Category: Cooperative Design

At the beginning of the year, business firms, families and individuals take stock of their financial situation.  The results of last year are known. January brings the credit card bills from the holiday.  Taxes come due.

This year all segments  are reassessing their liquidity situation amidst rising interest rates and growing layoffs.

A Financial Disneyland

Since 2008’s financial crisis erupted, credit unions and members have been living in a financial Disneyland.  Interest rates were kept at historical lows.  The recent Covid response resulted in two years  of short term rates at or near zero.

The Fed’s monetary policy of quantitative easing flooded financial markets.  When capital no longer costs anything, most investments look safe. Returns on short term government securities or insured savings were most recently in single basis points. People and organizations tried new or speculative assets  such as meme stocks or crypto solutions.

The disciplines of long-term investing were overlooked. The risk-reward calculus became warped. Market and housing returns suggested only upside.  Everyone could become a winner.

What We Believe About Money

Call FCU has an unusual member financial education program.  It begins with a questionnaire.  The purpose is to learn your personality type, or in their words, “the strengths and weakness of your relationship with money.”

Everyone has a different approach and individual situations when the talk is about savings, spending and financial goals.   We live in an economy in which consumer spending drives 70% of the output.  Wealth, fame and power are the trinity of individual success for many in a capitalist economy.  Moreover if one achieves the first, the other two can be bought.

How a person or firms manage their finances express our values and ambitions.  So I think Call’s approach is an important first step in any person or organization’s approach to 2023.

One Organization’s Statement of its Financial Philosophy

Non profit organizations have a unique relationship to finances.  They are not in business to build wealth, but they must demonstrate stewardship to donors, or like private business, they can cease to exist.

The Center for Contemplation is a 501 C 3 founded by Franciscan Richard Rohr to put spiritual unity  as the center of religious practice.

The organization has published its organizational financial approach.  It defines this as a “complex process that codifies their relationship with money: how they  raise it, manage it, and spend it. Our financial philosophy centers on values concerning donations and the stewardship of resources. Those financial principles are:

• We operate from a clear definition of “enough.”
• We practice transparency.
• We seek for money to never be the barrier to participation.
• We understand exchanges of money first and foremost as vehicles for advancing our mission and message.
• We commit to spend simply, equitably, and sustainably.
• We lead with giving and generosity.

Should credit unions create their own statement of financial philosophy?  Is a business plan a sufficient roadmap?  Does operating in the context of cooperative design and values provide a complete picture?

Might a credit union’s leaders consider the CAC’s principles above and ask whether they describe their financial philosophy? I believe the exercise could be as revealing as Call FCU’s individual assessment.  For example, when has a credit union ever defined what “enough” might mean?

Amahl and the Night Visitors-How the Story Ends

In an earlier post about credit union’s most essential members, I quoted an aria from the short opera Amahl and the Night Visitors, Do Rich People Know?  The  mother lives with her crippled son. The three kings spend the night before continuing their journey.  The mother tries to take one small nugget and is caught stealing by the King’s page.

Here is how that confrontation works out in the opera’s final lyrics:

MELCHIOR (seeing what has erupted) Oh, good woman, you may keep the gold. The child we seek doesn’t need our gold. On love, on love alone he will build his kingdom. His pierced hand will hold no scepter. His haloed head will wear no crown. His might will not be built on your toil. Swifter than lightning, he will soon walk among us. He will bring us new life, and receive our death, and the keys to his city belong to the poor. Let us leave, my friends.

MOTHER Oh, no! Wait! Take back your gold! For such a king I’ve waited all my life… and if I weren’t so poor I would send a gift of my own to such a child.

AMAHL (pipes up) But, Mother, let me send him my crutch. Who knows, he may need one, and this, I made myself.

MOTHER (drawing in a breath sharply) But that you can’t, you can’t! Suddenly, Amahl begins to walk without his crutch.

AMAHL I walk, Mother. I walk, Mother.

First Things, First

As we enter a new year with both individual and corporate financial challenges, should we first ask what our relationship to  money is?  What “crutches” do we lean on to get us by?  What if we risked giving them away to find out who we really are, as a person and leader of a financial service?

Where does moral courage come from?  How do we learn it?

That was the question asked of the actor in the one-man play about Jan Karski.  His character was a  soldier, member of the Polish resistance, and diplomat during  the most extreme conditions of WW II.

Karski had a photographic memory and made detailed reports of conditions as a courier in 1940–1943 to the Polish government-in-exile.  Jewish leaders in  Warsaw requested he visit the city’s Ghetto and Belzec death camp.  They asked him to report what he had seen of the Nazi efforts to exterminate the Jewish people to the Allies.   He did.

He was captured, tortured by the Gestapo who sent him to a hospital. His SS captors hoped to break him to learn the details of the Polish underground movement.  He escaped from the hospital.  The Nazis killed all of 32 hospital doctors and nurses where he had been treated.

He spoke directly with Churchill and Anthony Eden, the British Foreign minister.   In the US he met with FDR plus national political, press, and Jewish leaders including Supreme Court Justice Felix Frankfurter.  In all his meetings he gave great detail of what he had seen. He  asked Allied political leaders in both countries to act, to stop the Nazi’s genocide.

His wartime efforts are presented in a film Remember This of this one-man play.   It has just been released in heaters and will be shown on PBS Great Performances in March.

Why Remember?

Karski’s story is about more than the Holocaust.  It is about human nature in all its greatness and horror.

His words, not just his personal example, live on as timeless and timely insights into human character.

In the film he observes, “Humans have an infinite capacity to ignore things that are not convenient.”

This looking away occurs beyond  the horrors of war;  it is true of everyday life.

He commented that “Governments do not have souls.  Only people do.”  Caring for fellow humans is not done by organizations, policies or even regulation.  That is the responsibility of the leaders and members of an organization. There are no market “invisible hands” doing humane work.

When he briefed  Justice Felix Frankfurter, the first person of Jewish faith on the Court, Frankfurter replied, “I don’t believe it.”   He was not calling Karski a liar; rather he could not comprehend how humans could possibly be implementing a plan to eliminate an entire people.

A “Living Relationship”

Karksi stayed in the US following the war.  Poland was occupied by the Soviet Union.  He could not return.   For 40 yeas he was a professor of International Studies and Polish history at Georgetown  University.

He was awarded the Presidential Medal of Freedom by Obama a decade after his death in 2000.

Even with this heroic story, one of the co-writers of the script on the faculty at Georgetown, confessed he had walked by Karski’s campus statue for four years and paid no attention to it.

That typical oversight is why stories need be told.  And for their relevance to today’s and future generations.

The actor in the film stated he has “living relationship” with his character.  Karski’s life resonates still.   It is more than a remembrance of an extraordinary person.  It is an example that inspires, even compels us, to ask about  at our own lives.

Our Witness Today

In the Q&A following the film’s showing at the Shakespeare Theatre in DC, the question was asked of the actor: How did Karski develop the moral courage to act in these extreme circumstances?

The actor replied that he thought it was from his mother, a devout catholic.

I believe that people learn their values from watching others.  Whether in extraordinary acts of courage or lives long lived in service to people, we select those qualities we want to express in own professions.

Karski’s example is helpful for those working in the cooperatives.  One of our distinguishing features is an organizational design based on values and collaboration. We are called to a higher standard than might be practiced in other firms.

Credit unions were intended to protect and serve those who are exploited by others.  Our meme is the little guy with the umbrella.  But how easy is it to ignore our cooperative roots and imitate institutions for which credit unions were intended as an alternative?

Do we transfer responsibility for outcomes onto the organization in which we work?   Karski reminds that only persons have “soul,” that is the capacity to do the right thing.

It is not the cooperative model that fails.  Human agency matters whether consequences seem trivial or of utmost concern.

What I find compelling about his example is that after Allied leaders failed to respond to the Holocaust tragedy he reported, he never blamed others for inaction.

His witness of moral courage was not a basis for faulting others.   He did the best he could so that future generations could benefit from his example.

That’s why the film is called Remember This.

Organizational isomorphism.  That is a big word for the tendency of organizations in an industry to follow the herd.  Do what the other firms do and remain with the crowd.   To act contrary to the consensus is dangerous.   Staying in the herd protects individual reputation and accountability.

John Tippets, the longtime CEO at American Airlines FCU described this conforming tendency in his speech to the Navy FCU board in 2001:

One of the challenges of leadership is to constantly sort through popular ideas advocated by credit union peers. 

It seems that at every meeting, someone has a new fad or a new idea – they’re sure it’s the greatest thing since sliced bread!  A director will return from somewhere thinking he’s got the greatest idea; a staff member or a vocal member of the credit union will bring in great ideas. 

But many of these ideas do not fit.  For example, AAFCU has not felt comfortable about indirect lending; we do not actively participate in risk-based pricing; we do not see a fit for select employee group (SEG) expansions; we didn’t understand how dial PC banking could preserve our economics; and, so far, even credit cards do not seem to fit.  We declined to do these things because we haven’t been able to make them fit into our models. 

You have to make choices and you have to make trade-offs.

Layoffs in Tech:  Necessary or Herd Mentality?

Alphabet’s (Google’s parent) reported a 36% increase in 4^th quarter 2022 profit to $20.64 billion.

At the same time as these record financial results, the company announced 12,000 layoffs  or 6% of its workforce.  The public explanation was over-hiring during the pandemic growth and doubling down on AI solutions in the future.

Why all these tech layoffs after record profits and rising revenue?   If the average laid off employee cost $200,000 per year, then Alphabet saved $2.4 billion, about 10% of one quarter’s profit.

It doesn’t compute. Here is one writer’s interpretation in an article The Tech Layoff “Contagion.”

The industry is having a midlife crisis. And that means once the crisis is over, a new era will begin. . . More likely, we are in an intermission between technological epochs.

Some argue that, as they wait out this intermission, CEOs are copying one another—laying off workers not simply as an unavoidable consequence of the changing economy, but because everybody else is doing it. “Chief executives are normal people who navigate uncertainty by copying behavior,”  writes Derek Thompson of the Atlantic staff.

He cites business professor Jeffrey Pfeffer, who told Stanford News: “Was there a bubble in valuations? Absolutely … Did Meta overhire? Probably.

But is that why they are laying people off? Of course not … These companies are all making money. They are doing it because other companies are doing it.”

Pfeffer believes this “social contagion” could spread to other industries. “Layoffs are contagious across industries and within industries,” he said in the Stanford News article. If so, the story of tech layoffs could end up being a much broader story about work in America.

A Cooperative Opportunity

Because credit unions do not have a stock price, they can resist  market expectations and respond in ways for-profit firms cannot.

In the 2008-09 financial crisis credit unions continued to lend to consumers, when every other firm pulled back.  Who would want to make auto loans  when all of the major US  manufacturers were threatened by bankruptcy?  Both GM and Chrysler were reorganized in 2009.  But credit unions continued to lend on these brands.

Sometimes crisis can motivate credit unions to become more of what they were designed to be: a counter cyclical option, to be there for members when other firms pull back, reduce staff, eliminate products and shortcut customer service.

A Strategic Misread

Another factor in the tech layoffs is the possible strategic misinterpretation of Covid’s impact  on consumer behavior and market evolution.  Derek Thompson suggests this possible misreading of the future:

Many people predicted that the digitization of the pandemic economy in 2020, such as the rise in streaming entertainment and online food-delivery apps and at-home fitness, were “accelerations,” pushing us all into a future that was coming anyway.

In this interpretation, the pandemic was a time machine, hastening the 2030s and raising tech valuations accordingly. Hiring boomed across tech, as companies added tens of thousands of workers to meet this expectation of acceleration.

But perhaps the pandemic wasn’t really an accelerant. Maybe it was a bubble.

Choices that Fit the Cooperative Model

Many credit unions also followed this same future assessment, investing in digital and fintech startups as the inevitable pattern for future success.

Yet the strength of credit unions is their member relationship, not their technology leadership.  Employees are the single most important aspect of this service advantage.  Laying off staff or other “potential recession’ cutbacks, could compromise credit union’s mission when most needed.

As Tippet’s explained he would sometimes shun the prevailing wisdom: We declined to do these things because we haven’t been able to make them fit our model.

Credit unions begin the year on a sound financial and earnings base. Whatever the economic and interest rate events in 2023  now is not the time to copy market expectations to cut back.   Especially by laying off those who make the difference when serving members.

Plus honoring a firm’s obligations to its employees If the economy turns sour, is the right thing to do.

From March 2020 until two years later when the Fed began its rate increases, overnight rates were near zero.  For these years and the decade prior, monetary goals were dominated by ZIRP, or zero interest rate policy.  Federal reserve actions were characterized by “easy money” to encourage growth almost at all costs.

TINA was the real world consequence of an ever expanding money supply seeking higher returns.  There is No Alternative led to speculation in every market sector from crypto and all of its virtual spinoffs, the stock market with historically high valuations (price/ earnings  ratios) and in most other forms of investing such as residential and commercial real  estate.

With near zero cost of funds and asset appreciation occurring in every category, how could an investment not pay off?  Holding cash or buying short term bonds was for fools when higher returns were possible from virtually any other  investment.

Now the bubbles are starting to burst as the Federal Reserve continues its interest rate hikes and as these flow through to longer term yields.

The combination of ZIRP and TINA meant that valuations in stock markets, or new ventures , as well as traditional collateral based lending on real estate or commercial  buildings became separated from actual earnings or cash flow analysis.  Money managers were drawn to these alternatives assured by the decade long monetary easing culminating in ZIRP.

Entrepreneurs, startups and even established firms made decisions not based on actual business performance but future projections. These choices were based of valuations underwritten with assumptions of low cost of funding.

Impact on Credit Unions

In 2020 and 2021 credit union shares  grew by double digits. Consumers were flush with cash from multiple government stimulus spending packages.   They used these new funds to pay down traditional borrowings.

With only a 5-10 basis points return on short term funds, credit unions looked for alternatives.  They extended investments out the yield curve, sought higher yields from longer loan maturities, commercial participations, or other forms of indirect lending pools and even new CUSO investments.

In 2023 credit unions will navigate the 1-2 year adjustment process to correct these prior decisions. With patience and prudent balance sheet management most will transition to this new rate era and recover unrealized market losses.

This rebalancing may entail paying below market dividends on core shares until asset returns adjust to higher yields.    If the institution has a strong service culture and earned  loyalty, this reliance on member’s patience should  be successful.

However there were other investments by credit unions where the process becomes more complicated.  The two areas most vulnerable to ZIRP/TINA overvaluations are whole bank purchases and mergers. Or any other transaction which resulted in the creation of significant accounting goodwill.

The Bank Purchase Challenge

Most credit union bank purchases, where information is public, have been at multiples of 1.5X to 2X book value.   For publicly traded banks, these credit union offers were often much in excess of the most recently quoted stock price.

Total cash paid to bank shareholders depends on the size of the acquisition.  But these outlays are large involving tens to hundreds of millions of dollars.

Credit unions book the difference between the cash paid and the net value of the assets as goodwill.  This is an intangible asset.  It is non-earning.   These valuations are based on forecasts about cost of funds, the credit union tax exemption and any market synergies that may be achieved.

Most sizeable bank purchases will take 3-5 years to determine if the price paid will result in an accretion to ROA or perhaps reduce the prepurchase financial performance.  Operational and market integrations alone will take several years.   For purchases made in the ZIRP environment, these forecasts will have to be rerun.   Is the goodwill premium “real” or was it miscalculated?

Similarly in mergers combined with purchase value accounting, a goodwill gain for amounts greater than book value may be added to “equity acquired in merger.”   But is that goodwill actually long term or just a momentary valuation bubble caused by the low interest rates paid on deposits versus market yields?

If the goodwill recorded is unrealistic for any reason, then the valuation write downs  come out of current  earnings.  In this case, members pay twice:  once by sending  out cash to bank shareholders and again for expensing the decline in goodwill from current income.

Looking at Case Studies

In future blogs I will examine several whole bank purchases looking at the credit union’s performance before and after, and by benchmarking with peers.

I am inclined to prefer cooperative strategy which prioritizes organic growth through continuous innovation and consistent market focus for member benefit.  Engineering growth through acquisitions is a very different financial and operational skill.

In the capital markets these transactions are most often done with “play money,” that is the stock of acquiring companies, not actual outlays of cash.  The market’s judgment via the stock price of  post-acquisition performance is constant and public.

There is no such accountability in similar credit union purchases.   CEO’s and boards  leave and their successors must then  prove that these “investments” with a long tail were wise.

Ultimately it is not the valuation at the time of purchase that reflects opportunity; rather it is the ability to convert externally acquired assets for real member benefit.

2023 will entail assessment of investments driven by ZIRP, TINA and consultant’s fees to see if they really enhance the cooperative difference. That reckoning could be more critical and harder than traditional cooperative balance sheet transformations.

When the economy shut down in March of 2020 due to Covid, many office workers went home.  Hybrid and remote work options were developed.  However essential workers stayed on the job:  the trash haulers, public transportation, police, fire, hospital, construction  workers.  These blue collar and middle class service workers make community life possible for the rest of us.

Today the key economic question is will there be a recession?  For hundreds of thousands of white collar workers in the technology, finance and venture capital startups the layoffs are here.

Goldman Sachs, Pepsi, Gannet, CNN, Door Dash, Carvana, Roku, Amazon and dozens of other previously industry high flyers are in the first rounds of layoffs.

The dominance of the four FANG (Facebook, Apple, Netflix, Google) and their stock market performance has fallen back to the mean of the rest of the market over the past five years.

The bankruptcies of the crypto, NFT industry and its offshoots have cost investors over $2 trillion in losses with more to come.

However in almost every other part of the economy, especially the service sectors, there are millions of unfilled jobs.  Wages are rising from both employer demand and more aggressive employee actions.

The Well Off and Essential Labor

America’s experience with capitalism has often been characterized as a society where the successful, the wealthy, the better educated have dominated their poorer classes.  Here is an excerpt from a Heather Cox Richardson description of why Lincoln strongly supported universal education:

But when they organized in the 1850s to push back against the efforts of elite enslavers like Hammond to take over the national government, members of the fledgling Republican Party recognized the importance of education. In 1859, Illinois lawyer Abraham Lincoln explained that those who adhered to the “mud-sill” theory “assumed that labor and education are incompatible; and any practical combination of them impossible…. According to that theory, the education of laborers, is not only useless, but pernicious, and dangerous.”

Lincoln argued that workers were not simply drudges but rather were the heart of the economy. “The prudent, penniless beginner in the world, labors for wages awhile, saves a surplus with which to buy tools or land, for himself; then labors on his own account another while, and at length hires another new beginner to help him.” He tied the political vision of the Framers to this economic vision. In order to prosper, he argued, men needed “book-learning,” and he called for universal education.  

Congress passed the Morrill Land Grant College Act in 1862 to focus on the teaching of practical agriculture, science, military science, and engineering—although “without excluding other scientific and classical studies”—as a response to the industrial revolution and changing social class.

The Question Today: Do Rich People Know?

Gian Carlo Menotti’s opera Amahl and the Night visitors tells of the night the Three Kings, following the star to Bethlehem, stop for shelter at the home of Amahl, a poor, crippled shepherd boy who lives with his widowed mother.  The opera was first performed in 1951 and regularly at Christmas since.

The climactic scene occurs as the three kings sleep. The mother consider if she dare take a piece  of gold from  the king’s treasure chest. She debates the rightness of her action:

MOTHER (thinking to herself) All that gold! All that gold! I wonder if rich people know what to do with their gold? Do they know how a child could be fed? Do rich people know? Do they know that a house can be kept warm all day with burning logs? Do rich people know? Do they know how to roast sweet corn on the fire? Do they know do they know how to fill a courtyard with doves? Do they know… do they know? Do they know how to milk a clover fed goat? Do they know? Do they know how to spice hot wine on cold winter nights? Do they know… do they know? All that gold… all that gold! Oh what I could do for my child with that gold! Why should it all go to a child they don’t even know? They are asleep. Do I dare? If I take some, they’ll never miss it… (moving towards the boxes of gold…) …for my child for my child… for my child… for my child…

2023: the Year of the “Essential Member”

Credit union’s purpose was to address those in society who have the least or know he least when seeking financial services, especially credit.

The cooperative model proved that consumers are indeed a market that all financial institutions can profitably serve.  Today financing options for consumers are available for those with no or damaged credit to the elite credit cards made of titanium, not mere plastic, for the most well off.

Since deregulation the credit union system has grown, attracted tens of millions of new members and provided ever expanding institutional and professional opportunities for coop leaders.

Some coop executives see their opportunities in buying banks or scooping up their smaller brethren.  Senior executive coop compensation routinely rewards in the mid six figures.  For the best well-paid leaders, annual compensation comes with two commas.

The challenge for coop leaders will be the question asked by the widow in Amahl:  I wonder if rich people know what to do with their gold?

Have leaders so aspired to emulate their banking counterparts that the essential members whose loyalty created the institutions they lead has been forgotten?

Yes, the white collar tech, financial and previously high flying company employees now being brought back to earth by rising interest rates, will need our help as well.

But let’s never forget those who brought us to where we are today-a $2.3 trillion tax exempt financial force with a special role in society.  This institutional success has enabled many coop managers and boards to become members of the white collar class.

Do they know that America’s essential workforce may indeed be the greatest opportunity for credit unions in this pivotal year of economic and market realignments.