representative for CLF and redeem its capital stock by providing a formal notice to redeem its shares as provided for under the act.”

Nowhere is it stated what this redemption means. Through the corporate credit unions, natural person credit unions own the $2.0 billion in capital. These funds should be returned to the credit unions that capitalized the CLF in the beginning. 

Liquidity And The CLF

In his 2009 annual letter to Berkshire Hathaway shareholders, Warren Buffet said, “We will never become dependent on the kindness of strangers. … When the financial system went into cardiac arrest in September 2008, Berkshire was a supplier of liquidity and capital to the system.”

In this case the system was the capitalist system. His liquidity investments included Goldman Sachs, Tiffany & Co., General Electric, and Harley-Davidson, among others.

A liquidity crisis is a disruption of a firm’s ability to transact with a marketplace. It can be specific to an institution, an industry, or a country. It can even be global. Regulation cannot make lenders lend or market participants buy assets.

The CLF was a cooperative solution to the possibility of a financial-liquidity crisis. It is hard to imagine circumstances more dire than the global liquidity freeze in 2008 and 2009.

In this crisis, the corporate system did its job, credit unions never stopped lending and members learned they could count on their cooperative even as the largest and most highly rated financial and industrial firms required trillions of dollars of government funds and guarantees. Markets were closed to blue chip firms. Capital did not matter, only cash.

The cooperative system worked, even though individual corporates themselves were strained. That integrated and self-supporting system has been dismantled. The 4,500 credit unions that were part of a system-wide settlement process, with cash management provided by U.S. Central and its members, is now broken.

The problem requires more than fitting the pieces back together, like Humpty Dumpty. The glue, which is confidence in NCUA to work cooperatively, is missing.

The lessons of CLF availability and support during the financial crisis are mixed. NCUA had stated the CLF was not available for loans to the corporate system despite both precedent and clear statutory authority. The 2010 CLF annual audit (footnote 11) states the NCUA board had approved a $20 billion Funding Commitment and Agreement on March 20, 2009, for WesCorp and U.S. Central. Three days later, $10 billion was advanced.

These commitments dwarf the minor assistance made to credit unions for protracted assistance during the same period. These events suggest the CLF was merely an extension of NCUA’s regulatory activity, not a reliable source of liquidity for the credit union system. In fact, credit union advances from both the FHLB system and the Federal Reserve were the primary source of borrowing during the crisis.

NCUA’s most recent effort to maintain the CLF is an emergency liquidity proposal that would, by rule, mandate CLF membership, or a line with the Federal Reserve, or an investment portfolio with Treasury holdings. Most commentators on the proposal agree the CLF is desirable, but not with the current governance and management structure.

The FHLB system and the Federal Reserve were more responsive to credit unions during the crisis. They have a clearer set of lending guidelines and management authority then the CLF. For example, a Federal Reserve borrowing requires no capital investment, its list of qualifying collateral is broader than the FHLB system’s, and the funds borrowed can be used for any purpose. However, serving credit unions and ensuring the stability of the cooperative system are not the primary purposes of either of these organizations.

Critical Steps To Build Confidence

For NCUA to redesign the CLF as a meaningful option for the cooperative system, it would need to:

  • Publicly declare the $2.0 billion in capital belongs to credit unions and is returnable upon demand. This is what is happening today with regular members who routinely withdraw their funds. This would also remove any issues about funding or capitalization of the CLF.
  • Develop a CLF governance model that includes direct participation by the credit unions and their corporate agents.
  • Publish the lending criteria, especially the CLF’s ability to serve members in economic distress.
  • Coordinate the role of the corporates so their agent role is clear and not a further capital requirement.
  • Bring in outside assistance to listen to interested parties — including corporates — and design a system for the next 20-50 years.

The best way to design this new entity is through public hearings in which all parties could present their pint of view. That dialogue should then become a basis for formal proposals. Indeed, the former CLF role was designed using the recommendations of the National Credit Union Capitalization Commission’s report.

If the NCUA continues with its current approach to impose CLF membership, then the largest credit unions will choose the FHLB and Federal Reserve, the corporates will be unable to support borrowings, and the system aggregation capability to tap Treasury liquidity will be de minimus.

To borrow Warren Buffett’s term, NCUA is a stranger to the credit union system in its CLF management.   Other more reliable options exist. If the CLF is not quickly redesigned, then the fragmentation of solutions, both inside and outside the system, might only be a harbinger of greater disintegration. Why participate in a system if the system pushes members outside for solutions?