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What is the “New Normal” Interest Rate Curve?

The recent Federal Reserve increase in short term rates to fight inflation, is seen by some to be a “temporary” increase.  At some point when relevant price indices have fallen into an acceptable range, the Fed will settle back to some lower initial reference point such as 1%.  Interest rates will then revert to the pattern of the decade of the 2010-2020 pre-covid era.

But what if that assumption is wrong?  What if the Fed’s definition of normal, a 2% real rate of interest on top of an assumed 2% long term growth rate, means the overnight baseline is closer to 4%?

Today the overnight rate is 3%.  The Fed is promising at least two, maybe three, more rate hikes this year? How would  a “new” 4% normal affect the rest of the curve?   What pricing and investment assumptions from the most recent decade would have to be rethought?

What If  Recent Past Rates Are Abnormal?

A commentator on MSNBC observed this past week, that interest rates have not been “market determined” since at least 2008.  He commented that the Fed policy of low overnight rates and quantitative easing created an artificially low interest rate curve to respond to economic crisis and to get the economy growing.   Some would move the starting point back to the post 9/11 era of lowered rates to avoid a recession following the attack on the World Trade Center.

Two analysis can help address this question of what the “normal” post Covid, inflation fighting yield curve might be like.

One is a May 4, 2022 article by Tony Yiu, which asked Why  was there Basically No Inflation in the 2010’s?  Here is part of his analysis.

Why did inflation not arrive earlier during say 2014? Or 2017? After all the Fed had been stimulating the economy and markets using easy monetary policy and QE since 2008. So why did inflation not spike until a few months ago?

So back to the question of where was all this inflation in the 2010s? My theory is that during most of the past decade, the stock market (both private and public), the real estate market, and new markets like crypto acted like a massive sponge that soaked up all the money that could have otherwise gone towards pushing up the prices of goods and services.

This created a positive feedback loop where:

  1. Stock prices and home prices go up incentivizing people to put more money in the stock and real estate markets.
  2. Money going into asset markets instead of chasing goods and services keeps inflation low (home prices are ironically not a part of CPI).
  3. Low inflation allows the Fed to keep interest rates low, which stimulates credit growth (along with rising collateral values).
  4. Credit growth causes even more stock and home price appreciation as significant amounts of the newly borrowed money gets plowed back into asset markets. And back to step 1 to repeat the cycle all over again.

Notice two things about this. First, this feedback loop results in the financial economy getting increasingly bigger than the real economy as money keeps getting sucked into well-performing assets like stocks and real estate.

And second, it’s not just low inflation and low interest rates that cause asset prices to go up. But because of feedback, there’s a causal effect in the other direction as well where increasing asset prices help soak up money keeping inflation low.

This positive loop obviously can’t go on forever. At some point, like the players in the casino, people will start to realize that there’s just not enough real stuff to go around (and not enough future earnings to justify the valuations). People seem to be finally realizing this based on the massive declines of stocks like Zoom and Netflix.

This realization kicks off a rush for the exits and a decline in asset prices. And because rising asset prices helped keep inflation low, the reversal into a negative feedback loop forces all that soaked up money to pour back into the real economy to chase goods and services, thus higher inflation (and higher interest rates).

Finally, a unique aspect of this current selloff is that where Treasury bonds are usually a place that investors can escape to during a market downturn, they’re part of the problem this time. Near zero nominal yields (and extremely negative real yields) mixed with high inflation makes Treasury bonds all risk and no reward (I first wrote about this here).

Long-Term Mortgage Market Rates

The decade of 2010 also saw the lowest 30-year mortgage rates ever, fueling a housing boom with double digit price appreciation.

Jim Duplessis of Credit Union Times published a September 26 article which examined the outlook as current mortgage rates hit a 20-year high.    His analysis with the relevant data link follows:

Rates in the 7% neighborhood might feel high for those who started buying houses in the last 10 years but they are on the low side for the past 50 years, based on Freddie Mac data published by the St. Louis Fed.

For more than half of the 2,687 weeks from April 1971 through Sept. 22, the rate was at least 7.4%. The median was 9.1% from 1971 to 1999 and 4.8% from 2000 to the present.

Rates peaked at 18.63% for the week ending Oct. 9, 1981 when the Fed under Chair Paul Volcker was battling inflation that had started during the Vietnam war. Volker’s aggressive rate hikes sent the nation into a recession, but knocked back inflation.

The lowest rates from 1971 to 1999 were 6.49% for the week ending Oct. 9, 1998, when the nation was in an economic boom. The lowest over the past 51 years was 2.65% for the week ending Jan. 7, 2021 at the peak of the refinance boom that vanished as rates rose this year to tame inflation.

A “New Normal”

Both analyses suggest the most recent two economic decades are an aberration in terms of a significantly lowered interest rate yield curve.

The efforts to reduce inflation will be a central part of where current rates end up.  But then what?

History suggests that the yield curve will shift to a higher level versus what many consumers, businesses and investors grew accustomed to since 2008.

There are other factors as well.   There is increasing evidence that lower rates while seemingly consumer friendly, do distort the allocation of economic gains disproportionately to higher income individuals while incentivizing multiple forms of financially driven wealth (speculative) strategies.

Anyone can predict the future.  No one knows it.   But believing that recent experience is the best or only guide to future rates, would appear a much too narrow perspective.

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A Poem for Autumn

 

“In the following Sonnet #73 Shakespeare begins with a simple observation that in gazing upon him his lover sees only the remnants of age (“yellow leaves”) hanging upon the withered skeleton of his aging self (“bare ruined choirs” = leave-less trees).

“That Shakespeare was only 30 (probably younger) at the time he wrote the poem speaks to his ability to imaginatively command a scene he had not yet experienced. From that he expands to a meditation on death (“after the sunset fadeth in the west”) and in the third quatrain expands even that metaphor by likening his aging body/self as the last ashes of his burning youth.

“He pivots from these tokens of gloom to end on a positive affirmation of love, for as he tells his beloved he recognizes that it only makes his lover’s love stronger that he loves one who must soon leave (die).” (by Dr. Andrew Roth, Book Notes # 116)

Sonnet #73

That time of year thou mayst in me behold

When yellow leaves, or none, or few, do hang

Upon those boughs which shake against the cold,

Bare ruined choirs, where late the sweet birds sang.

In me thou see’st the twilight of such day

As after sunset fadeth in the west;

Which by and by black night doth take away,

Death’s second self, that seals up all in rest.

In me thou see’st the glowing of such fire,

That on the ashes of his youth doth lie,

As the deathbed whereon it must expire,

Consumed with that which it was nourished by.

This thou perceiv’st, which makes thy love more strong,

To love that well which thou must leave ere long.

 

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Credit Unions and Liquidity Management

Managing liquidity will be an ongoing priority during the interest rate transformation now being led by the Federal Reserve.

Today  I want to show how credit unions have prepared.

Relying on a Cooperative System

Credit unions managing  74% of assets ($1.57 trillion) use the FHLB system.   To borrow from the banks, credit unions must invest in a bank’s capital with borrowings a multiple of their contribution.

As cooperatives, the banks are owned by their members, pay a dividend on the capital and offer multiple borrowing, hedging and funding options.

These 1,271 credit unions report a total of advised lines of  credit of  $288.1  billion at June 30, 2022.

The credit union funded CLF at June 30 reports total membership 349 regular members plus 10 corporate agents which have funded the CLF capital requirements for their members with less than $250 million in assets.

The total CLF capital contributions represent approximately 26.2% of all credit union shares as of June 30.

In addition the CLF has total borrowing authority of $29.7 billion but has no advised lines of credit with credit unions.  This lending capacity, if fully utilized would equal just 10.3% of the total advised lines credit unions report from the FHLB system.

Two Observations

Credit  unions rely on the cooperatively designed, privately managed FHLB with boards elected by the owners, as their primary source of external liquidity.

The CLF, specifically designed for credit unions, has not evolved to respond to credit union needs.   The CLF managed by NCUA has no credit union representation or programs to encourage credit union involvement.

There have been no loans from the CLF to credit unions since 2010.   At that time the two most significant loans were initiated by NCUA as part of their corporate conservatorships of US Central and WesCorp.  These two borrowings were for $ 5 billion dollars each, guaranteed by the NCUSIF.

In the upcoming period of enhanced liquidity management, credit unions are turning to the organizations they own and can rely on.

 

 

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Cooperative Democracy: an Oxymoron?

Mark Twain Was Right: If Voting Mattered, They Wouldn’t Let Us Do It. There’s only one way to make your voice heard and it isn’t by protesting.

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James Clear: “Every system is perfectly designed to get the results it gets. If you want better results, focus on your systems.”

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When the coop’s democratic owner 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.

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, canceling 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. (CUSO Magazine)

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From Mike Mercer:

‘The extent to which cooperation is the norm depends on the extent to which the behavior is nurtured by the institutions of a society.’  In a time when power is concentrated in the hands of individuals with lots of capital or those with the keys to redistribution of wealth, it is hard to imagine that decentralized cooperation will organically be embraced from within the citadels of existing power. Rather, the cluttered path to a more civil economy will have to be cleared by those who lead democratically structured organizations that have already been formed to foster cooperative behavior.

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SIF’s Slippery Slope Slide Speeds Up

By Sancho Panza

As you might suspect, got a call from Don Quixote after that last opinion piece (“Tilting Windmills”). The Man from La Mancha, Illinois was, shall we say, wild-worded and a bit tilted.  Quixote claimed I had definitely blown any chance of ever serving on the NCUA Board. I attempted to express my regret.

But aghast and inconsolable, Mr. Filson mounted up and charged off into a philippic on another of his favorite windmills, the NCUSIF (a topic about which he blogs incessantly and quite opaquely!).

The National Credit Union Share Insurance Fund is your 1% deposit plus accumulated earnings, which undergirds the federal insurance of member accounts. The NCUSIF (agency staff’s nickname is SIF) is cooperatively owned by credit unions and mismanaged by the NCUA.

The continued mismanagement of the Fund is surprising for two reasons – Rodney Hood and Kyle Hauptman. Both gentleman imply in their resumes to have substantial acumen and experience in finance – Mr. Hood with Bank of America and Mr. Hauptman with Jeffries, a sophisticated, international investment house.

And of course as Republicans, one would hope that both men champion the prudent, conservative investment of your funds while under their supervision. Neither Mr. Hood nor Mr. Hauptman, however, seems to be paying attention. For the Republican-majority NCUA Board members is this yet another RINO  (“Responsible In Name Only”) example?

Robots and Ladders

Case in point, the NCUA’s “investment strategy” for the NCUSIF – your deposit, your investment, your Fund – is to invest the @$20 billion balance in U.S. Treasury securities with maturities “laddered out” over 10 years or less. “Laddering” simply means NCUA robotically spreads out that $20 billion evenly (approximately in this case) over seven or eight years.

NCUA’s investment gurus self-laud their approach, comparing it to “dollar cost averaging”; and pooh-pooh any suggestion of intelligent, strategic flexibility as  “risky market timing”. ‘Course it’s true, you can’t be called indecisive, if you never make any decisions. In investment circles this type thinking is called “real A.I.” – or true artificial intelligence.

But, let’s not argue with the “strategy”, let’s talk about the consequences to you of its’ execution. Any strategy, which defies common sense and ignores major shifts in the national economy, will invariably cause significant losses to the investor – that means you, the cooperative owners of the NCUSIF. How so? Well, did you know that any excess earnings on NCUSIF investments (over and above the legally required “net operating level” (NOL) of the Fund) are required to be paid out to the owners of the NCUSIF – hey, that’s you, your credit union and all 135 million American credit union members. Want an estimate of how much NCUA’s “real A.I.” strategy is costing member credit unions?

The Critical Question

Okay, here goes. First, which way do you believe interest rates are moving – up or down? Right! How did you know? “Because I can read!” is an acceptable, sensible answer. But in addition, you might add 1) because Jerome Powell, Chairman of the Federal Reserve says so, 2) because 10,000 of the world’s finest economists at the Department of Labor say inflation in the U.S. exceeds 8%, 3) because the slope of the yield curve, and lastly 4) because Jerome Powell says so. Everyone in finance, except the folks at NCUA (including RINOs?), knows the axiom “Don’t Fight the Fed” – if you do, you’ll lose!

Second, so if Chairman Powell had been telling you all yearlong that the Fed was going to increase rates rapidly and significantly – a major national policy change – would you rush out to lock in some 7 and 8 year, long term – sure to be underwater losers – investment rates? No, me neither; nor anyone on the planet including Bank of America, Jeffries, and your 6 year old preschooler – that would truly be “real A.I.”

Yet, that is exactly what the pointy-headed, investment gnomes at NCUA are doing with your money in the NCUSIF – evidently with the full support of the NCUA Board, RINO’s [“Relevant In Name Only”) included! Reinvestment activity at the NCUSIF historically occurs around mid-month in February, May, August, and November. In February $650 million was invested for @ 7 years at a yield of 2.01%, in May $650 million for @ 7 years at a yield of @ 2.84%. The August investment results will be released today at the NCUA Board meeting. Surely the folks at the NCUSIF didn’t repeat their mistakes of February and May – right?  (Wanna bet?)

The Cost of A.I.-Artificial Intelligence

Seven-year treasury securities as of 9-19-2022 are yielding 3.62%. Every one of the NCUSIF investments made in 2022 is substantially underwater.  In fact the “unrealized loss” in the NCUSIF portfolio has increased by over $1 billion in 2022 alone, following a similar $1 billion+ decline in 2021 – with much more to follow according to the Fed!

The “real A.I.” investment gurus at NCUA self-importantly and incorrectly point out that “unrealized losses” don’t matter, because the NCUSIF “holds to maturity” all investments. In a sense that is true because “holding to maturity” does wash out all their investment missteps over a 7 or 8 year period – their mismanagement never shows up on “their” income statement, so no big deal – right? No, that’s wrong! NCUA’s “real A.I.” strategy, in the current economic environment, wastes any prospect of your credit union receiving a premium payout of greater NCUSIF earnings – you’re the loser, as are your credit union members..

So, here’s the “real Republican” estimate – well-reasoned, conservative – of what “real A. I.” is costing you and your members. To start, assume Jerome Powell is a man of his word – a real Republican. On August 15, 2022 (the last NCUSIF investment date) the 7-year treasury was yielding 2.86%, the 6-month treasury was yielding 3.13%!. What if that last $650 million had been invested for just 6 months, while we all waited to see where the yield curve settles out? An intelligent, no brainer? An irresponsible, missed opportunity? A RINO alert?

The Lost Opportunity

If one could improve the overall yield of the NCUSIF by just one-half of one percent, the “excess earnings” would exceed $750 million ($20 billion x .50% x 7 years = $750 million). Remember the 7-year yield is now at 3.62% (with Powell promising more to come!), but we’re stuck with the 2.01% February and 2.84% May investments for the next 7 years! Would credit unions have any use for $100 million or so in extra income this year? If not; don’t worry, be happy!

A couple of rhinos skiing downhill in winter is quite an amusing thought. A couple of RINO’s frolicking in “the Swamp”, while ignoring the yield curve in an election year, isn’t quite so funny and could become a slippery slope.

 

 

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Tilting at Windmills?

By Sancho Panza

Chip Filson and I were friends until recently, but things have changed.

Calling him a modern day Don Quixote, for his relentlessly obscure attacks on the NCUA sparked the breach. Seeking to upend the “giants” of NCUA with logic, facts, and reason once is certainly an act of fantasy, persisting is delusional. I speak from experience, if you get my tilt.

Entrenched, NCUA trifles and traffics in bureaucratic unaccountability. Those Duke Street windmills remain churned by the oft-feckless winds of politics – and their own internal, hot air.

Mr. Filson aside, it is unsettling to find a Republican-majority, NCUA Board perpetuating – and even encouraging – the legendary, “we-know-better-than-you” bureaucratic insolence of the Agency.

Republicans, one thought, were the Party of less government, not more; of more accountability to the people, not less.

Republicans, one thought, were “Bill of Rights”-type folks, who believed that the Federal government should be less intrusive in our lives, not more.

Republicans, one thought, would easily spot that NCUA, an “independent” (answerable-to-no-one) Federal agency, is – more or less – a small “d”, democratic mess!

RINO’s

But, apparently, the two NCUA Republican board members, Mr. Hood and Mr. Hauptman, are “RINOs” not “RRs”! Real Republicans shouldn’t vote 3-0 on risk-based capital, unnecessarily increasing regulatory burden and overriding federal law.

Regan Republicans shouldn’t condone a mushrooming Agency budget in an era marked by far fewer credit unions, the availability of micro-cost digital monitoring, and virtual regulatory exams.

Responsible Republicans should actually stand for something, not just “go along” with the “dINO-mite” (democratic-In-Name-Only)  “Agenda of the Chair” (Mr. AOC!).

Whether RINO-1 (Republican In Name Only] or RINO-2 (Regulator In Name Only), something isn’t “right” with Mr. Hood nor Mr. Hauptman. Surely when “the base” realizes the problem, Mr. Hood won’t be dining again at Mar-a-Lago and will soon have more free time to enjoy opera.

As for Mr. Hauptman, hard to believe that his political sponsor – an Arkansas Senator – would “Cotton” to learning that his protégé has gulped down the in-house, let-them-eat-cake Kool-Aid and swerved off the right road into a ditch on the left.

Oh, by the way, wonder if Chip Filson remains a life-long “RR”?

Is that why he continues to tilt so earnestly…

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 Karl Hoyle and His Powerful Cooperative Talent

Last week Karl Hoyle (1943-2021), a  credit union advocate, was interred in Arlington Cemetery.

There are 450,000 other graves, an honor earned, not bought.

The ceremony starts with a brief service in the Old Post Chapel.  The Honor Guard brings in the urn. The Chaplain reads the 23rd Psalm; the attendees say the Lord’s Prayer.  The organ plays America the Beautiful and On the Wings of Eagles.

Following the service the congregation goes with the honor guard to the gravesite.  The American flag is meticulously folded in a triangle.

There is the seven gun salute, the bugle playing taps and the sacred moment when the flag is presented to Kathy Hoyle, Karl’s wife, by an officer on bended knee.

Afterwards, roses are placed on the grave next to the urn where the only identifier on the wooden box is Karl’s military medals.

The Air Medal and Purple Heart

I learned during the reception that Karl had been awarded the Air Medal.  This  Medal recognizes military and civilian personnel for single acts of heroism while participating in aerial flight in actual combat.  It is the equivalent of the bronze star.

Karl was deployed to Vietnam as part of the 9th Infantry Division.   At the support base, a call came for helicopters to  medivac the wounded from a platoon still in the midst of battle.    He volunteered, got on the chopper and went straight into the firefight to evacuate his fellow soldiers.

As his military colleague stated: “Karl was the guy you wanted on your team.”

His life subsequently expanded to be much more than that moment of choice marked by courage and duty.

Joining the Cooperative Team

Jim Barr and Karl were the top lobbyists in CUNA’s Washington Office when Ed Callahan, Bucky Sebastian and I arrived at NCUA at the end of 1981.  Both had worked together in the late 70’s at the newly organized NAFCU.

Karl would sometimes remark that his profession’s reputation was not always the highest.  His favorite line was, “If you run into my mother, tell her I am just the piano player in a whorehouse.”

However when mentoring many others on the Hill, he counseled that :  “To be a professional with integrity, know that everything you say will be remembered.”

Three Personal Contacts

Of the many occasions Karl and I spoke, three stand out.

  1. Karl learned that I had moved to Bethesda, MD in 1982 to be near NIH because my wife was being treated for breast cancer. We hoped to get accepted in one of their special cancer studies, but had no idea how to begin. Karl offered to call and see what might be possible.  Shortly he informed us that because Mary Ann had already been on several chemo therapies, she was not eligible for their new protocols.  The studies were limited to patients with no previous treatments.
  2. In 1984 NCUA and the entire credit union system endeavored to find a Congressional bill in which to insert wording to redesign the NCUSIF in the Federal Credit Union Act. Democrat Bill Bradley was a key player on the Senate Banking Committee.  Karl was aware that Bill and I had played basketball together.

He brought me up to the Hill and sent a messenger into a banking hearing saying Chip Filson wanted to talk to the Senator.  Bill came out, motioned me into an elevator with him.  Lobbying Congress was not something I did for a living.  I don’t remember what was said, although I suspect Karl gave me the points to make.

Later that year Congress passed the Deficit Reduction Act, with bipartisan support, creating the NCUSIF’s new cooperative financial structure based on credit union’s 1% deposit perpetual underwriting.

  1. In May 1985, Ed, Bucky and I left NCUA to set up Callahan & Associates with a first office in the Triangle Towers building in Bethesda. Initial capital, $1,000. The location allowed me to be close to home, since I was a single parent with two teenage girls.

Shortly after, Karl called and asked if we needed any furniture.  CUNA was moving offices and had several old desks and chairs which we could have if we moved them ourselves.   We did.

He also asked if we needed any staff.  All three of us had worked in state or federal government for the past decade and were used to having support.  We said yes.   He said his wife Kathy, a superb office manager, was looking for a new opportunity.   She became Callahan’s first hire.

Karl’s Essential Cooperative Skill-Connecting

Karl’s special talent was facilitating the power that results from connecting people for common purpose.  Connections are what tie us together in community or when confronting personal circumstances.

Bucky said Karl’s success  was the result of his building relationships with  the staff in Congressional offices.

A former hill staffer at the reception knew Karl.  Her husband had been killed in the Air Florida crash in the winter of 1982 when the Potomac had frozen over.  She said Karl’s way of helping was: “Don’t call. Just show up.”

Tawana James, Karl’s deputy when he was Executive Director at NCUA, said “he cared about people.”

Credit unions’ competitive advantage is at its strongest when leaders collaborate.  Karl’s talent for connection came naturally, it was not an artifice.

Staying Connected

Two examples of his talent are in the pictures below.  One was a note to Bucky when Karl was in Madison at CUNA’s headquarters.  The second, a photo with the coach of the credit union team at the time, on which Karl was such a vital player.

Kathy like Karl has filled many roles  within the credit union system.  This year she will retire after working  more than a decade at InFirst Federal Credit Union.

Kathy and Karl: A relationship  bound by common purpose and service.

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People Say the Darndest Things

With an important agenda of public meetings including the  Federal Reserve, I think it is helpful to start the week with a little humor.

Quotes from a court reporter’s favorite testimonies.

ATTORNEY: She had three children , right?
WITNESS: Yes.
ATTORNEY: How many were boys?
WITNESS: None.
ATTORNEY: Were there any girls?
WITNESS: Your Honor, I think I need a different attorney. Can I get a new attorney?

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ATTORNEY: Is your appearance here this morning pursuant to a deposition notice which I sent to your attorney?
WITNESS: No, this is how I dress when I go to work.

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ATTORNEY: ALL your responses MUST be oral, OK? What school did you go to?
WITNESS: Oral…

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ATTORNEY: Now doctor, isn’t it true that when a person dies in his sleep, he doesn’t know about it until the next morning?
WITNESS: Did you actually pass the bar exam?

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ATTORNEY: What is your date of birth?
WITNESS: July 18th.
ATTORNEY: What year?
WITNESS: Every year.

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ATTORNEY: The youngest son, the 20-year-old, how old is he?
WITNESS: He’s 20, much like your IQ.

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Outside The Box Thinking…

( a Jim Blaine classic post)

In the beginning ( no I was not there!); credit unions were created as cooperatives, which were to be owned and controlled by the members and managed in their best interests.

One member / one vote; a democratically elected Board; a common goal, a common purpose – the common good !

“We’re all in this together…”

But today, some Boards and CEOs have become “more creative” in how they view their relationship with and their responsibilities to those member-owners.

Kind of an “outside the box” sorta view….
See the problem? 
The members have become “outsiders”…. 
and therein lies our greatest challenge for the future!
A complete
box set!


Don’t box yourself in, 
don’t box your members out!
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The NCUSIF Look Back: Its Vulnerabilities after 40 Years

The radical, cooperative redesign of the NCUSIF was approved by the NCUA board in October 1984.

In this board meeting video excerpt, Chairman Callahan thanked all who had worked to put this new “safety net” in place.  He called it a “great victory that is truly unique and sets the credit union system apart from all other financial institutions.”

Board member PA Mack stated his support of the new plan:  “I think this is an outstanding product as a partnership among government and credit unions. “

Chairman Callahan closed with these words about what it would take for this redesign to succeed:  “The real challenge now goes to the people at NCUA. The system can work beautifully for credit unions in the future. . . the real secret now is the operations.” 

This look back suggests the wisdom of Ed’s insight.  For the unique structure is only as effective as the people responsible for its implementation.

Immediate Success Brings Temptations

In NCUA’s  1985 NCUSIF’s Annual Report, the board  led by Chairman Roger Jepsen reported that in the first year the restructuring had “returned over $275 million in tangible benefits” to credit unions.  (Page 5)

The major initial concern was whether the agency’s multiple supervision efforts to resolve problem situations could reduce the losses charged to the fund.    The 1985 Report reported five-year trends that documented losses for all liquidations at only 1.5 basis points of all credit union insured savings.  Net losses in closed credit unions were $3.1 million, the lowest in the previous five years. The fund’s $29 million dividend at yearend was a payout ratio of 46% of  net income.  The Fund still maintained its 1.3% equity ratio.

But the fund’s fourfold increase in size, revenue, earnings and financial success also resulted in changing the long-standing practice of how the agency’s operating costs were allocated to the NCUSIF. From 1981 through 1985,  this allocation had ranged from a low of 30.5% to 34%.  This ratio aligned with the percentage of state charted credit unions insured by the NCUSIF.

At yearend 1986, state charters were just 33.3% of all NCUSIF insured institutions.   However the NCUA board increased the indirect expense to 50%.   As stated in that year’s Annual Report “The cost of these services which totaled $16,821,936 and $8,069,244 for the years ended September 30, 1986 and 1985, respectively, are reflected as a reduction of the corresponding (operating) expenses in the accompanying financial statements.”

The NCUA’s operating expenses charged to FCU’s “declined” from $21.5 million in 1985 to $17 million in 1986. This 100% increase in the NCUSIF’s expenses reduced the operating fee paid by federal charters. There was no change in the proportion of state chartered credit unions covered by the NCUSIF. This was an easier political option than raising the fee charged FCU’s.

This 50% increase in the expense allocation highlighted the most frequent concern expressed by credit unions about the new plan.  Here are some questions asked at a Q & A open meeting about the plan as reported in NCUA’s 1984 Annual Report:

Questioner:

What if the fund doesn’t operate on the interest earned?  If you don’t pay a dividend?  What happens if the agency is poorly run?  (pages 18, 19)

The concern was specific.  If the agency was given more money, wouldn’t it just be tempted to spend more?   Could the agency change the guardrails at its sole discretion?

This 50% increase in the Overhead Transfer Rate (OTR) was just the beginning of efforts to use the increased resources, not for insurance costs, but to underwrite the ever expanding agency budget.

“Building Out” The Agency

Soon after the 1986 OTR adjustment, the NCUSIF became the funding source for the NCUA’s building aspirations.  In 1988 the Operating Fund “entered into a $2,161,000 thirty-year unsecured note with the NCUSIF for the purchase of a building. . .In 1992, the Fund entered into a commitment to borrow up to $41,975,000 in a thirty-year secured term with the NCUSIF.  The monies were drawn as needed to fund the costs of constructing a building in 1993.”  (NCUA 2003 Annual Report pg 52.)

The variable rate on both notes was equal to the NCUSIF’s prior month yield on investments.  The interest was paid by the Operating Fund, 50% of whose expenses were then charged back to the NCUSIF.  The NCUSIF loaned the money and then paid half the interest on the loan!

It should be noted that during this construction and move to a new building in Alexandria , VA financed by the $42 million loan, the NCUSIF still paid a dividend  every year from 1995 through 2000, as the fund’s yearend equity ratio was above the 1.3% cap.

A Double Whammy in 2001

The Fund’s financial management which had produced six consecutive annual dividends was altered in two significant steps in 2001  by the NCUA Board.

The first was to increase the percentage of the fund’s OTR from 50% to 66.6%.   This resulted in a 37.3% growth NCUSIF’s operating expense while the operating fund reported a 31% decline in expenses in just the first year of this change.

The operating assessment for FCU’s fell by 20.4%.  The NCUA board was able to lower this fee on all FCU’s by shifting the expenses internally to the NCUSIF funded by all credit unions.

Each year since 2001, NCUA has calculated a different OTR’s based on “a study of staff time spent on insurance-related duties versus supervision-related duties.”   This ever fluctuating OTR peaked at 73.1% in 2016 under Chairman Matz.

During the past two decades of variable OTR, the percentage of state chartered credit unions in the NCUIF has remained more or less constant.    At June 30,2022 the 1,811 stare charters were only 37.3% of all FISCU’s.

The second administrative action was more consequential, because it modified how the normal operating level (NOL) was calculated and thus when the dividend is required. In a footnote 5 to the NCUSIF’s 2001 audited financials the following change was announced:

The NCUA board has determined that the normal operation level is 1.30 %  at  December 31, 2001 and 2000.   The calculated equity ratio at December 31 was 1.25%. The equity ratio at December 2000 was 1.33% which considered an estimated $31.9 million in deposit adjustments billed to insured credit unions in 2001 based upon total insured shares as of December 31, 2000.  Subsequently, such deposit adjustments were excluded and the calculated equity ratio at December 31,2000 was revised to 1.3%.

The Fund reversed its year earlier NOL determination. But even with this retroactive adjustment to the December 2000 equity ratio, the footnote continued:  Dividends of $99,490,000 which were associated with insured shares as of December 31, 2000 were declared and paid in 2001. 

Since the 1% deposit redesign in 1985, this annual adjustment has always been collected  in the following year.   And until this 2001 modification, the retained earnings/equity ratio was based on yearend insured savings.  A dividend was paid if retained earnings exceeded the .3% cap.

By not counting the 1% true up until the amount was billed results in an understatement of the actual NOL. It eliminated a dividend in years when the ratio would have exceeded the .3% cap under the prior practice, starting in 2001.

The Ultimate Guardrail Change

Since 1985, the NCUSIF normal operating level (NOL) had always been set at 1.3%.  In many years the cap was not reached, but the resulting ratio was considered adequate even if under the cap.  During and after the Great recession, the Board did not change the 1.3% cap even though they had been authorized to do so in the 1998 CUMAA.

Then in 2017 the board voted to merge the surplus from the TCCUSF into the NCUSIF.  But this surplus would have raised he NOL to greater than 1.5%.  To retain this amount above the traditional 1.3% cap, the board took two actions.  It raised the cap to 1.39%, the first time this change had ever happened.

The agency also immediately expensed and added to loss reserves $750 million from the TCCUSF surplus to pay for potential losses in natural person credit unions.   This action directly contradicted the congressional language establishing the TCCUSF that the fund “was not to be used for natural person credit union losses.”  But it did reduce the NOL to 1.39% even after setting aside a dividend for credit unions from a portion of the surplus.

This was the first time that the cap had been raised above the longstanding 1.3 level.  No verifiable details were provided about how this new level was determined except for summary data unsupported with actual calculations.

NCUSIF Success Raises Temptations

Credit unions’ concerns about supporting a perpetual 1% underwriting were well founded.  Their worry was “If we send more money to the NCUA, won’t they just be tempted to spend it because that is what government does.“

Subsequent NCUA boards have converted the “partnership” understandings referred to by Board member PA Mack into a perverse interpretation:  that to “protect the fund” the agency has to spend more and more on its operations to accomplish that objective.

From 2008 through 2021, the NCUSIF spent $2.2 billion on operating expenses and only $1.88 billion on actual cash losses.

NCUA has converted the fund into the agency’s cash cow. It has transferred much of its annual budget increases to the NCUSIF.   For example in 2012 the operating fund expense was $90.6  million; six years later in 2017 the expenses were still only  $90.3 million   All of the annual increases in the agency’s operating budget and more, in this six years, were paid by the insurance fund.

Federal credit unions became “free riders” as the operating fee paid an increasingly smaller share of the agency’s expenses.

The NCUA Board’s Responsibility: A Legacy Being Squandered

While staff proposes, the board disposes of their recommendations.  NCUA and its budget are literally exempt from any outside approval.  The agency is independent.  This absence of oversight raises responsibility of political appointees.

The annual OTR transfer have lost any connection to insured risk.  Instead they remind one of a person declaring their waistline to be 32″; but then, when you gain weight, redefining 32″ as whatever your waistline happens to be.  Insurance activity is whatever we want it to be.

The shortcomings have been bipartisan.   Republicans and democratic appointees have repeatedly affirmed transparency and actions to protect the fund.  But in practice the agency has declined to release the accounting options provided by its own outside CPA firm Cotton, the details in setting its annual NOL limit above 1.3, or the investment options and risk analysis used in managing the fund’s portfolio.

Every NCUA board member inherits a unique cooperative legacy in the NCUSIF that requires both knowledge and diligence if the fund is to be sustained.  This responsibility takes work and continual vigilance.

When the critical guardrails of the fund are modified one by one, the initial signposts of success are forgotten, and critical facts routinely omitted, then the prospect of a sound NCUSIF future is undermined.

The most important success factor in the Fund’s special public-private partnership is the ability to ask hard questions.  When this is not possible for board members to do and to followup, then it is up to credit unions or Congress.