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A Modest Proposal for Secondary Capital

NCUA’s June delay in implementing a new risk based capital (RBC) rule was in part explained by the need to examine whether a secondary capital option should be part of the new capital model.

Cooperative design and history suggest there is an immediate and straightforward additional capital option. This solution can be implemented regardless of the outcome of the RBC discussions.

The 1934 Federal Credit Union Act mandated that the par value “shall be $5 per share,” an amount in the law based on twenty five years of state-chartered credit union practice.

Credit unions had no share insurance funds, state or federal, until the 1970s.  Prior to that all member shares were at risk, that is equity for the institution.   An ongoing consequence of this financial structure, even in the era of deregulation, is that credit union shares are second in payment priority in event of liquidation to all other liabilities. This means that third party lenders to credit unions, such as the FHLB system or banks, know that equity is more than a credit union’s retained earnings. In the event of failure, the insurance fund must pay lenders’ outstanding loans ahead of shares.

The $5 Par Share Value Today

The historical par value of  $5 was often purchased on an installment plan, for example,  25 cents a week. This par value, now a variable amount, was the foundation for all funding and was at risk should the credit union not succeed.  Virtually all FCUs and state charters still active today, were financed with this membership shares-at-risk model. This shared fate meant that the cooperative model was indeed based on common values and purpose.

The value of the $5 initial member share purchase requirement today depends on which index one uses to analyze changes in economic value.   There are at least seven choices from the consumer price index to various efforts that track the cost of labor, to nominal GDP per capita. The range of results from these various indexes shows that the value of the $5 share in 1934 would range from $62.70 (CPI) to $373 (GDP per capita) in 2019.

Reengaging Members in the Cooperative Model

The option to ask members to purchase one at risk (uninsured) capital share with specified minimum par value would provide additional equity but more importantly signify once again the uniqueness of the cooperative model. It would be available only to members, limited in individual amounts, and subject to terms and conditions set by the boards.

There is no need to invent multiple plans for secondary capital sold to third parties creating a potential conflict with member’s returns. Instead the original design that successfully launched tens of thousands of charters could become today’s solution for capital flexibility when that is in the members’ best interest.

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My Favorite Summer Movie Experience: Shining Night

Summer movies can provide escape, inspire, provoke and entertain.

All of these qualities are in the documentary Shining Night about American Composer Morten Lauridsen. I sought out the movie following a week of learning to sing Lux Aeterna, (a contemporary requiem composed on Lauridsen’s mother’s death), at a Richmond, VA choral workshop organized by Berkshire Choral International.

A Composer’s Thoughts

Born in 1943, three of his compositions are the most popular choral sheet music ever sold: Lux Alterna, O Magnum Mysterium, and Dirait-On.

The movie is a biography of the composer, and more importantly conversations about his creative motivations. Lauridsen is a mystic who translates both older Christian scriptures and contemporary poetry (“time tested words”) into musical expressions.

His descriptions of the these efforts are insightful. He is inspired by the belief that “There is something bigger than us out there. We must tap into that.”

He talks about “an absolute desire” to create because you have been sparked by something that makes you “feel whole” and provides inner peace.

An Inner Song

For Lauridsen, his way of finding meaning was writing music to share “this inner song.”

Very few are blessed with the genius of combining words and music to express one’s purpose. He acknowledges that sharing an “inner song” is no easy task, but that doing so “will change lives.”

That is the creative contribution we too often take for granted. But that is the light or to use his Latin word, Lux, that helps each of us believe each day is indeed worth living.

I hope an experience that enlightens will also be part of your summer.

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The Cooperative Model’s Longevity Advantage

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

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

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

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

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

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Why Closing a Newspaper is Like Merging a Healthy Credit Union

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

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

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

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

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

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

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

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

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

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

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

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

“Scared for the Community”

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

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

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

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

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

P.s. added 8/2/19

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

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Twenty Five Years as CEO and Counting

The Chairman of CU*Answers announced at the CUSO’s 2019 Annual Meeting that the CEO would have his twenty fifth anniversary this month.

Many important accomplishments could be listed from this quarter century of management leadership. But I would highlight two critical processes that have contributed to this success.

The first is his ability to always plan ahead, not just manage the present moment. An example was the announcement that the cooperatively-owned CUSO will be investing over $400 million in technology spending in the next five years. That fact underwrites the CUSO’s ability to “pay it forward” for future generations of users and their members. The first rule of technology management is that it requires constant reinvestment.

A second factor oftentimes overlooked, is Randy’s unceasing efforts to encourage participation by all the owners and users of the CUSO. This is accomplished by more than traditional cooperative practice of boards, committees and annual meetings. He constantly invents new ways to incent feedback by owners through boot camps, leadership conferences, board planning sessions, and a never ending deluge of emails seeking reactions.

As important as money may be to sustainability, it can never substitute for passion. And participation encourages passion and cooperative pride of ownership.

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The Source of Credit Unions’ Soundness

“Our movement does not exist because it was created from the top down. Rather it was created from the bottom up. . . we did not tell Congress we wanted to be “safe and sound” institutions. We always knew that if we were lending to our members, there was risk involved. Serving came first; safety and soundness was a means to the end of serving.”

(Ed Callahan May 1999)

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Independence Day Names Only Half the Holiday

July 4th is the grandest of America’s patriotic observances. We celebrate the declaration that the colonies are free from the rule of the British crown.

Freedom is frequently described as freedom from something: fear, want, rule by an external force or exigency.

But freedom from also enables the ability to do something that might otherwise be feasible. It is this empowering opportunity that Ed Callahan as Chairman of NCUA singled out in a speech to the Mass CUNA League’s Annual meeting on November 3, 1984.

Deregulation had freed credit unions from the government’s rule making and oversight of operations and given that responsibility to boards and managers. It had provided a context where credit unions were empowered to make decisions not previously open to them. Ed singled out three new freedoms:

  • Freedom to compete: credit unions now make their own business decisions;
  • Freedom to serve: credit unions now decide who the membership will include;
  • Freedom of security: credit unions have their own unique insurance safety net and liquidity fund.

These freedoms were possible because of the unique cooperative design that harnessed members and credit unions in a interdependent system of self-help and self-reliance. Combining independence and interdependence is what makes the cooperative system unique.

The Rouser at the End

Ed as an old football coach often completed his speeches with a motivational exhortation.

In this case he challenged the attendees to go beyond the rhetoric of people helping people, or reciting the movement’s historical milestones. He stated: “You’ve got to go forward from this time to document that people serving people is not just a slogan, but a reality.” Show your congressman what you have done for the elderly, the retiree, the people moving, the high schoolers, the kids and children.

“We’re all flesh and blood. We turn to our credit union to help us out.”

Freedom enables both independence and interdependency. Collaboration and autonomy. United in cooperative design.

Credit unions are as American as apple pie. They enable members’ financial well-being and to be engaged in a community of peers.

“Independence Day” includes a special irony. For it is not just freedom from, but freedom to do.

And credit unions are a unique example of the fruits that this freedom can produce: social impact and personal fulfillment.

Happy 4th

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An Example for Today’s Credit Union Pioneers

In 1925 Michigan passed its first credit union act. A November 21, 1925 brief article in the Grand Rapids Press reported on efforts to implement this new authority with the following lead:

Roy F. Bergengren, Boston Secretary of the Credit Union National Extension Bureau conferred with several business men and Association of Commerce officials Saturday regarding organization of credit unions in Grand Rapids.

The article then describes what a credit union is and its purpose: “to help members and give them good credit standing.”

The final paragraph records a powerful example of the cooperative’s appeal Bergengren used in his talk. “15 telephone girls in Boston organized a credit union with $4.50 in total funds. The credit union now has 13,000 members and $280,000 in total funds.”

From Small Seeds

While learning the immediate reactions to his pioneering proselytizing would require more research, today Michigan has 225 credit unions headquartered in the state, serving over 5 million members and managing $67 billion in assets. Credit unions hold 20% of all financial deposits making Michigan one of the most heavily credit-unionized states in the country.

From a small seed mighty results have emerged. How might Bergengren react to the fruits of his labors almost a century later? With satisfaction? Or perhaps with questions such as:

  • Where are today’s credit union pioneers?
  • What seeds are they planting?
  • What partnerships are they building in their communities?
  • How have the members benefited from the growth of credit unions?

My sense is that he would be asking questions knowing that the answers will condition the future of the credit union movement in Michigan. While brief, the article illustrates several timeless factors necessary for today’s cooperative entrepreneurs who seek to further the work of the original Credit Union National Extension Bureau.

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The Greatest Generation: What They Did for Credit Unions

Tom Brokaw’s characterization of my parent’s generation as the “greatest” is recalled every time a WWII commemoration is presented.

But as the recent celebration of the 75th Anniversary of D-Day is overwhelmed by present events, it is important to remember another vital contribution this same generation made when not fighting a world war.

Children and young adults born of Depression-era parents, also accelerated a self-help movement for economic democracy that continues to thrive today. It is the $1.5 trillion cooperative credit union system which counts almost a third of Americans as member-owners.

The seeds were laid from 1909 to 1934 in states that passed over 25 laws authorizing cooperative charters. That pioneering “proof of concept” provided the credibility to pass the Federal Credit Union Act in 1934. Now credit unions could be formed anywhere in the country.

A Chartering Tsunami

What happened next is as dramatic a change as occurred in any post-war industry in America. For with the encouragement of the Bureau of Credit Unions housed in a small niche of the Department of Agriculture, the credit union option flooded across the US.

From a first-year total in 1934 of 78 new credit unions, the total of active federal charters peaked in 1970 at 12,977. Except for the war years of 1943-45, the net growth of new charters was 300-400 per year, with a high point of 852 new credit unions in 1954.

By 1970 the total of all credit unions was 23,687 of which 10,132 were state-chartered.

How could this dramatic expansion in just one generation have taken place?

Two Who Helped Build the System

Just as the war years produced leaders and heroes, so also did this national chartering effort by those fighting for consumer choice in a financial service industry dominated by for-profit firms.

Many factors aided the dramatic growth of cooperative charters: the need for consumer credit, the support of employer-sponsors, the creation of support organizations for the credit union system, and the post-war economic boom. However, these favorable circumstances still needed cooperative entrepreneurs.

One of Those Was Louise McCarren Herring (1909-1987)

I first met Louise while at NCUA in 1982 where she was escorted by Sam Rizzo, the President of the National Deposit Guarantee Association (now called ASI), a cooperative state-chartered insurance alternative to the NCUSIF.

Her stories about participating in the founding of CUNA in Estes Park, Colorado in 1934 were memorable as she was sole living participant from that event.

But more significant than being present at the beginning, was her role in chartering hundreds of credit unions throughout the state of Ohio, including 17 within the Kroger Company’s grocery store chain  where she had found her first job.

Louise’s contributions were more than chartering. She helped create organizations that were essential to the growth of the emerging credit union support system including leagues, centrals, and alternative deposit insurance. She was an ardent supporter of choice and dual chartering.

Her passion for cooperatives was unabated late in life. She believed everyone should have an opportunity to belong to a credit union. During deregulation when credit unions were arguing whether credit unions could have member overlaps, she defended the opening of the charter and the importance of serving entire communities with the logic: Poverty is not a common bond.

The Organizer

Lance Barden (1896-1967) helped organize 400 to 500 credit unions. After WWI service and college, he joined the US Farm Credit Administration (FCA) in Berkley, Calif. While there he formed a credit union for the employees and served as both manager and treasurer.

A year and a half later he was appointed federal credit union organizer in the FCA’s credit union section for northern California.

In the book The California Story, his wife describes his work as a credit union organizer. “Our entire lives were wrapped up in credit unions. Even our weekends; managers of small credit unions would visit us regularly on Sunday afternoons and Lance taught them bookkeeping and accounting.’’

Lance was sent to Hawaii in 1936 to continue credit union organizing. The plan was to stay two weeks and start a half dozen or so. Instead he stayed the entire winter and organized close to a hundred.

He also helped to form leagues in California and Hawaii. His work became a family vocation and commitment. His son and daughter became credit union CEOs. His granddaughter Sue Longson became CEO of a credit union in her teens and continues as a consultant today.

Lance’s example of hard work, sharing firsthand experiences and an exceptional commitment to the cooperative model demonstrates what one government employee can accomplish. While verifying specific numbers of new charters is difficult, what is clear is that whatever the final count, he helped to found more credit unions than NCUA has chartered in all the years since 1985.

Lance’s wife told a story that illustrates Lance’s belief in the credit union model. When he organized a new credit union, he would ask for the money right on the spot. “Right then and there. There was one time a very poor man had just died. The credit union didn’t even have its books setup, but Lance lent the first nickel he collected to the man’s family for his funeral.” He always said, “When you give your money to a credit union, it will be put to good use immediately.”

The Greatest Generation’s Gift to Us

This phase of credit union history is about more than new organizations and building organizational support. Lance and Louise’s contribution was more than hundreds of new charters. What they “paid forward” was a set of values along with institutions to sustain those ideals.

Recent events have shown how cooperative institutions can be quickly and quietly merged or closed.  The loyalty of generations lost.. Objective accomplishments are overlooked.. Shared values are the foundation that sustains cooperatives.

The greatest generation paid forward an enormous legacy for their children  Can we maintain and extend this inheritance?. Should  we aspire to do anything less?

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NCUA Board has a Unique Opportunity to Eliminate the Flawed Risk Based Capital Proposal

This Thursday (June 20) the NCUA Board has only one topic on the agenda: the Risk Based Capital Rule (RBNW). Rodney Hood will be the 4th Chairman to address the issue.

He and fellow board member McWatters will have the chance to set a whole new direction for regulatory policy if they choose to do the obvious and cancel outright this deeply flawed rule-making effort.

Not only would such an action align with the administration’s policy priorities, it would also end a regulatory approach that is problematic. All other financial regulators have moved away from the belief that future risk can be both predicted and modeled so accurately so as to require specific and relative levels of capital more than sufficient for any future crisis.

The Proposal’s Flawed Foundation

In the post 2008/2009 financial crisis, FDIC and bank regulators reduced reliance on risk-based approaches in favor of a simple leverage capital ratio. Tomas Hoenig, the former Vice Chairman of the FDIC, championed this clearly understood and easily calculated capital ratio. At the same time, he repeatedly documented the flawed premises and historical errors of modeling future risk relativities among myriad categories of bank assets.

However, NCUA under Chairman Matz introduced this flawed approach that was so lacking in factual foundation that the initial draft had to be withdrawn; but then it was reintroduced a second time.

This revised proposal drew significant dissent from new board member McWatters who was in the minority 2:1 board vote to approve the regulation.

“Based upon my thirty plus years of experience as an attorney who has worked in many intricate issues of statutory and regulatory interpretation, I am of the view that NCUA does not possess the legal authority under the NCUA to adopt a two-tier RBNW regulatory standard.

NCUA staff did not undertake a formal estimate of the recurring compliance costs of the proposed regulations… Regrettably this additional burden falls on a financial services sector that is not too-big-to-fail and was in no manner responsible for the recent financial crisis.”

Kicking the Can Down the Road

The objections and complications of the rule were so great that NCUA delayed the final implementation until 2019 to allow time for the agency to expand its call report and internal software to be able to monitor the new rule.

When there were two board members only, Metzger and McWatters, they agreed to postpone implementation another year, til 2020. Congress has even proposed a law to delay this proposal further, a traditional political tactic when a flawed policy cannot be ended outright.

In the meantime, credit unions reported continually rising levels of capital, ending at over 11% collective net worth as of March 31.  This is 400 basis points over the well-capitalized regulatory requirement of 7%.

Taking a Cue from Bob Dylan

In 1966 the folk singer Bob Dylan faced a circumstance which he memorialized in the song 4th Time Around.  It starts with these words:

When she said, “Don’t waste your words, they’re just lies.” I cried she was deaf.

This is the 4th NCUA Board to consider imposing a detailed capital model when the credit union system was the only one to navigate the last crisis relatively intact under no risk-based rule. The RBNW rule is not only flawed but potentially dangerous to the future of credit unions. It rates certain categories of assets as risk free versus other assets.

This approach could induce credit unions to make decisions that could end up pushing all credit unions into the same risk profiles. As FDIC Vice Chairman Hoenig pointed out, the lowest rated risk categories before the Great Recession were sovereign debt and real estate collateralized securities. Both asset classes were at the center of the declines in asset values in the 2008-2009 crisis.

As the woman in Dylan’s song pleads, “Don’t get cute.” The circumstances and history of this wrong-headed regulatory effort suggest that it is time for the board not to get cute once again. Rather it should reject this approach to determining credit union capital adequacy. Or will the Board be deaf to the lessons provided by the last six years of this misguided effort?