Save the Credit Unions!

by: Felix Salmon

The good news is that the two largest corporate credit unions -- cesspits of toxic waste which loaded up on mortgage-backed securities for no good reason and in violation of their raison d'etre -- have been "conserved" (taken over) by the NCUA, the credit-union equivalent of the FDIC, which has finally woken up to the fact that the current management at these shops is utterly incompetent and can't be trusted.

The bad news is that the NCUA is still committed to the disastrous decision it made back in January, to whack 56 basis points off the net worth of every federal credit union in the country, as well as reducing those credit unions' return on assets by 62 basis points, in an attempt to bail out these selfsame untrustworthy corporates.

NCUA believes that the actions to conserve the two corporates, in tandem with established plans to enhance liquidity and generally stabilize the corporate network, represent the most cost effective and prudent alternative available to the credit union industry.

Today's decision is proof, if proof were needed (and frankly it wasn't) that the old plans -- which essentially involve member-owned and well-run retail credit unions being forced to bail out a bunch of sharks and gamblers -- were not only misguided but also woefully insufficient. I'm particularly mindful here of the small community development credit unions like the one I live next door to and sit on the board of, LES People's.

We were always extremely assiduous in our loan underwriting, our asset quality is very high despite the fact that our membership has very low credit ratings, and our operating income has never been higher. Yet this proposal from the NCUA would force us to expend extremely precious and hard-fought-for capital in order to bail out the wastrels at the likes of WesCorp. At a stroke, it manages to redistribute capital from the people who really need it -- the poor members of local-community credit unions -- to faceless financial institutions which were lying to their regulator about their solvency all along.

Here are the facts about community development credit unions (CDCUs), and how they'll be affected by the proposed bailout:

Last year, CDCUs nationally posted approximately $12.75 million in net income. Assuming all factors remain equal, a mandatory investment of 62 basis points translates into $28 million and would represent a net loss for CDCUs of $15.3 million in 2009, wiping out the modest gains made this year. The fallout from the economic downturn, coupled with the lack of capital, will result in a rapid reduction in community wealth, and for CDCUs, a crippling loss in earnings. We fear these challenges could permanently shutter dozens of CDCUs nationally.

Remember that all things are not going to remain equal: banks in general are suffering from rising delinquencies, and credit unions are no different. But after they've carefully built up capital cushions to protect themselves from exactly such an eventuality, it's unconscionable for their regulator to then turn around and remove that capital cushion just when they need it, saying that a bunch of speculators with more money than sense managed to gamble it away in the RMBS markets.

The big question in Washington these days is simple: "How can we get banks lending again?". Any sensible answer to that question must involve credit unions, which have proved themselves to be extremely responsible lenders. We should be bolstering their capital right now, rather than confiscating it.

Now that the NCUA has woken up and realized that the corporate credit unions are beyond redemption, its board must rescind its extremely harmful decision to ask the real, consumer-facing credit unions to bail them out. At the very least, come up with some way of recapitalizing the small but vital credit unions which will be worst hit by this misguided policy. It's a nasty world out there, but they can be a hugely important force for good. If only you'll let them.