When credit unions fail

By Felix Salmon
September 24, 2010

There are lots of great credit unions in America, all of which are owned by their members. And then there are the corporate credit unions, which are atrocious and expensive failures. Today, the final nail was placed in their coffin when the last three big corporates were officially taken over by the government.

Trying to explain what’s going on here isn’t easy, but essentially corporate credit unions are credit unions’ credit unions. While you or I might belong to a friendly local credit union with human members, that credit union, in turn, is itself one of the members of a corporate credit union. I’m a member of (and on the board of) Lower East Side People’s Federal Credit Union, for instance; LESPFCU is one of the 2,076 members of Members United Corporate Federal Credit Union, which got taken over today. Since we’re part owner of Members United, we’re going to lose money now that it has failed. In total, the NCUA (that’s the credit union equivalent of the FDIC) reckons that credit unions are going to lose somewhere between $8.3 billion and $10.5 billion on their investments in the corporates.

We’ve already written down a large chunk of our equity in Members United, so this latest blow will be manageable. But the fact is that pretty much everybody in the country who’s a member of a credit union will be affected in some way by the implosion of the five big corporate credit unions. They got away with things that most credit unions could never dream of — things like investing billions of dollars in subprime securities, for no obvious reason. When that trade blew up, thousands of responsible small credit unions ended up being socked with enormous losses.

So when the chair of the NCUA, Debbie Matz, says that all of this is being done at no cost to taxpayers, that’s only partially true — there are millions of taxpayers who belong to credit unions, and all of them will be affected in some way, because collectively they own the institutions which are going to end up losing billions of dollars. And nobody along the chain could reasonably have avoided these losses: you suffer no matter which credit union you’re a member of, because the credit unions themselves had to belong to a corporate, and pretty much all of the corporates have failed.

The fact that all of the big five corporate credit unions have now failed is — or should be — a massive embarrassment to the NCUA, which was meant to be their regulator. What incentives were in place such that all of these entities ended up neck-deep in toxic assets, and such that their regulator didn’t stop them? Indeed, how on earth, in the wake of this fiasco, has the NCUA survived as an independent agency at all? It has failed the very credit unions it was meant to be protecting: its lax oversight of the corporates means that all of them have suffered substantial losses. Other lax regulators, like the Office of Thrift Supervision, were closed down by the Dodd-Frank bill. But the NCUA lives on, to dream up multi-billion-dollar good-bank/bad-bank securitization schemes. I wish it were a bit more accountable for its failures.


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Plenty of embarassment to be spread around, NCUA included.

The chief issue was how to separate out, or remove via an arm’s length transaction, the truly unworthy balance of bad assets (the lions share is private-label MBS) without cratering further the prevailing deep hole in negative equity. The bulk of these assets were held by the 2 largest firms taken over in 2009: US Central, and Western Corporate. Ergo, that’s where the bulk of realized / unrealized ivestment losses lie. While these measures are not seamless, progression into a new & eventually better corporate (wholesale) system can only begin from here.

There are a handful of other, smaller corporate CU that weathered the proverbial s*t-storm with better success. In fact, a few have been successful in acquiring new capital & making preparations for a day just like this. Those can likely go it alone, with a few key services (ACH, payments) provided through a centralized CU in place of US Central (previously in Lenexa, KS).

Posted by McGriffen | Report as abusive

You call them “corporate” credit unions. Weren’t they governed by their member unions?

Posted by walt9316 | Report as abusive

There are some fundamental questions that come from this about the basic income statement model of credit unions. They are owned by and serve their members; a great basis for an organization but that does create some tensions. Part of the corporate credit union problem was that a few years ago credit unions were chasing every basis point of yield they could on their investment portfolios. The corporate credit unions abetted that push and the NCUA completely failed to control the risks of the situation as the corporates facilitated those choices. With 7500+ credit unions, at least some had management teams and (all volunteer, uncompensated) Boards that were not qualified to understand the related risks. Tthis is the failure of the NCUA- they should have been better at protecting credit union management teams that were out of their depth in evaluating the risk-reward components.

But the other side of the coin is taking place today. Credit unions want to do everything possible for their members…its their very purpose, and a good one. But at times like today when deposits (called ‘shares’) are flowing in and new loan volume is not there to balance it they end up with lots of excess funds to put into investment securities. Many credit unions still make it a priority to pay highly competitive share rates to be ‘good to members’ but now have no reasonable investment options to gain any kind of spread over those deposit rates to help fund operations after expenses of just running the shop. So, while the chasing of investment yields was the past issue that has come home to roost, there is a very serious risk that many credit unions will fail to adequately control liability growth (and interest expense) and will see already difficult earnings situations degrade to the negative. As institutions without the ability to raise capital other than through operating earnings, once they are losing money and capital falls below regulatory thresholds it becomes very difficult to correct the situation. Banks, in a simplification, just lower deposit rates (often in their CDs) to rebalance their positions, but credit unions seem culturally unable to take that approach.

And this could well be the NCUA’s next systemic failure: the failure to properly monitor credit union asset-liability balancing with so many credit unions failing that there will be no realistic disposition strategy (again, they cannot really be sold like a failed bank). There are already historic levels of credit unions with below-the-line capital levels and CAMEL ratings, but right now the NCUA seems to be taking a ‘lets see what happens tomorrow’ approach…feels like hope, not a plan.

Posted by TRKAdvisors | Report as abusive

It shouldn’t come as a surprise. GAO reported on the pressures on corporates and the risk they posed all the way back in 2004. see Corporate Credit Unions: Competitive Environment May Stress Financial Condition, Posing Challenges for NCUA Oversight http://www.gao.gov/new.items/d04977.pdf

Posted by mort_fin | Report as abusive

I clicked through on the “explain” hyperlink and found the following:

“Wholesale credit unions, also known as corporate credit unions, invest money for retail credit unions and provide them with check clearing and other services.”

To this question: “What incentives were in place such that all of these entities ended up neck-deep in toxic assets, and such that their regulator didn’t stop them?” I would suggest the following:
1. BoD of member credit unions should read some blogs- Calculated Risk and Naked Capitalism would be a good start;
2. In summer 2006, realize there is a major problem in MBS market;
3. Decline to let your “corporate” credit union “invest money” for your retail CU or provide any “services” other than check clearing (as I personally did with e.g. WaMu around that time)
4. Chuckle as you watch other retail CU’s take big hits.

Posted by johnhhaskell | Report as abusive

^To your point, jhaskell, a good number of the biggest CU (Navy Fed, among others) became wise to your points sooner than others (from what I know about it). Perhaps their sizable total asset values allowed them to employ sharper people, or they just acted upon a risk-reduction scheme.

Posted by McGriffen | Report as abusive

Mutual Savings banks like mine are in the same boat as your credit union (which being based in New York is probably bigger than my bank.)

We face an increased annual FDIC assessment, a special assessment that had to be paid 3 years in advance. And our FHLB (Federal Home Loan Bank) stock now pays no dividend because they got into the exact same private lable MBS that your wholesale credit unions did.

There is no other system but for the rich to bail out the poor the smart to subsidize the stupid and the conservitie bail out the risky. That is the natural order of things.

Posted by y2kurtus | Report as abusive

The FHLB system, beneficiaries (among many, actually) of the very direct $100 billion+ in TARP/government capital “invested” into Fannie Mae, and Freddie Mac. An investment unlikely to yield any true return, either.

Some banks in the FHLB system were better than others in managing the MBS portfolios, but still: owning a FNMA / FHLMC-issued, Agency MBS pass-through magically means your MBS bonds are not trading at $40-60 like the private label MBS kindred. Poof, make it so and it was.

Posted by McGriffen | Report as abusive