Category: Co-ops in Capitalism

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Uber and Taxis: Competitors or Partners?

The first question Hawaiian League President Dennis Tanimoto  asked following  my zoom speech to a conference in late November, had nothing to do with my talk.  It was about an event two years earlier at NCUA.

His question:  Do you think NCUA’s sales of the taxi medallion loans was a fortuitous decision?

NCUA had announced the sale pf the medallion  borrowers’ loans on February 19, 2020 to Marblegate Asset Management LLC a hedge fund specializing in buying  “distressed assets.’

I called the sales of these 4,500 loans a betrayal of  the borrower-members in a post four days later.  NCUA refused multiple FOIA requests for information the board claimed to have used when approving the decision. The cash payment for the portfolio’s book value I estimated at 31 cents per $1 from  numbers in a WSJ article.

Marblegate received the discounted loans, NCUA got cash, the NCUSIF (credit unions) were charged for the difference ($700-800 million) and the borrowing members, nothing.  Just more payments, at the loans’ remaining value.

NCUA’s McWatters said the agency would follow up to make sure the “winning bidder works with the taxi medallion loan borrowers in a transparent, good-faith manner and in full compliance with all applicable consumer protection laws.”

McWatters is gone. No such efforts were reported.   NCUA declined multiple FOIA requests to provide the documents used in  their decision.  One month later,  March 2020,  Covid closed down the economy and  with it virtually all transportation needs.

I assumed that was the context for the question.  Did NCUA in retrospect make the right decision?

My response had two parts.  The first was from whose point of view was it fortuitous?  NCUA’s in exchanging cash for assets of uncertain value in the insurance fund?  The borrowers, who were hit by the economic shutdowns?  Marblegate, the purchaser?

I also responded that any assessment depended on what period of time you evaluate the outcome ?  Here’s why.

In early November 2021 an agreement between the city, taxi owners and Marblegate was reached as reported in the press:

NYC taxi workers celebrate after medallion debt relief agreement reached; hunger strike over

Under the new agreement, Marblegate will restructure existing loans to a principal of $200,000, with $170,000 as a guaranteed loan and the remaining $30,000 as a grant from the city and a 5% interest rate. The restructured loans will be on a 20-year plan with scheduled monthly payments, which will be capped at $1,122 for “eligible medallion owners.” The city has said they will act as a guarantor for the principal and interest — a longtime demand of the NYTWA — and will negotiate with other lenders to work out the same agreement.

The bailout applies to owners of fewer than three medallions.  For those, Marblegate has gained an earning asset worth  at least $200,000. This consists of a New York city guaranteed loan for $170,000, a $30,000 cash payment, and a fully collateralized earning asset at 5% for 20 years.

NCUA refused to disclose any details about the portfolio’s sale, but a Wall Street Journal article suggests the loans were sold at an average price between $75 to $100,000.

If accurate, Marblegate doubled their money in about 18 months while earning some interest and principal pay downs on top of this in the meantime.

These  borrowers now have a reasonable opportunity to pay off their loans and own the medallion outright.

Only NCUA and credit unions are left with no upside. The NCUSIF  loss remains fixed at $750 million in return for $350 million in cash earning  25 basis points (.25%) for assets with a face value of over $1.1 billion.

The hedge fund owners, not the members, received the benefit of this discounted loan sale.

The NCUSIF  underwrote the deal in which the Wall Street purchaser more than doubled their money while putting  member-borrowers’ fates  in the hands of the same for-profit firm.

Credit unions had asked to manage the portfolio on behalf of borrowers, the industry and  NCUA.  McWatters response:  The agency carefully considered a proposal for a public-private partnership to purchase the loans; however, with a firm offer already in-hand and no assurance when, if ever, the proposed partnership might be able to act, the agency could not risk losing its qualified bidder.

Credit unions have seen this picture before.  It is direct from the corporate credit union playbook.   The industry was denied the chance to resolve its problems as NCUA sought Wall Street financiers to take the responsibility off their hands.

 Why Review This  Decision Now?

Credit union and NCUA can learn how ignoring options can cost hundreds of millions in recovery potential when selling at the bottom of a market.  NCUA continues to miss out on the critical advantage of cooperatives when resolving problems.

Cooperative structure allows time and patience so  better options can be developed as markets change and cycles of value recover.  As Warren Buffet noted:

“The true investor welcomes volatility. A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses. It is impossible to see how the availability of such prices can be thought of as increasing the hazards for an investor who is totally free to either ignore the market or exploit its folly.”  (emphasis added)

But if we extend the window out farther, might taxi owners still lose the “solid business” battle and the medallion ownership still remain devalued?

The competition in the on-demand public ride and delivery market is intense. Taxis are in a market disrupted by UBER/Lyft,  among others. Can medallion owners compete with these billion dollar unicorns, venture-backed technology platforms relying on hundreds of thousands of gig workers to produce revenue?

One long time CEO medallion lender said the issue will be decided by the drivers, not institutional financial power.  He suggested a way to think about the future is to ask: if given a choice between being an owner or an employee, which option would you choose?

UBER’s Yearend Financial Report

His question resonated as I reviewed the latest Uber financial updates as of December 31, 2021.

Uber’s mission statement is now generic, not just ride share: “to create opportunity through movement.” The following are some operating and financial highlights from the report:

  • Cannabis pick-up: Announced an exclusive partnership with Canadian cannabis retailer, Tokyo Smoke, to provide consumers with the ability to place orders from Tokyo Smoke’s catalog and unique accessories on the Uber Eats app. Tokyo Smoke is the first cannabis merchant to list itself on the Uber Eats platform.
  • Membership: Officially launched Uber One in the U.S. in November as our single cross-platform membership program that brings together the best of Uber. For $9.99 per month, members have access to discounts, special pricing, priority
  • Monthly Active Platform Consumers (“MAPCs”) reached 118 million: MAPCs grew 8% QoQ and grew 27% YoY to 118 million.

While interesting examples of the firm’s operating efforts, UBER has never made a profit and accumulated total operating losses of $23.6 billion.

From the company’s unaudited December 31, 2021 Balance Sheet

Accumulated deficit:  $23.6 billion

Stockholders equity:    $14.5 billion (total stock issued $38.6 billion)

Goodwill as an asset:    $ 8.4 billion

Loss from operations in 2021:  $3.834 billion

And one of UBER’s latest  innovations to reach profitability?

Uber Taxi

Local taxis at the tap of a button

 No need to try to hail a taxi from the curb. Request a ride from your phone with Uber Taxi.

  • Licensed, local taxi drivers
  • Pay with cash or card
  • Track your ride

That’s right, they now want to partner with the taxi drivers in various cities.  I clicked on the button to see if any of the over 100 cities listed included a taxi option.  I could not find an example.  Or maybe they are just trying to hire the drivers, and lure them to abandon the quest to own  their own medallion.

So if you can’t beat them, why not join them?

One further thought with this taxi  partnering  effort.  To whom do you think Marblegate will try to sell their fully performing, guaranteed 3,000 to 4,000 medallion loans, to make another quick gain on the restored book value? UBER still holds over $4.0 billion in cash.

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CCULR/RBC Unconstrained by Statute: An Arbitrary Regulatory Act

The new RBC/CCULR rule must meet two administrative procedural tests, as any other rule, when NCUA claims to be implementing a law.  The first was outlined yesterday:  Was there substantial objective evidence presented to justify the rule?

As I described, NCUA presented no systemic data or individual case analysis whatsoever. In fact, the credit union performance record  shows an industry well capitalized and demonstrating prudent capital management over decades.

In the December board meeting Q&A , staff confirmed that in the last ten years, only one failed credit union would have been subject to RBC.  But today 83% of the industry’s assets and 705 credit unions are now subject to its microscopic financial requirements.

The second test is whether the rule conforms to Congress’s legislative constraints when giving this rule making “legislative” authority to an agency.  The PCA law was very specific in this regard when extended to the credit union system.

NCUA’s PCA implementation must meet three tests: that it apply only to “complex” credit unions, “consider the cooperative character of credit unions,” and be comparable to banking requirements.

NCUA had already passed these PCA implementation tests before. In 2004 GAO reviewed NCUA’s risk based net worth (RBNW) implementation of the 1998 PCA requirement and concluded:

The system of PCA implemented for credit unions is comparable with the PCA system that bank and thrift regulators have used for over a decade. and,

. . . available information indicates no compelling need. . . to make other significant changes to PCA as it has been implemented for credit unions.

At that time the risk based capital (RBC)  requirements had been in place for banks since 1991.

Today  NCUA’s new RBC/CCULR rules clearly fail all three of these constraining criteria.

A “Simple” Interpretation of “Complex”

NCUA 2015 RBC rule declared that the complex test include all credit unions over $100 million.  After the full burden of the rule was apparent, in 2018 the board changed complex to mean only credit unions over $500 million in assets.

Some credit unions clearly undertake operational activities or business models that are more involved than what the majority of their peers might do.

Examples could include: widespread multi-state operations, conversion to an online only delivery model,  lending focused on wholesale and indirect originations, high dependence on servicing revenue, using derivatives to manage balance sheet risk, funding reliant on borrowed funds versus consumer deposits, innovative fintech investments, or even the recent examples of credit unions’ wholesale purchases of banks.

The agency did not define “complex” using its industry expertise and examination experience to identify activities that entail greater risk.

Instead, it made the arbitrary decisions that size and risk are the same. In fact, most data suggests larger credit unions report more consistent and resilient operating performance than smaller ones.

In changing its initial ”complex” definition by 500%, it demonstrated Orwellian logic at its most absurd.  Complex turns out to be whatever NCUA wants it to mean, as long as the definition is “simple” to implement.

Universal for Banks; Targeted for Credit Unions

For banking PCA compliance, RBC was universally applied.  Every bank must follow, no complex application was intended.

By making size the sole criterion for “complex” the board reversed the statute’s clear intent that its  risk-based rule be limited in scope and circumstance when applied to credit unions.

The absurdity of this universal, versus particular,  definition is shown in one example. The rule puts $5.6 billion State Farm FCU, a traditional auto and consumer lender with a long-time sponsor relationship, in the same risk-based category as the $15.1 billion Alliant, the former United Airlines Credit Union. Alliant has evolved into a branchless, virtual business model with an active “trading desk” participating commercial and other loans for other credit unions.

NCUA’s “complex” application of the PCA statute is totally arbitrary based on neither reason nor fact.

Capital design: the most important aspect of “Cooperative Character”

The PCA authority additionally requires that the Board, in designing the cooperative PCA system, consider the “cooperative character of credit unions.” The criteria, listed in the law are that NCUA must take into account: that credit unions are not-for-profit cooperatives that:

(i) do not issue capital stock;

(ii) must rely on retained earnings to build net worth; and

(iii) have boards of directors that consist primarily of volunteers.

The single most distinguishing “character” of credit unions is their reserving/capital structure. Virtually all credit unions were begun with no capital, largely sweat equity of volunteers and sponsor support.

The reserves are owned by the members. They are owed to them in liquidation and even partially distributed, in some mergers.

These reserves accumulate from retained earnings, tax exempt, and are available for free in perpetuity-that is, no periodic dividends are owed.  Many members however can receive bonuses and rebates on their patronage from reserves in years of good performance.

Most products and services offered by credit unions are very similar to those of most other community banking institutions. The most distinctive aspect of the cooperative model is its capital structure, not operations.

Cooperative Capital Controlled by Democratic Governance

This pool of member-owner reserves is overseen by a democratic governance structure of one-member one- in elections.  The reserves are intended to be “paid forward” to benefit future generations.  This reserving system has been the most continuous and unique feature of cooperative “character” since 1909.

This collective ownership forms and inspires cooperative values and establishes fiduciary responsibility.  Management’s responsibility for banks is to maximize return to a small group of owners; in coops the goal is to enhance all members’ financial well-being.

This capital aspect of the cooperative charter is so important that if credit union management decides to convert to another legal structure, a minimum 20% of members must approve this change. No other financial firm has the character of a coop charter with its member-users rights and roles. Not even a mutual financial firm.

Bank’s Capital Structure Very Different from Cooperatives

For banks, capital funds are raised up front, usually from private offerings or via public stock. Owners expect to profit from their investments. Dividends are paid on the stock invested as part of this anticipated return. Today shares represent about 50% of total bank capital.  In credit unions, it is zero.

Bank capital stock, if public, can be traded daily on exchanges. The market provides an ongoing response to management’s performance.

This capital is not free as most owners expect a periodic dividend on their investment.  As an example, in the third quarter of 2021, the banking industry distributed 79% of its earnings in dividends to owners.

There is no connection between a bank’s capital owners, and the customers who use the bank, unless customers independently decide to buy shares in the bank. In credit unions, the customers are the owners.

The remaining component of bank capital is retained earnings. However, every dollar of earnings before  added to capital, is subject to state and federal income tax. Credit union retained earnings are the only source of reserves as noted in the PCA act.  These coop surpluses accumulate tax free.

In design, accumulation, use and governance credit union reserves are of a totally different  “character” than bank capital. Their purpose is to support a cooperative financial option for members and their community.

Bank capital is meant to enrich owners through dividends and/or future gains in share value.  Credit unions’ collective reserves are to benefit future generations of members.

Credit unions are not for profit.  Banks are for profit.

In a capitalist, private ownership dominated market economy, the cooperative’s capital structure is the most distinctive aspect of credit unions.  This is not because of its amount or ratio.  It is its “character,” from its origin, perpetual use and  oversight by members.

Nothing in the CCULR/RBC rules recognizes this especial “character” of credit union capital.  By not addressing this issue, the rule ignores this constraint of the  PCA enabling law.

The historical record demonstrates that  credit union reserves are not comparable to bank capital.  Rather they are a superior approach tailored to the cooperative design.

Tomorrow I will look at the third test, whether RBC/CCULR conforms to the PCA’s requirement of comparability.

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A Coop Veteran on Opportunity

Randy Karnes led CU*Answers and its affiliates for over 25 years as CEO.   Combining network strategy in the Internet era with cooperative design was critical to the CUSO’s strategy.

He has stepped back from the CEO’s role and is heading to retirement.  He continues to share thoughts on what makes credit unions and CUSO’s successful.

Seeing Opportunities Within and Without

How do leaders rally their teams to moments of opportunity? Drive themselves to see others’ initiatives in a system as part of their own?

There have been times when inventorying the business problems in a marketplace was the right play to call out opportunity.  But when defining problems becomes more debilitating than inspiring as opportunities you have to change gears. 

This is a market of opportunity for employees and professionals – to open their eyes to the chance to be more.

Show everyone around you how to engage for opportunity, that they are the solutions and entrepreneurs with spirit.  Engage…..and corporate tricks like mergers, re-organization, and internal gambits will be far less inviting.  Engage your team one task at a time and watch your confidence in the way forward grow.

In my entire career I have never seen a marketplace so ready to reward people who are simply positive about the opportunity all around them. 

Cooperative Governance and Advisory Boards

Cooperative Business Designs and the drive for customer-owner governance:

Can 7 directors  (CU or CUSO) be seen as credible for 100,000 customers, 12-24 business lines, multiple product/service distinctions, and the intensity for cooperative passion? 

Our niche (cooperatives and credit unions) doubt it every day in pushing back against our competitive model.   But do we push back with actionable and tangible examples that overcome the issues?

There is a reason that Jim Blaine (SECU) had nearly 300 advisory boards – perception matters – the design and the faces of governance matter.  That is fundamental to a network’s success.  Our governance should be a meaningful platform for our competitive advantage and distinction.

This is not to say that there is a size limit for cooperatives. Rather this is to say that scaling governances, delineating the passions applied, and marketing customer-owner leadership closer to the delivery of the value, are the key to everyone’s seeing that cooperatives are different, no matter the size.

 

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An Opportunity for Credit Union Disruption

Multiple stories have reported banks closed 2,927 branches in 2021, a 38% jump.  The troubled  Wells Fargo closed 267, closely followed by US Banks’ 257.

Even with  recent efforts to align with FinTech startups or other virtual entrepreneurs, credit unions have traditionally followed a “second to market” strategy in their growth efforts.

They have done so using a disruptive model, offering products or services that are better, faster or cheaper than existing providers.

When many think about disruptive efforts, their focus is on technology or other innovation. Two classic examples are digital music downloads replacing compact discs.  Recently Zoom has emerged as a huge disruptive innovator during the pandemic, owing to its modern, video-first unified communications with an easy and reliable performance.

The more classic disruption described by the Clayton Christensen, the author of this business concept, is not about new technology but targeting vulnerable market segments held by dominant firms. This  is the classic definition:

Disruptive Innovation describes a process by which a product or service initially takes root in simple applications at the bottom of a market—typically by being less expensive and more accessible—and then relentlessly moves upmarket, eventually displacing established competitors.

Tapping Undesirable or Ignored Markets

For many credit unions a crucial competitive advantage is local presence and reputation.

They serve members ignored by incumbents who typically focus their products and services on their most profitable customer base.

Closing branches and exiting markets which banks no longer see as attractive can open up opportunities for credit unions. From these market footholds,  they can then move upmarket eventually displacing the original established providers.

Most credit unions establish new footholds by stressing superior service and local commitment.   These bank branch closures may open up new opportunities employing  classic cooperative advantages.

FinTech Innovation may be more fun and sexy to talk about.   But credit union growth has typically followed traditional disruption design.  Are these branch closings happening in your market area?

 

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BON MOTS II for Friday

A member comment on the Proposed Merger of WarCO FCU and First Financial:

The merger may appear to be a financially good move as First Financial of Maryland FCU has more assets. However, the documentation indicates the Pocomoke location “will remain open for a period of time.” There are no First Financial of Maryland FCU’s located on the Eastern Shore. Therefore, all work will need to be done electronically and one most likely will no longer be able to walk into an office anymore.  Brian Cook, Member, WarCO FCU

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“You have to pick the places you don’t walk away from.”  Joan Didion

* * * *

Jim Blaine: I think one of the ideas which used to ring true was the thought that trying to compare CUs to banks was like trying to compare Ralph Nader to GM because they were both in the car business….any attempt at comparison doesn’t really make sense…entirely different purposes. Credit Unions should never be “comparable” to banks; it seems a useless exercise…CUs should provide the “contrast” to banks. ( January 2022)

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 Jeff Bezos: If you’re competitor focused, you have to wait until there is a competitor doing something. Being customer-focused allows you to be more pioneering.

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Ed Callahan: “The only threat to credit unions is the bureaucratic tendency to treat them, for convenience sake, the same as banks and savings and loans. This is a mistake, for they are made of a different fabric. It is a fabric woven tightly by thousands of volunteers, sponsoring companies, credit union organizations and NCUA-all working together.“  (Chairman, National Credit Union Administration, April 1985)

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Samuel Johnson  observed that “what is written without effort is generally read without pleasure.”

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Weekend reading recommendation: The Fed’s Doomsday Prophet Has a Dire Warning for Where We Are Headed.   The article illuminates the distinction between traditional consumer price inflation and asset inflation (S&P index up 47% the last two years) and the consequences for our political economy.

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A Finnish Co-operator’s Suggestion for U.S. Credit Unions

The following observation is from Leo Sammallahti, Marketing Manager for the Cooperative Exchange.   He follows cooperative enterprises in Finland, Europe and the United States. His article suggests a specific investment credit unions can make to help another cooperative effort in the US.

“There are many examples of new legislation seeking to help cooperatives.  But  first we in the movement should  try to find ways to utilize the existing legislation better. Before illustrating this existing opportunity, I want to present something extraordinary happening in Iowa City.

Taking on a FinTech

In 2018, the local food delivery app in the city was bought by Grubhub, which already controlled more than half of the market in the US. They doubled the delivery commission from 15% to more than 30%, wreaking havoc among the local restaurants.

John Sewell was one of those restaurant owners, but he had also worked in  organizing purchasing cooperatives and similar arrangements for rural hospitals. He started an initiative that grew into Chomp, a cooperative food delivery app owned by the local restaurants.  Chomp takes a modest commission and distributes any surplus generated back to the member restaurants.

By the end of the year, it had outcompeted Grubhub with twice as many restaurants on its platform. It became a sort of mass movement with the majority of the residents using it. Rather than a global monopolistic rent-seeker, it transformed the model into a local democratic institution creating community wealth.

Typically, each local market has one delivery platform that with a leading market position – most likely Grubhub. Restaurants join the platform with most customers and customers join the platform with most restaurants.

These “network effects” drive platform  businesses models like food-delivery apps towards a “winner takes all” outcome. These kinds of monopolies and monopsonies are exactly one of the market failures cooperatives counter and fix.

Once a for-profit company app gains a dominant market position, its incentive is to extract as much value from the restaurants for the shareholders as possible. However, for a restaurant owned cooperative platform, the incentive is the opposite. If it gains a dominant position, it has no motive to extract monopolistic “rents” from the restaurants.

Rather it can use economies of scale to lower costs. set lower prices or pay higher dividend rebates. By doing this the monetary benefits go back to the restaurants which pay the delivery commission. If the cooperative  kept the money for itself, the restaurants could elect a new board of directors.

The Credit Union-Cooperative Opportunity

This cooperative food delivery option is now being replicated in seven cities (1)– one in Jersey City, New Jersey.  This is one of only eight states where state chartered credit unions can make direct equity investments in other cooperatives.

Only one credit union in the country, Vermont State Employees Credit Union, is actually using this legislation to invest in other cooperatives. This authority is an example of a very useful but underutilized legal tool.

An immediate example where this option could be especially useful is  helping local restaurants in Jersey City who  are creating a platform delivery cooperative to keep money circulating locally and more equitably.

Supporting Local Economies Via the Members

However, there is much any credit union could do besides investments. It’s common for credit unions to provide retail discounts for their members, for example, 30% off  on movie tickets.

Restaurant cooperatives promote themselves with discounts sending a coupon code for a free first delivery. Credit unions could distribute this discount for a free first delivery in the six cities where  a restaurant owned delivery platform cooperative is being formed.

These discounts provide a tangible benefit in the everyday life of a credit union member. It would align credit unions with the wider cooperative ecosystem generating community benefits and social capital. It would help the restaurant delivery coops reach a mass audience  quickly and inexpensively.

It reduces the uncertainty of the startup and avoids the costs of  big tech ad intermediaries like Facebook or Google. Instead, credit unions could directly reach around one-third of adults, on average, who are credit union members.”

(1)The six additional cities are:

KNOXVILLE, Tennessee

OMAHA, Nebraska

RICHMOND, Virginia

LAS VEGAS, Nevada

TAMPA BAY, Florida

LOS ANGELES, California

 

 

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Asset Bubbles and Credit Unions

During his time as Vice Chair of the FDIC, Thomas Hoenig challenged the agency’s implementation of risk-based capital requirements.  He questioned both the theory and practice, pointing to the lending distortions which contributed to banking losses during the Great Recession.

I became aware of  his views when in 2014 NCUA began the process of imposing the same flawed system on credit unions.   Hoenig believed the best capital indicator was  a simple leverage ratio, the credit union model for 110 years, until December 2021.  Then NCUA dictated a complex, three-part capital structure, CCULR/RBC, to replace this century long capital standard.

Hoenig’s Other Regulatory Dissent

Hoenig was a career regulator.  He began as an economist in bank supervision at the Kansas City District Federal Reserve Bank an area of the country where he had grown up. In the 1970’s during a period of unprecedented double-digit inflation, he saw first-hand the impact on lenders and their borrowers whose relationships were underwritten with collateral-based loans.   The security was believed to be ironclad during this decade of ever-rising prices for farmland and commercial real estate.

Hoenig’s story is told in a new book, The Lords of Easy Money,  and a summary article in Politico. The article describes how he became the lone dissenting vote in November 2010 on the Federal Reserve’s Open Market Committee.  He opposed extending the monetary policy called quantitative easing beyond the Great Recession to jump start the economy.

His opposition was based on his early Midwestern regulatory experience, as the Fed tried to get inflation under control. From Politico:

“Under Volcker, the Fed raised short-term interest rates from 10 percent in 1979 to 20 percent in 1981, the highest they have ever been.

“You could see, Hoenig recalls, that no one anticipated that adjustment.” More than 1,600 banks failed between 1980 and 1994, the worst failure rate since Depression.”

But the banking failures and borrower bankruptcies were not the primary reason for Hoenig to  oppose Fed Chair Bernanke’s continued quantitative easing.

The “Allocative Effect” of Asset Bubbles

When borrowing rates are effectively negative, as now, this fuels inflation with surplus liquidity looking for places to go.   Too many dollars chasing too few goods. With funding costs near zero, any reasonable investment looks like a sure thing.

As asset prices rise quickly, a feedback loop develops. Higher asset prices today drive tomorrow’s asset prices ever higher. Especially when those assets are pledged to support more borrowing.

For Hoenig, his greatest concern with this low interest rate policy is the distortion or  “allocative effects”  of the additional wealth created by this monetary stimulus.

As summarized in Politico:

“Quantitative easing stoked asset prices, which primarily benefited the very rich. By making money so cheap and available, it also encouraged riskier lending and financial engineering tactics like debt-fueled stock buybacks and mergers, which did virtually nothing to improve the lot of millions of people who earned a living through their paychecks.

Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system.”

The Economic Consequences Hoenig Warned About

Those distortions are here now.  One need only look general stock market levels as well as individual company valuations that are unhinged from  performance to see examples that don’t compute.

In a January 7 essay “A Stock Market Crash is Coming and Everyone Knows It” the writer notes wild stock valuations: The price earnings ratio for the S&P index of stocks historically averages 15.  Today the ratio is 29 times;  Amazon’s ratio is 60 and Tesla’s 330.

This disconnect between stock prices and a company’s financials is most visible in meme stocks, IPO’s and SPAC’s often with no history of positive net income.  These new offerings and crypto-currency  asset hype are explained as harbingers of  a  newly emerging digital-metaverse economy.  Predictions of these asset bubbles bursting go back at least two years.  Because it hasn’t happened yet, doesn’t mean the Fed’s changed policy won’t be disruptive.

The Credit Union Impact

Credit unions are creatures of the market. Co-ops whether by design or neglect that have become distant from their members, are even more dependent on market sourced opportunities.

Approximately 80% of all credit union loans are secured by autos, first and second mortgages, or commercial assets. Before asset bubbles burst, decisions about new loans and investments look straightforward, easy to project future returns.

The most frequent example today of this financial euphoria is credit unions buying whole banks, frequently in new markets.  When the cost of funds is .25- .50 basis points, paying a premium of 1.5 to 2.0 times book value for a bank looks like a can’t lose opportunity.   Even when the bank’s financial performance is being supported by the same low cost of funds and its underwriting  secured by commercial loans with continuously appreciating assets.

GreenState Credit Union in Iowa, Hoenig’s home state, is so eager to take advantage of these current opportunities that it is buying and absorbing three banks simultaneously, all operating outside its core markets.

In North Carolina, Truliant  Federal Credit Union announced in December that it had raised $50 million in an unsecured  subordinated term note at a fixed rate of 3.625%, The purpose reported in the press: “Truliant has primarily grown the credit union’s loan portfolio organically, however management is open to acquisitions in the $500-$750 million asset range.” 

The announcement is a public invitation for brokers to bring their deals to Truliant’s table.

When funding looks inexpensive and asset values stable or rising, what could go wrong?

The short answer is that  the Fed’s inflation response will disrupt all asset valuations and their expected returns.  The larger question is whether buying businesses whose owners believe now is the time to cash out, and whose results were created by a very different model and charter, will even match a credit union’s capabilities.

In an earlier analysis of credit union whole bank purchases I raised these issues:

As credit unions pursue whole bank acquisitions, are they buying “tired” business models built with different values and goals? Are these credit unions giving up the advantages of cooperative design and innovation attempting to purchase scale? Will combining competitors’ experiences (and customers) with the credit union tax exemption create an illusion of financial opportunity that fails to prove out when evaluated years down the road.

The Discipline Required of the Co-op Model

The co-op member-owner model protects credit unions from some of the rough and tumble accountability of constantly changing stock market valuations.  This difference requires strong management and board discipline to remain focused on the people (members) who respond to and need a credit union relationship.

Buying into new markets and customers through financial leverage, versus winning them in competition, is a new game for credit unions.  Organic growth builds on known capabilities and experiences, not externally purchased originations.

Hoenig’s critiques offer a third lesson relevant for these leveraged buyouts.  The financial consequences of public policy changes can take years  for their consequences to be found out.

It took seven years for the FDIC to recognize there was no cost-benefit outcome with RBC. And eleven years to understand the full economic impacts from when he first opposed quantitative easing as the primary tool for the fed to keep the economy growing.

Credit union success is not because they are bigger, financially more sophisticated, or even led by superior managers versus banks.   They win when their capabilities  align with member needs.  Members join based on their choice, not because their account was bought from another firm.

The beginning of a significant economic pivot, long forecast by the Fed, seems a very suspect time to use member capital to pay out bank owners.   The bank owners are asking for members’ cash, not the stock that other bank purchasers would offer, to protect these sellers from valuation uncertainties.

Credit union leaders buying banks are betting (paying premiums) that they can  manage the bank’s assets and liabilities for a higher future return than their for-profit managers were able to do.

Rather than compete with a superior business design, buying banks intending to run them more effectively, feels like surrendering to the opposition.

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We the People: A New Year Awaits

In the mid 1990’s, Navy FCU’s annual report theme was, “Our strength is Our Union.”  Today’s message is “Members are Our Mission.”

Both ideas affirm a community’s collective effort to work together.  The idea is as old as the preamble to the constitution, “We the People. . . in order to form a more perfect union . . .”

For 2022 that objective, could be the most important goal for the cooperative system.  Before looking at this challenge another observation must be noted.

Incredible Two Years of Credit Union Performance

In 2020 and 2021, the credit union system recorded two of the most financially successful years in decades.   The double-digit savings growth and continued member expansion were accomplished with zero insurance losses.  The results were achieved despite the sharpest recession ever caused by the abrupt March 2020 national economic shutdown.   And a pandemic that continues to cause disruption in every area of American life.

The cooperative system proved its resilience while responding to unprecedented member needs.

The 2022 Outlook

Projections for the New Year will include the present knowns:  inflation, how long and how strong? Covid’s continued presence; the rise in interest rates; ongoing economic growth; cyber worries and crypto opportunities; the midterm elections; and international trade and political challenges.

In my view these are not the primary cooperative challenges.  Rather the age-old tension between individual success and system interdependence will continue to play out.

For some there is no issue.  Their view is that  responsibility extends only to their charter.  Whatever the management and board decide to do is their business only.  That’s what the members “elected” them to do.

I believe rather that the system is interlinked in multiple ways.  This means  the reputation and example of one, whether good or ill, affects the perception of all.

The concept that coops take care of each other in times of need, includes both the member-owner and the multiple interlocking systems in which all credit unions operate.

Every credit union is open today because of a legacy handed to them and  starting all the way back to the chartering date.  These founders began with nothing but a vision of shared effort for the common good.

Some of today’s “leaders” have interpreted their responsibility the opposite of their founders, that is to return their  members to their pre-chartering state.   And on the way to charter dissolution, help themselves to some of the spoils.

The Cooperative Journey

Credit unions are now mid-way through the fifth chapter of their 112  year evolution.   Each chapter takes about a generation, or twenty five years.  The present  chapter dates from 2009 with the Great Recession.

The journey has always included two challenges.  One set is the externals of the economy, indifferent regulation, competition and ever present technology change.  Credit unions have rarely  been found wanting in meeting the realities of a market based system.

When failure occurs, it is the internal journeys where leaders become lost.   The idea that every members’ bottom line is the credit union’s, is reduced to only  the credit union’s bottom line.  Fiduciary duty  becomes  a  singular focus on financial success.  And when that becomes too challenging, the result is to throw in the towel and turn the members’ future over to another organization with no relationship or history to them.

The 2022  challenge

I believe this year will be pivotal as to whether credit union leaders can once again put member well- being above institutional and personal self-interest.  Can cooperatives restore their roots with the owners whose trust is their real strength, as Navy FCU proclaimed decades ago?

For it is We the People who are responsible for a more perfect union.  That is true for both our civic politics as well as our financial cooperatives.

 

 

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It’s a Wonderful Life and a Question for Credit Unions?

A great movie becomes a classic because it informs and inspires not only when released, but also for generations to come.  Frank Capra’s film has been a part of every Christmas season since its release at the end of WWII.

The story resonates because it portrays an individual and a community coming together to create a better life for all.  Because of its  popularity there are continuing efforts to address the film’s relevance today.

The Real Hero: Mary Bailey

Washington Post columnist Monica Hesse argues that Mary Bailey not George, is the actual hero of the story.

Mary deals with the same leaky roof and small-town limitations as her husband with one major difference: She never complains. She doesn’t need an angel named Clarence to descend from heaven and inform her that she’s actually led a wonderful life.

She knows intuitively that wonderful lives are not made by collecting passport stamps or military honors; they are made by investing in the community around you and wallpapering the bejesus out of an old Victorian.

“Why must you torture the children?” she asks George when he takes out his foul work-mood on the family. Why indeed? She’s the one who’s been home all day with a sick toddler and a clanging piano. . .

Once you see it, you can’t unsee it: The entire movie celebrates the personal sacrifices of a nice man while ignoring the identical sacrifices of a nice woman. Why? Because “It’s a Wonderful Life” assumes something that society assumed in the 1940s and sometimes continues to assume to this day: A wife is supposed to sacrifice, buck up, make do, slog through. But when the husband does it, the whole town must take note.

Communities With Pottersvilles

Writer Jared Block suggests the theme of home ownership is a critical area on which America is falling short.  Here is his interpretation: We’re driving full-speed into Pottersville.

George Bailey’s day-to-day goal is simple:

To help every working family own their own home.

“Just remember this, Mr. Potter: That this rabble you’re talking about, they do most of the working and paying and living and dying in this community. Well, is it too much to have them work and pay and live and die in a couple of decent rooms and a bath?”

 We desperately need more George and Mary Baileys — people of goodwill who serve instead of siphon, who are pro-human instead of market-driven, who knit together the fabric of society instead of tearing it apart.

We also need more people to build Bailey businesses — companies that give instead of take, that contribute instead of extract, that cement communal stability instead of undermining its foundations.

Sadly, homeownership will soon be as out of reach for the middle class as it already is for the working poor.  America is not heading toward an idyllic Bailey Park.  

I note one organization estimates America needs at least 7 million additional affordable housing units. At the current pace of 110,000 per year, supply will never meet demand.

The Moral Lesson: One Life Makes a Difference

Another observer asserts we need more of George Bailey’s “ministry” in today’s society.  The film from his perspective:

George Bailey who dreams of leaving his small town of Bedford Falls, traveling the world, and building bridges and airfields and skyscrapers a hundred stories high. But he never does those things because his father dies, he takes over the Building and Loan, and marries the girl next door.

George carries on a one-man crusade against Potter, a cruel, joyless miser who has milked the townspeople dry, forcing them to pay exorbitant rents to live lives of quiet despair in his broken-down tenements

Eight-thousand dollars meant to square the books of the Building and Loan accidentally end up in the clutches of Potter, causing George to fall foul of the bank examiner.

Only the intervention of a bumbling angel named Clarence saves George from taking his own life. To prove to George the value of his life, Clarence allows him to see what the world would have been like had he never been born.

Without the ministry of the Building and Loan, Bedford Falls becomes the twisted creation of slumlord Potter, a dark, hopeless, soul-crushing world of smoky bars and seedy dance halls, pawn shops and peep shows. As for George’s family, without him there, his mother becomes a bitter old woman, his wife an old maid, his uncle an inmate in an asylum, and his brother, whom George had saved from drowning when he was a boy, a corpse.

One life, George learns, touches so many other lives. Far from a failure, his life was the glue that held together his family, his business, and his community. 

The Film and Credit Unions

Some have opined that credit unions are today’s embodiment of  Bailey Savings and Loan.   Led by idealistic, hard working men and women and overseen by volunteers, all of whom are committed to uplifting their members and communities.

The film’s message shows success earned by overcoming personal, financial, economic and competitive challenges. Every credit union still confronts these today.   Including uncaring bank examiners.

The comparison feels relevant for another reason.  It celebrates the role of individuals have within a community.

Credit union’s common bond requirement is simply the identification of an existing group which hopes to improve its well-being by working together.

The feeling of “local” is created when users believe something is theirs.  It is not just a geographic concept, but also a sense of shared purpose.  And there is no more powerful sense of place than when members can own their home.

What makes the film timely is that the same challenges from 1946 exist still for members.  The film’s promise has yet to be realized by many.

The spirit of shared effort is still the most powerful coop advantage in a marketplace where competitive dominance is everyone else’s goal.

In the final scene, the people of Bedford Falls gather around Bailey and his family, donating the money to restore the Building and Loan which helped them achieve their own dreams of freedom, independence, and dignity.

The film poses an ongoing question being asked  today: It’s a Wonderful Life, but for whom? How credit unions respond to that challenge will determine if they are the true heirs of the film’s spirit.

 

 

 

 

 

 

 

 

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Two Cooperative Applications of Clayton Christensen’s Final Message

I met business theorist Clayton Christensen once.  He had just finished a panel on the potential for disruptive innovation in higher education-including his courses at the Harvard Business School.

Thinking that his new online offering on disruptive concepts might be useful for credit union strategy, I asked if we might talk with him about this innovative effort.  He gave me his card, turned it over to show his administrative assistant’s name, and asked we contact her.

We did.  That is how Callahans became a partner in distributing and applying his ideas of disruptive analysis  with credit unions.

His Final Work

Professor Christensen’s last work was How Will You Measure Your Life? In this brief excerpt he begins with a case– the example of Blockbuster’s demise after Netflix’s replaced the DVD rental model with online streaming.  By 2011, Netflix had almost 24 million customers while Blockbuster had declared bankruptcy the prior year before.

His explanation of how this happened:

Blockbuster followed a principle that is taught in every fundamental course in finance and economics: When evaluating alternative investments, ignore sunk and fixed costs (costs that have already been incurred), and instead base decisions on the marginal costs and marginal revenues (the new costs and revenues) that each alternative entails.

But it’s a dangerous way of thinking. This doctrine biases companies to leverage what they have put in place to succeed in the past, instead of guiding them to create the capabilities they’ll need in the future. 

In this article he extends the errors of marginal-cost logic to a person’s choosing right and wrong. He tells the story of deciding not to play in the British Universities National Championship basketball game for Oxford where he was studying on a Rhodes Scholarship.  He learned that the final game would be played on a Sunday, the Sabbath for his church.   He was the starting center.  His teammates challenged him: “You’ve got to play. Can’t you break the rule, just this one time?”

He did not play.  He compares the temptation he felt to “adjust” his principles just this once, as similar to the logical error in marginal cost thinking.

If you give in to “just this once,” based on a marginal-cost analysis, you’ll regret where you end up. That’s the lesson I learned: It’s easier to hold to your principles 100% of the time than it is to hold to them 98% of the time. The boundary — your personal moral line — is powerful, because you don’t cross it; if you have justified doing it once, there’s nothing to stop you doing it again.

The Personal Decision Underlying Every Merger of a Sound Credit Union

Sometime in the first decade of this century a credit union manager described the private merger deal making going on in his state.  In the example cited, he said the “retiring CEO” had requested a payment of six times the annal salary to recommend his credit union as the merger partner.   The CEO turned down the “opportunity.”

Tomorrow I will address Christensen’s business critique of marginal cost analysis in bank purchases and mergers.   Today I  will apply his logic to the underlying principles that guide our thinking when making any consequential decision.

He describes his importance of his decision at Oxford not to play on the Sabbath:

Resisting the temptation of “in this one extenuating circumstance, just this once, it’s okay” has proved to be one of the most important decisions of my life. Why? Because life is just one unending stream of extenuating circumstances.

The Moral Challenge in Mergers

Since NCUA’s 2017 rule requiring disclosures of additional compensation for senior executives when merging with another credit union, the payouts, once private are now public.

The amounts range from bonuses and Golden Parachutes as high as $1.5 million plus continued employment in specific cases.  One CEO set himself up with payments of $35 million to a non-profit he incorporated just  60 days prior to the merger announcement.

CEO’s defend this additional bounty with various rationales.  These vary from “this is the usual and customary practice” to legal obligations for payments under employment contracts when a charter is ended.

Some situations appear to be nothing more than the CEO selling the credit union and taking a portion of the reserves as a bonus for so doing.

Rarely are any specific plans or concrete examples of member benefits presented in the members’ merger notice.  Rather it is the deal makers who  reap immediate, specific windfalls.

The CEO’s and senior management who have negotiated these benefits have done so publicly.   Their personal choices are clear.

However every “seller” requires a willing buyer.

The issue Christensen raises is about the other CEO’s, those on the accepting end of  these conditional deals.  How do their employees and boards view these significant “bonuses”?   Will their CEO be tempted to follow the same path?   What member interest is being served?  Are these situations promoting their credit union’s values?   How do these mergers  support the purpose of their member-owned credit union?

What will be the character of a movement built upon internal consolidation of long serving, strong performing firms versus growth from  winning via market competition?

I have heard the reasoning that these are one-off opportunities.  If we had not agreed the CEO would have just gone to another credit union and we would have missed our chance for this free and easy growth.  Moreover since we are larger now, the members will be getting a better deal, etc.

Christensen’s explained his choice of not playing on the Sabbath:

It’s easier to hold to your principles 100% of the time than it is to hold to them 98% of the time. The boundary — your personal moral line — is powerful, because you don’t cross it; if you have justified doing it once, there’s nothing to stop you doing it again.

The Choice

One of the cooperative values is autonomy, the ability to manage an independent institution free to make its own business decisions. For some, this will be  to “roll up” smaller institutions, take  their free member capital and pursue an open-ended effort at acquisitions.

For others, the decision will be to turn down overtures, focus on innovative growth, and support the diversity and variety of institutions flying the credit union flag.

Christensen’s bottom line: Decide what you stand for. And then stand for it all the time.