Category: Co-ops in Capitalism

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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

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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.

 

 

 

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A Compensation Revolution Started by a CEO

Credit unions, corporations and multiple organizations are finding it difficult to fill vacancies. One response is to raise pay for both existing and prospective employees-especially at the lower end of the wage scale.

Some credit unions have announced increases to a $15 minimum starting wage; others have used hiring bonuses or payments for employee referrals.

The majority of these adjustments are at the entry level or bottom of the pay scale.   But is there another way to think about compensation that would start at the top?

What if credit unions were to emulate the example of CEO Dan Price and rethink their approach to pay starting with the CEO?

Reducing the CEO’s Pay from over $1 million to $70,000

Gravity is a  credit card processing and financial services company founded in 2004 by brothers Lucas and Dan Price. The company is headquartered in the Ballard neighborhood of Seattle, Washington and employs 100-200 people, including a branch in Boise, ID. It is a private company and plans to stay that way.

In 2015 CEO Price, now the sole owner, reduced his salary to $70,000 and made that amount the starting annual pay for any employee in the company.   The story went nationwide.   Inc magazine reported the action immediately; there have been follow ups to see the results  into 2021.

The company’s efforts were converted to a Harvard Business School case study.   This January 2018 article summarizes the case and concludes with a link to a 27 minute video in which Price and the Harvard professor discuss the underlying reasons at a Young Presidents Organization meeting.

In an April 13, 2021 twitter post, Price summarized the company’s results since the 2015 change as follows:

Since our $70k min wage was announced 6 years ago today:

 *Our revenue tripled

 *Head count grew 70%

 *Customer base doubled

 *Babies had by staff grew 10x

 *70% of employees paid down debt

 *Homes bought by employees grew 10x

 *401(k) contributions grew 155%

 *Turnover dropped in half

Price says a number of employees earn more than this minimum.  As the sole owner, this aspect of Price’s wealth grows as the company value increases.   He explains his approach and why it upsets many in the private sector:

“I did this as a private business owner. It affected no one but myself (I cut my salary from $1.1M to $70k) – the definition of private enterprise. But what I did was very threatening to them because it disrupts the narrative of “CEOs must be paid 1,000x more than their employee.”

Is there a Credit Union Lesson in This Spirit?

The increase in CEO salaries has continued across credit unions even during the pandemic.  Numerous consulting and trade firms provide data and peer comparisons to ensure CEO’s compensation remain competitive and growing.

What would happen if the whole salary paradigm were turned upside down as Price did at his company?  Gravity is a customer service firm where relationships matter. Price is very important.  Success depends on sales and every employee being an entrepreneur and accountable.

Price acknowledges this approach to compensation is contrary to most economic theory and business models.

He believes that once an employee’s concerns over money worries becomes only the fifth or sixth priority in their lives, more powerful intrinsic motivators will become dominant.  These include mastery of a craft, serving a bigger purpose, and autonomy.

When these characteristics spark employee behavior, then the business outcomes he cites can happen.

What Would Happen If?

Critics point out that the majority of Price’s wealth is in his ownership of the company.  So he can call the play Warren Buffett uses.   Buffett has been paid the same annual salary for the last 40 years-$100,000.

Credit union CEO’s do not have Price’s “stock” appreciation—although a small number have cashed out their positions by negotiating significant special merger payments as their credit union’s final act.

Skeptics point out this model would not work in low pay, low margin, slow growth industries such as food service and mass retail. In these industries robotic solutions and customer self-service are replacing traditional low wage employees converting variable salary expenses to a fixed capital investment.

Price’s response is automation makes the need for creativity, marketing and initiative in the remaining jobs even more critical.

Today a number of credit unions share their success with employees through various gain sharing programs.  These do not change the basic structure of the salary scale.

What would be a cooperative equivalent of this approach to employee motivation, accountability, compensation and organizational success?  Or as Price alluded, would this change be too disruptive of the existing narrative about how credit union CEO’s are compensated?

What would  be credit union member-owners reaction?   How might such a plan influence the way employees talk about the cooperative advantage with members?

Are there examples of credit unions  aligning compensation at all levels following a cooperative approach to this challenge?

I would be glad to share any examples incorporating this innovative spirit.

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Are Credit Unions Democratic? Does it Matter?

On paper and as a long standing, unique cooperative value, the best answer is,  “Maybe.”  After all for federal and many state charters the member-owners have one person, one vote in elections, and no proxies allowed.

The required annual meeting is the recurring opportunity for members to decide who will represent them.  To approve their current leaders or to vote them out.

This is a crucial process in co-op governance.  However, the practice rarely lives up to the theory. One person sent me his summary of board elections with the title:  It’s a scam.

Here is my observation on the subject of Board elections:

1-The credit union board of directors appoint a nominating committee.  The committee are usually directors NOT up for re-election.

2- The nominating committee nominates the incumbent directors.

3-The nominating committee does not nominate any non-incumbents.

4-The ballot is “no contest” – the number of directors up for election is the same number of directors on the ballot.

5-There are no director term limits.

6-Directors arrange to “resign/retire” mid-year so the position can be filled by appointment – by the incumbent board of directors.

7-Once appointed the director will seek “re-election” by way of the nominating committee – composed of the board of directors

If a member seeks to run for the board they need to stand in front of the credit union and solicit signatures on a nominating petition & the number of signatures required is substantial.  

If it is not a scam, contested elections are certainly a rare occurrence.

While cynical, there is more than an element of truth in this former CEO’s observation.

Does the Absence of Director Elections Make any Difference?

Many very large federal credit unions have never had an, open contested board election in this century.   In seven states where proxies are used by state charters, the board itself controls all of the votes even were there to be a nomination by petition.  The result is that boards end up perpetually controlling who serves.

Incumbent directors and CEO’s would defend the process by pointing to the industry’s financial results and member growth.  They would argue that is the real measure of the responsiveness of board leadership.

Others would point out that  credit unions regularly publicize  board nominations when announcing the annual meeting, but never receive any interest from members.

For many the idea that any member might collect sufficient signatures to stand for the board is unsettling.  After all it takes expertise and experience like that of current office holders, to be able to be a director.

If most credit unions succeed without democracy does it matter?

Can this co-op concept of “democracy” succeed if the member-owners never vote?

What kind of leadership culture and responsiveness will exist at the board level knowing that their tenures are never subject to member approval?

How will co-ops present themselves versus for-profit institutions where shareholder rights and activity are frequently used to bring issues to the fore at annual meetings?

Finally, how does one explain the voting manipulation that occurs with mergers of long serving, solvent credit unions where substantial benefits are paid to the merging CEO?

The  merger transaction promises members only rhetorical future benefits. But the person responsible for the merger, who gives up leadership responsibilities, receives significantly more compensation (a golden parachute) than by staying and retiring from the job.

One writer described the outcome when democratic practice is usurped by those in power:

“when you get rid of the democratic oversight of a sector of the economy, it becomes a black market free-for-all, a winner-take-all-loser-dies-in-poverty survival-of-the-fittest dog-eat-dog game.

The masses lose, the commons suffer, individual rights get trampled, and power amasses to CEO’s maximizing their personal outcomes. “

The Most Important Loss

While the erosion of democratic processes, may take time to manifest itself, the failure to cultivate co-op’s unique member-owner design may be the system’s biggest vulnerability.

Recently the Vanguard Group of mutual funds began a new television campaign.   The theme: “You’re not just an investor, You’re an Owner.”

This is only the second national TV campaign in the firm’s history.  As their initial product advantage of low cost, index-based mutual funds and ETF’s was matched by all their competitors, they are now singling out the one difference no other fund can match.

The message: “A rich life is about more than just money. That’s why at Vanguard, you’re more than just an investor — you’re an owner. So you can build a future for those you love.”

The agency which created the ads explained: the campaign was introduced “to celebrate the benefits of Vanguard’s unique corporate structure which makes clients, owners” and that the goal is “to underscore the value that investors can realize by investing through a firm with no outside owners other than its clients.”

More than a Design

Credit unions which fail to practice and celebrate their unique member-owner design, may be surrendering the most important advantage they have.

Democratic governance is not just another organizational option.  It is a critical aspect of an organization’s beliefs and practices for relating to the members who created and own the credit union.

When the advantage is not used, it goes away.   Co-ops become indistinguishable from banks.  Members are just another name for customers.  And leadership progressively presumes its judgments and choices are the primary basis for all decisions-even those ending the charter’s independent existence.  Even authoritarian leaders can survive, for a while.

When democratic practices are habitually circumvented, they are difficult to restore.   Without regular succession processes, the ability to find new leaders, or even generate interest in leadership is squelched. And at any moment, the sirens of self-interest can appear, cancelling the credit union’s future for all members.

Democracy matters, until it doesn’t.    The good news is that this is a fundamental flaw that every credit union has in its own power to fix.

 

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Veteran’s Day: Honoring the Responsibility of Public Service

A recent news story’s headline:  Sub’s Leaders Fired after Hitting Mountain.

The article described how the USS Connecticut, one of the fastest, most modern nuclear powered submarines had hit an underwater object  described as a “mountain”  in October.

The accident injured about a dozen sailors, but the sub navigated on its own back to Guam for a damage assessment.

One immediate result of the event is that the commander of the fast-attack sub, the executive officer and the senior enlisted Master Chief were all relieved of their duties.  Vice Adm. Karl Thomas, commander of US 7th Fleet, determined that “sound judgment, prudent decision-making and adherence to required procedures in navigation planning, watch team execution and risk management could have prevented the incident,”

The Military and Leadership

From the first day of active duty, every member of the military learns about responsibility and accountability.   From the ordinary tasks of getting up, wearing the uniform, or cleaning a work area, everything is subject to inspection.

All responsibilities come with accountability.   And when performance is above average there are awards and recognition beyond a positive fitness report.  But there is also the reprimand in the file when something goes wrong.   I received both in my four plus years of active duty.

I received the Navy Commendation Medal as Supply Officer during combat support operations:

“His outstanding managerial abilities combines with a ceaseless drive to accept and surmount challenges resulted in the establishment of many services for task group ONE SIXTEEN POINT ONE personal (the Navy Seal Team at Solid Anchor) that were not previously available.  Filson’s leadership and devotion to duty reflected great credit upon himself and were in keeping with the highest traditions of the United States Naval Service.”

Fitness reports recommended “accelerated promotion and augmentation to the regular Navy.”

But there was also the letter of reprimand in the file.   Upon being relieved as Supply Officer to transfer to shore duty, the audit of the ship’s store inventory found a shortage of $1,850.   After repeated recounts, there was no explanation, but the event occurred on my watch.

Many think of military duty as primarily combat.  I was a gunfire control officer.   Several times this meant telling everyone to clear the mount so a sailor can take a 3 inch 50 round that failed fire and throw the dud over the side.  Or the evening the siren’s sounded at Solid Anchor, the phosphorous flares suspended from tiny parachutes to light up the perimeter, the immediate scrambling of the two gunship helicopters, and running in night clothes to the bunkers built with sandbags.

These moments were the exceptions from much of the daily routine.   Nevertheless, the concepts of responsibility and accountability applied to all our activities.   Captain Mann personally signed off on every communication from the ship that I authored. He explained the only way his commanding officer knew how he was doing was from reading the ship’s traffic and whether the we arrived and departed port on time.

Respect for Service

The military gave me the chance to meet some of the most honorable, decent, and effective people I have ever known.    When I left banking to join Ed Callahan and Bucky Sebastian, it was not my thought to seek a government career.  Rather it was seeing in them the same qualities that make the military service special.   They believed that government employees are responsible to the public, that wise stewardship of resources is expected, and that everyone will be accountable for their duty.  Success was always a team effort.

Government service for them was not about political ideology or power.  Rather it was about serving the public.   When Ed announced the three of us were leaving NCUA in 1985 to form an undefined new company, he explained that we had accomplished what we came to do at NCUA, and it was time to move on.   Just like service in the military.

Dishonoring a Heritage of Service

Yesterday I received a member notice dated November 4, 2021 announcing the proposed merger of the $457 million Heritage Credit Union with the $3.7 billion Connexus, both in Wisconsin.  Each is very  strong financially.

The required disclosures say that the Heritage President, a 40-year employee, will retire immediately after the merger.  The additional benefits she will receive for her final action includes a $487,546 payment due as employment contract runs through 3/2/2023; continuing health care benefits of $1,750 per month through age 65; a lump sum payment on her 457(f) in the amount of $425,282; and a merger clause payout  per her employment contract of $326,284.  The total of the additional compensation known amounts is $1.239 million plus the monthly health benefits.

The practice of a retiring CEO selling the credit union as a final effort to create a personal golden parachute is not new.  The most troubling aspect is the leadership failure by both the CEO and board ending all that Heritage had enabled–the shutting down of independent career opportunities for 124 employees, the ending of local relationships in 12 communities, and the betrayal  29,000 members’ loyalty first begun in 1934. This action is the antithesis of  the credit union’s founding story on  their web site-an event that enabled the professional leadership opportunities  the CEO and board have enjoyed for decades.

But it takes two parties to make a deal.   Connexus’ CEO and board agreed to these sale terms, issuing a joint press release.  Merger math is simple:  1 + 1 = 1.  The cupidity of the one side is matched by the morally comatose on the other.   Members are not dumb.   They see the self- dealing and loss of their Heritage.

Moreover employees of both organizations will look past the superficial statements of what’s in it for them.  They will ask is this the kind of organization, leadership and values to which I want to be a part of?

Why We Remember Honorable Service

This additional example of self-enrichment trumping fiduciary responsibility is even more troubling because the regulators-both state and NCUA-routinely sign off on these self-enrichment practices.

The concepts of responsibility and accountability have traditionally been the hallmark of effective public service—professionals in their conduct and expertise and conscientious in their duty.

The military’s example, combining honorable service with accountable conduct, is something we properly salute.   We celebrate the values inherent in this public duty. But these concepts should not be limited to military employees.

The credit union system could stand much taller and be more potent if the traditions of honorable service that created the $2 trillion system today, were followed by those responsible for overseeing its conduct today.

The logic of mergers like Heritage and Connexus is nothing more than simple monopoly capitalism.  Members become the means to growing ever larger, not the reason for the cooperative’s creation.  Management’s self-interest has usurped member’s best interest.

A good first step would be to learn from the Navy example.  There is an obvious regulatory shortcoming  of “sound judgment, prudent decision-making and adherence to required procedures.” There needs to be  “relief of duties.”

But that would take leadership at the top.  Leadership that can distinguish cooperative purpose from corporate capitalism.   And that remembers the values and commitments that created the credit union alternative in the first place.

Veterans Day tributes remind all of us what really matters in life, especially by those who aspire to public service.