Category: Co-ops in Capitalism

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Why Cooperatives Exist in a Market Economy

While it is true that cooperatives create “common wealth” to be paid forward for use by future generations of cooperative members, the context of why this option is critical in a market economy is often overlooked.

The following statement by Mark Carney, Governor of the Bank of England, in a May 29, 2014 speech, outlines the importance of the contribution from cooperative design:

Just as any revolution eats its children, unchecked market fundamentalism can devour the social capital essential for the long term dynamism of capitalism itself. . .Prosperity requires not just investment in economic capital, but investment in social capital; that is the links, shared values, and beliefs in a society which encourages individuals not only to take responsibility for themselves and their families, but also to trust each other and work collaboratively to support each other.”

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Just Another Bank?

From the 2008 Filene study: The Credit Union Brand: What is it good for?

“For years now, it seems that credit unions have placed themselves more and more in the bank brandscape, and our research supports this conclusion. What a pity that credit union members think that credit unions are just another bank. But when you look at credit unions, what is there about them that signals to consumers that they are not banks? The buildings are often designed to look exactly like a bank. Consumers conduct their financial affairs in a similar manner. Often even the advertising shouts “bank!” These signals do not go unnoticed by consumers. And, it appears that some credit union management may have felt that credit unions as financial institutions didn’t get the same respect as banks in the past; thus a natural reaction would be to try to make credit unions more like banks to attain the same status.“ (page 41)

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The Cost of Not Learning from Our Brethren’s Mistakes

Over the past twelve months the credit union community is on the hook or paid the bills for the following situations:

  1. A $1 billion cash payout for the Melrose CU and LOMTO FCU liquidations;
  2. An estimated $40.5 million shortfall for a two decade embezzlement by the CEO at CBS Employees FCU;
  3. A $125 Million write off at Municipal Credit Union at June 30, while under NCUA conservatorship.

In each situation there has been no objective, public discussion of what happened. No lessons have been taken away from these extraordinary losses and how they might be eliminated or mitigated in the future.

Specifically:

  • NCUA has said nothing about its Municipal Credit Union conservatorship as the credit union reported the largest loss ever at June 30.
  • In Melrose’s case the primary publicity has been about suing the former CEO for accepting vendor’s trips and other self-interested actions.
  • For CBS Employees FCU’s extraordinary embezzlement, the throw away characterization has been that the CEO was a former NCUA examiner and therefore knew how to hide his two decade defalcation based on his examiner experience.

No Return for Casting Judgment

When a loss occurs, there is a rush to judgment. What went wrong? Who screwed up? Why did this happen, again?

The natural response is to point fingers, blame someone for the problem. Then punish or banish wrongdoers from ever working at a credit union. And resolve the loss by paying for the shortfall out of the NCUSIF—and move on.

While indicting possible malfeasance may be necessary, it can miss entirely the lessons to be learned. The result is that there is no return on the money expended. Credit union monies are swallowed up in a regulatory “black hole.”

Discernment: A Powerful Form of Judgment

For informed judgement is about discernment, understanding the circumstances of what happened and identifying the possibly numerous opportunities to have done something about the situation much earlier.

Judgement is much more than holding people accountable. In the cooperative community, all members pay for the individual losses via the NCUSIF. Therefore the most important benefit should be corrective actions or processes that can prevent similar circumstances from getting “out of hand” in the future.

For example, NCUA says correctly that it sent a letter about potential problems in the taxi medallion industry to all examiners in 2014. The letter did not identify the possible disruption of the entire industry by Uber and Lyft, but it did reinforce proper underwriting including the ability of borrowers to service the debt.

But somehow the problem grew and grew and no one knew how to manage through a cyclical decline in asset values. This is not a new situation for credit unions. Loans secured by real estate, autos and leases, and/or commercial properties and farm land will all have changes in the value of security during the term of the loan.

But somehow these inevitable fluctuations in value cause reactions as if the problem has never occurred. Before. This panic often exacerbates the situation, freezing new responses and resulting in irreversible financial decisions at the lowest point of value for the security.

A Responsibility to and for the Community

Cooperatives are interdependent on each other for market success. The most consequential connection is via the shared capital pool created in the NCUSIF. While the temptation may be to approach difficult situations with an eye to eliminating the problem, that not only may be the least desirable outcome for members of the credit union, but more importantly, it may not be the positive example needed by the whole cooperative community.

Credit unions were created to solve problems especially for members and in circumstances when normal market options were unavailable or too expensive. When problems are just done away with and all circumstances swept under the rug because of sufficient resources to do so, everyone loses. Other credit unions facing similar loan challenges as the taxi medallion example, those with concerns about the adequacy of their internal and external audits; or credit unions with underfunded pension or other liabilities could all benefit from a thorough knowledge of the above cases.

Every credit union board and CEO any CPA or auditing firm and every DP, bonding and any vendor connected to the credit unions above, has an interest in knowing what happened. That knowledge is necessary if there is to be a common commitment to do better in the future. NCUA has to lead by example. The three circumstances above would be excellent places to start with full public reviews. Credit unions have received nothing for the $1.25 billion spent so far. The buck has to stop somewhere before credit unions run out of bucks.

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Strategy: How Important is Scale?

A common assumption by many working in credit unions is that scale, that is increasing a credit union’s balance sheet size, is critical to competitiveness, and therefore survival. As one CEO wrote:  “Given our market and community field of membership, we believe scale is more important than ever.”

Facts versus Truth

This belief in “scale economies” is often supported by citing average financial performance by peer group size.   These averages do show that larger credit unions tend to grow both members and assets faster than smaller ones.   Also, they generally operate with lower expense ratios, larger dividend payouts, and generally higher ROA’s and loan to share ratios.

However even within the same peer group (over $1 billion in assets) there is a wide variation in these ratios.  Becoming larger does not automatically create these outcomes.

The logic that data confirms the necessity for scale, does not hold true across all situations.  Facts alone may not reveal underlying truths about successful cooperative performance.

Moreover, the facts used may rely on an assumption or mindset, that itself is debatable.

The Scarcity Mindset

Scale matters in a competitive market, some argue, because it can lead to larger market share and therefore greater economic power.

Scale is achieved by growth, that often means out running competitors.  This can be done organically or more recently, by some credit unions soliciting mergers or buying out bank competitors.

Growth thus becomes the primary objective, if not the mission of the credit union.  It is driven by an assumption of limited resources (or members) and that an institution must get their “share” before someone else takes it away.

I call this the “scarcity mindset” myth.   Credit unions think of strategy as a struggle to get more and more, and can never slow down, because ultimate scale is always unreachable.  The end point keeps growing from $100 million, to $1 billion to $10 billion in assets.  No asset size is ever enough.

The Cooperative Abundance Assumption

Credit union were founded on belief in the power and resources of community.  That by working together we can mobilize savers (those with more) to help borrowers (those with less).

By institutionalizing this process, members become empowered and the well-being of all is improved.  It is not the amount of resources that matter, but rather how they are managed for the common welfare.

This approach created by self-help and collaboration rests on the assumption of abundance. Credit unions are motivated by relationships and mission.  This focus creates trust that underwrites the inevitable cycles of economic fortune that will occur either individually or organizationally.

Instead of a scarcity mindset that focuses on getting whatever one can to grow an institution, credit union design rests on a belief in commerce organized around neighborliness and community.  In my individual capacity, I may not have what I need; but in my collective contributions, there is enough for all.

A Fork in the Strategic Road

The vast majority of credit unions have never had a major merger.  Most credit unions do not seek to buy out their financial competitors.

However, there is a commercial motivation promulgated by self-interested brokers, consultants and growth-oriented CEO’s and boards that assert survival depends on outmaneuvering the competition through size.  This market driven ideology of institutional success subverts the cooperative focus on purpose.

The cooperative model was created to give member-owners the opportunity to create and manage their own financial options in a market dominated by firms that make a profit from relationships.

The cooperative goal is to transform individual options and bring the resources of like-minded persons to build an institution using the resources available, that is a belief in an “economy of abundance.”

The credit union approach is sustained by a community of shared values, not just more plentiful resources.

Questions to Consider

As boards consider strategy, it may be helpful to ask the following:

  • How do we measure our scale, if that is an objective: institutional outcomes or member relationships?
  • Is our motivation for growth from fear or confidence? If it is fear from uncertainty, will we survive by doubling down on the familiar?
  • If scale is critical, what is the plateau we are aiming for? How is it determined?

As I look across the multiple examples of success among all credit union asset groups, I note that those who possess less are less possessed by motives for scale.   And instead of intending to be sustained by their savings from scale, they rely instead on the member’s trust and loyalty.

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The Cooperative Model’s Longevity Advantage

Creative destruction has been a characteristic of capitalistic markets especially in the last 100 years of public markets and plentiful financial takeover funds.

The result is that the average lifetime of a Fortune 500 company becomes shorter and shorter. According to one study, the 33-year average tenure of companies on the S&P 500 in 1964 narrowed to 24 years by 2016, and is forecast to shrink to just 12 years by 2027. (https://www.innosight.com/insight/creative-destruction/)

But good news for mutual and cooperative design just came from an updated list of the 500 largest insurance mutual and coops.

The average longevity (i.e. the age or number of years in business) of the world’s 500 largest mutual insurers companies is 97 years, supporting the theory that mutual and cooperative insurers are closely associated with sustainability, stability and long-termism. Notably, 235 (equivalent to 48%) of the Global 500 have been in operation for 100 years or more; 71 (or 14%) have been in business for 150 years or more; and 16 companies (3.3%) were over 200 years old.

Source: The world’s 500 largest mutual and cooperative insurance companies have once again been ranked by the International Cooperative and Mutual Insurance Federation (ICMIF) in the 2019 edition of its Global 500 report.

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Why Closing a Newspaper is Like Merging a Healthy Credit Union

This July 7 article in the Washington Post described the impact on the community of the decision to close Youngstown, Ohio’s only local newspaper, the Vindicator, after 150 years of operations.

Some reactions and consequences described in the article were the following:

“Mere moments after the start of the hastily called community forum, the tears started to flow.

“Gobsmacked,” was how one Youngstown reader described her horrified reaction to the surprise announcement,

“The Vindy connects us all. A community without a strong, central newspaper is missing leadership — and a big part of its identity.”

With the Vindicator’s closing, Youngstown will become an unfortunate first: a good-size city with no daily newspaper of its own.

For Mark Brown, the Vindicator’s general manger, the loss is personal, devastating.

His family has owned and run the paper for 132 years. His mother, Betty Brown Jagnow, the publisher who is well into her 80s, still comes into the office regularly and has called the decision “gut-wrenching.”

“It’s all we’ve ever known and all we ever wanted to do,”

The Vindicator’s 44-member newsroom staff digs deep into local issues, and has won plenty of state awards for general excellence, for reporting and commentary, and for its website, which has no paywall.

“I’m scared for the community” the paper quoted Mark Brown.

What this means, said Joel Kaplan, associate dean of Syracuse University’s Newhouse School, “is that no one in that community will be covering, on a regular basis, school board meetings, city council meetings, the cops and the courts. Democracy, as we know it, is about to die in Youngstown.”

“Scared for the Community”

The facts of the Vindy’s demise are not unusual. Decades of declining circulation, $23 million in accumulated financial losses, and no local alternatives for the community to turn to.

Whenever a locally-focused, community-based organization is closed whether by merger, failure or sell out, the community’s future is undermined. Some may respond that there are multiple mass media and social news sources to keep the community informed. But that misses the point of local ownership and focus. Local ownership matters: leadership is responsible to local priorities, not a faraway corporate business model. Local employees bring expertise and commitment to success; a legacy of  pride, community well-being and knowledge is created and sustained.

While newspapers and credit unions have very different business models, the continued merging of strong, well-managed and long-serving credit unions into much larger organizations often hundreds of miles away or even out of state, sacrifices one of the most important leadership and economic factors underwriting the viability of local towns, subdivisions and even small cities.

The myth of “expanded services” used to justify management’s surrender of a charter and assets created over generations undermines cooperative principles critical to credit unions remaining the alternative to for profit financial firms. These “voluntary” mergers violate the fiduciary, democratic foundation of cooperative governance. They are little more than commercial transactions benefitting not members, but individual and or corporate ambitions.

Like the loss of a town newspaper, every time I read about the merger of well run, established and successful credit unions, I too become scared for the community: in this case the cooperative option.

P.s. added 8/2/19

Today’s press announced a merger of two credit unions 1,200 miles apart with no historical sponsor or other connection. The $754 million Vibrant Credit Union, chartered in 1935 to serve the employees of John Deere is located in Moline, IL. Infinity FCU ($333 million) is located in Westbrook, ME, and was founded in 1921 to serve telephone workers. Why would members in Maine want to use outlets or services in Illinois? How does having an East Coast hub in Maine benefit members in Illinois? The reasons for the combination raise the question: whose interests are being served by combining two well run, strong community charters with no common heritage or prior relationship, and literally time zones apart? This disclosure should make interesting reading for the members of Infinity who must vote to give up their 100 years of local control of policy, resources, and leadership in the state of Maine.

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The Cooperative Liquidity Advantage of Member Ownership

The primary focus of credit union strategy is the member-owner. While business lending is growing, it is only a small percentage of loans. For almost all credit unions, member shares are the primary source of funding, not borrowings or large organizational deposits. The same is not true, on average, for banks.

Following is a comparison of insured deposits (balances less than $250,000) as a % of total deposits for banks and credit unions for the past five years:

Year-end:              Credit Unions % Insured Savings         Bank % Insured Deposits

2018:                                     93.0%                                                    59.6%

2017:                                     93.2%                                                    59.0%

2016:                                     93.6%                                                    59.2%

2015:                                     94.1%                                                    59.5%

2014:                                     94.5%                                                    61.0%

The $79.9 billion in savings in excess of the $250,000 NCUSIF insurance coverage are dispersed among 3,628 credit unions.

Over 40% of banks’ total funding is in uninsured deposits totaling $4.99 trillion at December 2018 year end. The peak year for insured deposits for banks was in 1991 at 82.1%.

In evaluating liquidity risk, the most common assumption is that consumer deposits, are the most dependable source of funding in a crisis.

The cooperative member-owner design further enhances this financial strategy. It is the member relationship, sometimes developed over generations, that is the intangible capital providing credit unions stability and relevance, especially when financial markets are disrupted. The value is real, even when unrecorded or perhaps unrecognized.

As a member, I trust the credit union values my participation as more than a consumer of products.

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Junk

This play by Ayad Akhtar is a story of the financial industry in the mid-1980s and the disruption caused by the creation of junk bond financing. The play is loosely based on the career of Michael Milken who perfected the technique of leveraged buyouts funded by high-risk high reward bonds.  It introduced a whole new means of financing outside the traditional options provided by the “white shoe” Wall Street investment firms that had dominated market access.

The play’s leading character describes this financial innovation by his repeated assertion that “debt is an asset.”

As credit unions increasingly push access to “secondary capital” to the top of their regulatory or strategic priorities, it may be useful to remember that “secondary capital” is nothing more than an unsecured term borrowing at rates much higher than credit unions pay their members for shares.

Calling these long term, high cost financial borrowings capital, because of payment priority in the very remote event of liquidation by NCUA, seems akin to calling “debt an asset.”

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The New Capital: Member Data

Member data is an asset. It is so potentially valuable that FDIC Chair Jelena McWilliams calls it the “new capital.” But that asset is nowhere on the balance sheet. However, it might be inferred from traditional institutional numbers such as average loan and share balances.

Because member data is not recorded financially, the necessity to convert this “capital” into a member service opportunity is often opaque. That is, until an outside party comes and wants access to some information to promote a new service or solution such as a software to manage an aspect of member’s life such as teen spending.

The member-owner design can help position credit unions as trusted fiduciaries with this information. Fintech innovators often view credit unions as valuable partners for targeted solutions because of their trove of member information and assumed trust.

What is the opportunity within the cooperative movement for the stewardship of this “capital?” How can credit unions both teach the value of and facilitate member benefit from their information?

Several countries including the United Kingdom have implemented the concept of “open banking.” https://www.americanbanker.com/opinion/us-way-behind-the-curve-on-open-banking

One way to explore this concept would be for credit unions to provide members the ability to grant permission of their financial data to other third parties. Under this concept, members would gain the ability to seamlessly and securely allow trusted third parties access to their member information.

Today this process is partially accomplished by aggregators such as Yodlee, but this is an uncertain process subject to operational disruptions. It is frequently limited to traditional product information available by screen scrapping.

By teaching members to value their data, credit unions can initiate member experiences that can help test new financial tools or solutions—thus enhancing the cooperative’s role as an intermediary.

As a member, I would certainly be interested in participating in these kinds of consumer innovations. Increasing my financial awareness, can only enhance my relationship to the cooperative.

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Understanding Disruption Within a Full Economic Cycle

At the FDIC’s April 23 Fintech conference, frequent reference was made to the growing role of “marketplace lenders”; firms using internet technology to reach customers directly versus traditional branch based, depository strategies.

Two frequent credit disruptors were cited: Quicken and peer lenders such as Lending Tree, Sofi, etc.

One estimate is that 40% of unsecured consumer credit was provided by fintech firms last year. Quicken was the number one mortgage originator in 2018.

While the advantages of internet based providers were easily listed–convenience, speed, ease of use, targeted market capabilities–the potential challenges were also noted. Most internet providers rely on external funding, which could disappear in a sectoral or broader economic downturn. Moreover the majority of marketplace lending innovation has been done in the very low and benign post-2008-crisis interest rate environment. Would their funding strategies be as viable in a higher or more volatile rate climate?

More importantly, the credit quality of most unsecured consumer lenders has not been subject to the stress of a economic downturn with rising unemployment. This part of the cycle is when capital adequacy is most tested.

There are real consumer benefits from financial innovation. However the lesson is to be careful about concluding that disruption in the short term will necessarily reshape markets over a full cycle. Market shakeouts may seem immediate, but the ultimate restructuring may not be known until incumbent firms and innovators experience a full cycle of financial competition.

Might such a perspective have informed credit unions’ and NCUA’s responses to the disruption of the taxi medallion industry? A subject for ongoing examination.