The standoff between the Obama Administration and Congress over funding the government and raising the U.S. Treasury’s debt ceiling has important implications for the credit union system. This event should serve as a warning signal about credit unions’ dependence on outside liquidity providers and how that threatens the system’s financial stability in a crisis.
Short-term actions have resolved the current impasse; however, the ongoing strife between competing political ideologies remains. The potential for future acts of brinksmanship exists. Relying on government funding, even temporarily, is uncertain in a systemic or limited crisis — especially for an industry exempt from federal taxation.
The credit union system has until recently positioned itself to be self-funding for any liquidity event. Now that NCUA has dismantled the cooperatively funded Central Liquidity Facility (CLF) and regulated the corporate credit union system into insignificance, credit unions must turn to banks or government sources for liquidity. Neither has the financial sustainability of the cooperative system as their primary responsibility.
The Intended Consequence Of NCUA Regulatory Reform: Corporates Diminished, Liquidity Scattered
In June 2007, the corporate system had reached a new high in market share, holding 38.2% of all credit union investable funds. So pervasive were corporates that every one of the top 100 credit unions had an investment with one or more of them. These 100 largest credit unions had 35.4% of their total portfolios invested in the corporate network. In fact, three of the nation’s largest credit unions each reported more than $1 billion in corporates. State Employees’ Credit Union in North Carolina led the system with $3.5 billion invested.
As of June 30, 2013, the largest 100 credit unions collectively held corporate investments of only $3.4 billion — that’s less than what SECU alone had invested just six years earlier. Today, 31 of the top 100 credit unions report no corporate relationship at all. The remaining 69 credit unions invest only 3.9% with a corporate credit union, that’s approximately one-tenth of the amount invested six years earlier. The 100 largest credit unions altogether have investments of $148 billion but hold only 2.3% of this total in the corporate network.
This dramatic decline is reflected across the investments of all credit union sizes, not just among the largest. At June 30, 2013, only 7.1% of the combined $394 billion in cash and investments for all credit unions were on corporate balance sheets. Further, the $22.2 billion in corporate shares at midyear was a decline from the $32 billion reported one year earlier, this despite the growth in total investments.
Corporates were vital in providing system-wide aggregation of surplus funds, which allowed for cooperative resources to manage any market crisis. New regulatory limits prevent this aggregation that had pre-positioned credit unions to be self-funding in every prior liquidity crisis including the most recent Great Recession.
An Investment Diaspora Throughout The Market
Today, credit unions individually direct more than 90% of their investments outside the system’s internal aggregation. For example, credit unions reported more than twice the amount of investments, $48.6 billion, in banks than the $22.2 billion in corporate shares at midyear.
Over 25 years, the corporate network had developed its role as the cooperative liquidity safety net on which all credit unions could rely. Liquidity means not only having investments on the balance sheet but also the ability to readily convert these assets, whatever term, to cash without significant principal loss. Investments in corporates were mostly short term and readily liquid, even if the credit union had to borrow against a longer-term certificate. This collective capability to fund credit unions was dramatically demonstrated during the recent financial crisis. No credit union had to deny funding for borrowers or savers, even as markets froze across the world.
Moreover, the corporate network provided funding for the CLF in its role as the dedicated cooperative “lender of unfailing reliability” with congressionally approved borrowing capability of more than $40 billion. Today, the CLF has slightly more than 140 members and a borrowing capacity reduced to less than $2 billion. The cooperative credit union system has neither an internal nor an external liquidity solution. Every credit union is left on its own to plan for systemic or local liquidity threats.
When corporates held 35% of credit unions’ investments, those funds were essentially always liquid. There was significant value for every credit union, large or small, to be a part of this broad liquidity pool. Both the structureof the investment products and the fact they were not subject to available-for-sale or held-to-maturity classifications made them fungible if ever needed. This liquidity cushion no longer exists; the CLF backup thatcorporates funded is not credible in its current structure, and regulatory limits prevent corporates from expanding their role even if they wished to do so.
Each credit union must manage its individual cash flows and investment portfolios to respond to whatever external changes might impact its balance sheet. But most alarming is that in a crisis, NCUA has made the continuing operations of credit unions dependent on the government — and as events have shown, that source is not reliable.
Two Wake-Up Calls: Why Restoring A Cooperative Liquidity System Must Be A Top Priority
In May, Fed Chairman Ben Bernanke announced that the Federal Reserve would begin tapering its purchase of investments as part of a strategy to reduce monetary easing as the economy gained momentum. The market response was instantaneous — longer-term rates as measured by the 10-year Treasury rose more than 100 basis points. This yield curve change immediately caused a decline in the value of investments with terms longer than two or three years. Callable securities extended beyond the call dates and prepayments of mortgage-backed collateral slowed. Credit union investments became much less liquid, some even frozen, as drops in value made it costly or impractical for credit unions to rebalance portfolios for liquidity purposes.
The government funding impasse produced two other uncertainties. One was the specific impact on cash flows for credit unions with government employees or contractors enrolled in payroll deduction that were temporarily stopped. And with only a short-term solution reached, those cash flows are still unreliable. This cash-flow problem comes at a time when members are relying on their credit unions to provide lines of credit or other accommodation as they lose control of their own cash flows.
The second impact is on the certainty of government borrowing. Some members of Congress at the center of the debt-ceiling showdown commented that a default by the government might not be significant for the economy. For credit unions, this casts doubt on the two minimal liquidity lines of credit remaining: the $2.0 billion of potential CLF draw and the unused balance of the TCCUSF, which is to be used solely for the corporate resolution.
Restoring The Cooperative Liquidity Safety Net
The political gamesmanship being played out now in Washington in part reflects the much stronger state of the economy. One can only imagine what this ideological intransigence might cause in a real crisis — whether national in scope or isolated to a particular region or industry. Can any sector expect to receive government funding, even temporarily, given the political dynamics? This would seem especially dubious in the case of the tax-exempt credit union system whose regulator had defunded the cooperatively designed safety net.
Credit unions were started with no government support, no insurance, no access to the Fed or FHLB system, and no external capital. They were seen as an alternative, independent model to the financial systems that had failed. Isn’t now the time to go back to this core concept and create a cooperative alternative before the next threat to liquidity and credit union stability materializes?