The Big Credit Union What If
Banks Are Assailing Credit Unions For Expanding Fields of Membership. How CUs Got Where They Are Demands Understanding Where They Were, Say Those Involved, Who Also Offer Responses To The Question: 'What If NCUA Had Stuck To The Bankers' Interpretation of The FCU Act?'
The way Edgar Callahan tells it, the liquidation of one more credit union was nothing new for the National Credit Union Administration in 1981. But something in him made this particular liquidation the final straw.
"The NCUA board had liquidated a Baltimore credit union when its sponsoring veterans hospital closed rather than allowing it to merge with another V.A. hospital credit union in Washington, D.C., or merge with another local credit union that didn't serve a V.A. hospital," said Callahan. "Something had to be done; otherwise, credit unions weren't going to survive."
Callahan, who retired Jan. 1 as president and chief executive officer of Patelco Credit Union, San Francisco, was the newly appointed chairman of NCUA at the time of the liquidation. The early 1980s were a time when a severe financial recession collided head-on with industry deregulation, fostering a decade that changed the face of financial services. Single- or limited-sponsor credit unions, which were being liquidated by the hundreds as their sponsoring companies disappeared under the waves of a mounting recession, were not in good position to embrace a more challenging future.
The eventual changes, engineered by Callahan and then NCUA staff members Charles "Chip" Filson and Wendell "Bucky" Sebastian, proved to be a one-two punch that changed the nature of credit unions at their very roots, turning them into more competitive financial institutions and helping the movement survive.
The moves were as simple in concept as they were far-reaching in their impact. By reinterpreting the Federal Credit Union Act beyond the interpretation that credit unions were to be limited to single-employer or group affiliations, and instead supporting a view that permitted affiliations or multiple groups serving similar interests, followed by a move to shore up the National Credit Union Share Insurance fund with the then controversial 1% of shares deposit obligation for all federally insured credit unions, Callahan opened wide a door that heretofore had merely been a narrow crack in the financial services world.
But opinions differ as to whether the move was as profound as hindsight might sometimes imply.
"What Ed did was a bold move and saved the credit union movement," said industry veteran Larry Blanchard, now senior vice president of corporate and legislative affairs for CUNA Mutual Group.
"Had the move not been made, credit unions simply would have found another way to cope," says Bill Hampel, CUNA's chief economist.
Understanding the decision within the historical context in which it was made sheds brighter light on the impact of the decision by Callahan and his fellow regulators at the time.
Brother, Can You Spare a Billion Dollars?
Prior to joining NCUA, Callahan had been director of the State of Illinois' Department of Financial Institutions in Springfield. Filson served as supervisor of the Illinois Department of Credit Unions and Sebastian was the department's general counsel and director of administration, both working under Callahan with offices in Chicago. That was during the 1970s, when there were almost 18,000 credit unions in the U.S., recalled Sebastian, now president of GTE Federal Credit Union in Tampa, Fla.
At the time the situation among state-chartered credit unions in Illinois, as well as Wisconsin, California and the New England states, was similar to what it is today. State laws allowed state-chartered credit unions to serve similar groups of like-minded individuals and even communities if the connection was demonstrable and state regulators approved. At the federal level, however, things operated very differently, Sebastian recalls.
"Our predecessors at NCUA interpreted the Federal Credit Union Act's reference to 'a common bond of occupation' as describing a specific, single employer," says Sebastian. "The word 'employer' does not occur anywhere within the Act, but NCUA's interpretations still meant like credit unions couldn't merge."
The language in question is found in section 1759 of the Federal Credit Union Act and reads, in part, as follows:
Membership.-Federal credit union membership shall consist of the incorporators and other persons and incorporated and unincorporated organizations, to the extent permitted by the rules and regulations prescribed by the Board.except that Federal credit union membership shall be limited to groups having a common bond of occupation or association, or to groups within a well-defined neighborhood, community or rural district...
In Callahan's mind, and despite the previous administrations' interpretations, the emphasis on "groups having a common bond of occupation or association" made clear that limits imposed on credit union merger activity were artificial at best, harmful at worst.
"The federal government stated clearly that it was up to each agency to reinterpret the law and we chose to interpret it our way," Sebastian says.
Filson, now head of the consulting firm Callahan & Associates in Washington. D.C., takes an even more strident view: "How groups were added to a credit union's charter should be a business decision, not a regulatory decision. This was consistent with many of the early credit unions that were formed to served entire communities in the northeast."
An operational adjustment to accommodate the overriding credit union philosophy that all U.S. citizens should have access to credit union membership might have been enough to justify the re-interpretation. But there also were pressing financial considerations that came into play. Frankly put, the U.S. economy was drowning and credit unions were going down right along with it.
Between 1980 and 1982, the American economy experienced its worst downturn since the Great Depression of the 1930s. OPEC flexed its muscles and oil prices began to rise. Rust Belt industries in the industrial north were beginning to crumble as manufacturing moved overseas. Unemployment was headed toward 12% and business were laying off workers and closing plants.
According to Dun & Bradstreet research, business failures more than doubled between 1970 and 1984, reaching a rate of 81.6 failures per 10,000 businesses. In 1982, business failures took down 25,000 enterprises, a number that would rise to more than 31,000 failures in 1983 and more than 52,000 failures in 1984. Tied to many of these failed businesses were small credit unions that regulators were forced to liquidate because, based on their interpretation of the Federal Credit Union Act, there was nothing else they could do when their sponsors closed their doors.
"I'm from Youngstown, Ohio, a city that had five steel mills," said Callahan. "Each of those mills had its own credit union and each of those credit unions went out of business when its sponsoring plant closed because NCUA said we couldn't merge institutions.
"And at the very time members needed them most, those credit unions were no longer able to serve. It was wrong," Callahan says.
According to data from NCUA call reports compiled by CUNA Economics & Statistics, credit union mergers and involuntary liquidations began to rise sharply in 1975, a period corresponding to an economic softening prior to the full-blown recession.
Between 1975 and 1980, credit union mergers averaged 195 per year, while involuntary liquidations averaged 152 per year for the same period. Some of those mergers were assisted mergers, meaning NCUA provided financial support to help offset losses of the merged institutions. In the case of liquidations, the regulator was forced to pay depositors from the National Credit Union Share Insurance Fund. Despite an increase from 19 cents per $100,000 on deposit in 1975 to 32 cents in 1979, officials began to wonder how long the fund would be solvent.
Then in 1980, the economy and credit unions took a turn for the worse. "The bottom line was we eventually had more credit union losses on the books than we had money in the fund, and if that wasn't bankruptcy in the making I don't know what was," says Callahan.
In 1980, there were 313 credit union mergers and 239 involuntary liquidations. In 1981, those numbers jumped to 333 mergers and 259 involuntary liquidations, with no end in sight as the economy continued to tank.
The newly elected Reagan Administration responded to the challenge by deregulating every industry it could, including financial services, in hopes that a free-market economy would help sort things out. Newly unleashed banks and thrifts cut rates, raised interest and crossed state lines in pursuit of shareholder gains, further putting small credit unions at risk.
"Ed came into my office and said, 'We have to do something now,' and so we did," Sebastian recalls.
The Depository Institution Deregulation and Monetary Control Act gave credit unions something they had long fought for, the ability to establish share draft accounts, and also raised maximum allowable interest rates for the first time in 46 years, opening the door for a more competitive environment. That same year, NCUA raised the amount of deposits per account insured by the fund to $100,000, a dicey proposition considering the condition of the fund.
Finally, on April 1, 1982, at Callahan's prompting, the NCUA board approved a change in its interpretation that allowed mergers, field-of-membership expansions and multiple-group memberships. The move was as much one of operating philosophy as it was of survival, says Filson. "Ed believed that through deregulation the responsibility and power for making business decisions fell into the hands of managers and boards rather than the federal government."
The days when credit unions would call NCUA every Monday morning to see what interest rate they could charge that week-a long-standing and now seemingly ludicrous practice-were over, Filson says.
In 1985, Callahan delivered the second punch by assessing credit unions an additional $850 million to raise a newly restructured and now recapitalized National Credit Union Share Insurance Fund. The move would boost reserves to $1 billion. Callahan borrowed the model from American Share Insurance, a Dublin, Ohio, private share insurer that assessed a credit union 1% of its total assets, requiring each institution to keep the funds in reserve pending the company's possible need.
Overnight, the fund increased from a then struggling 31 cents per $100,000 on deposit to $1.28, making it the strongest insurance fund in the financial services industry and the only one that did not eventually require federal assistance.
Survival of the Fittest
The impact Callahan's move had on credit unions' ability to operate safely and compete effectively was profound, say supporters and critics alike.
"That move really saved us," says Art DeRusso, a consultant with Shay Financial Group, Miami, and former president of what is now Eastern Financial Florida Credit Union, Miami.
Eastern Financial began in 1958 as the credit union for the now defunct Eastern Airlines. By 1989, the airline had gone bankrupt, a move that in the past would have meant credit union liquidation. By that time, however, DeRusso had engineered a change that turned Eastern Airlines Federal Credit Union into Eastern Financial Credit Union, with $1 billion in assets, 20 branches nationwide, 50,000 members and 350 select employees groups.
"If we wouldn't have been able to expand our charter, I don't know what we would have done," De Russo says.
John Tippetts, president and chief executive officer of American Airlines Federal Credit Union, Fort Worth, Texas, agrees there have been changes to the good thanks to Callahan's move. But the chief administrator for the airline credit union, which still serves only American Airlines and its spin-off companies' employees and their families, doesn't necessarily think the move saved the industry.
"We would have had fewer credit unions by half without the change. That's the impact the economy would have had," says Tippetts. "The surviving credit unions would have been stronger."
In either case, the most surprising reaction came from the competition. "This was a uniformly welcome set of decisions and no one opposed it," says Sebastian.
NCUA had duly notified the House and Senate banking committees and received no opposition. Even the banking and thrift industries, on whose committees Callahan often sat, did not oppose the move. "Their mindset was 'We won't object to your changes if you don't object to ours,'" says Sebastian.
There was also significant support for the dramatic increase in the share insurance fund to $1 billion. Even thought federal officials couldn't spend the money other than in support of credit unions, Sebastian said the government could count that $1 billion as an offset against the growing federal deficit.
"That freed up the guys in D.C. to spend another $1 billion on something else," Sebastian says. "It was passed into law the next day."
Despite differences of opinion in other areas, most agree the reinterpretation of the Federal Credit Union Act and subsequent recapitalization of the NCUSIF worked hand in glove to build the credit union movement into a stronger, more competitive force. Some say it also may have saved a regulatory agency not prepared to face the challenges that lay before it.
"NCUA adopted the new policy not to further credit union growth, but to minimize losses to the share insurance fund," says CUNA's Bill Hampel. "It was a survival move in favor of the insurance fund."
That such survival tactics also fostered credit union growth has as much to do with the superiority of credit union products and the desire for more people to take advantage of services, Hampel said. The influx of $1 billion into the fund in 1985 provided immediate relief, which allowed institutions to worry less about survival and more about service to increasing numbers of members, he says.
CUNA Mutual's Blanchard agrees. "Deregulation coupled with the recapitalization of the share insurance fund was a visionary move," he says.
"You need might to sustain operations in today's environment, and without the ability to merge into larger, stronger credit unions, many would not have had the infrastructure necessary to survive," Blanchard adds.
Would credit unions have been substantially different had Callahan not re-interpreted the Federal Credit Union Act? Opinions differ strongly.
"I'm not sure it would have been that much different an environment," says banking consultant Bert Ely. Credit unions issues have been compared to the savings & loan crisis that occurred at roughly the same time, but Ely is quick to point out there is really no comparison.
"The issues facing S&Ls weren't about who they could serve, of course, but in which powers they could engage under deregulation," says Ely. Failure by thrifts to diversify from portfolios dominated by low-interest long-term fixed- rate mortgages at a time when rates skyrocketed were the primary cause of their demise, said Ely, who achieved some fame by predicting the coming S&L crisis.
Other critics say that credit unions' moves toward state charters and the growth of community credit unions would have begun simply out of necessity some 15 years earlier. Fallout among the smaller, federally chartered credit unions still would have been significant, which Ely says still posed a threat to the NCUSIF. "The private insurers had the same problem - how to deal with all the corpses," says Ely.
The fact that community charters under state regulators always existed as an option gave credit unions a way our of the situation, says Hampel. "But because people follow the path of least resistance, this is probably the most growth we could have gotten under the circumstances," he says. Without the move, Hampel said the movement could have expected more credit unions with fewer assets and members.
Blanchard takes a stronger position. "We wouldn't have the credit union movement we have today and we wouldn't be serving 80 million Americans like we are today," he says. "Remember, it's not the number of credit unions but the number of members served that makes the difference."
Callahan agrees it was more of a practical than a philosophical move on his part. "This was an emergency and it made no sense to me to do anything else," he says.
"I won't say that we saved the credit union movement, but the fund was in bad shape and Congress would have closed us down," Callahan adds. "You got to do what you got to do."
What the former regulator, recently recognized for lifetime achievement with a Herb Wegner Award and now retired from credit union service, wishes that he would have done was to make sure not only credit unions but the world at large better understood what the two moves meant in terms of making credit unions safer, more competitive and more consumer-oriented players in the financial services arena.
"In hindsight, I would have tried to totally deregulate credit unions and have it written into law," he says. "I see no reason to set any limits on who credit unions can serve.
"Had we done that, the credit union movement would have been triple the size it is today," says Callahan.