Why CUs Need A Plan B-And Plan C
Toward the end of 2008 I began urging credit unions to devote at least a small amount of time during upcoming strategic planning sessions to developing strategies that would deal with an extended period of ultra-low rates and soft loan demand.
The basis for this was that the credit bubble unwind would take years to process. I mentioned a time frame of five to 10 years. We're now 2.5 years into that process and very little progress has been made. I think the low end time range of my estimate now looks too generous.
Consumer debt has fallen a bit through pay-downs and write-offs, but the big debts have merely been shifted or ignored. Governments have taken on the roll of credit provider and guarantor. Sovereign debt issuance has more than taken the place of private debt.
The fire ignited by the latest Greek flare-up has been doused, for now. Greek debt will actually grow in the process, although Greece still might not pay. But the European Union is unwilling to suffer the consequences of biting the bullet and facing the inevitable now. Greek's debt burden has merely been shifted to the entire EU. I believe we'll look back and realize that Greece is Europe's Bear Sterns.
Bear Sterns was taken over by JP Morgan in 2008, just hours before the firm would have gone bankrupt. The markets were relieved and analysts thought the financial crisis would abate. Conventional wisdom was that if any other institutions did get into trouble, a solution would be worked out to avoid bankruptcy. Then Lehman happened. There was no last minute takeover or solution, and the financial rout was on.
The Rain In Spain...
If Greece is Europe's Bear Sterns, I fear that Spain will be Europe's Lehman Brothers. While the debt of Spain looks more manageable on the surface, all is not what it seems. First, the unemployment rate in Spain is more than 20%, 5% higher than Greece. Second, there is no real secret that the real estate meltdown in Spain has left the economy devastated and, more importantly, left enormous losses on the books of lenders. But arcane rules and regulations have allowed those lenders to ignore certain losses. Eventually lenders will have to recognize losses. The Spanish government might then step in to guarantee banks and other lenders, and the debt of Spain will explode. Spain is a far bigger piece of the European puzzle. A guarantee of Spain by the other European Union members is just not reasonable. Spain could be Lehman.
If not Spain, there are plenty of other landmines in Europe. The point is, the markets are in the fantasy stage-that the problems will be contained in Greece-just as the mortgage problems in the U.S. were supposedly limited to subprime only.
This is where you come in when you go into your planning sessions. There is a reason that t-bill rates out through six months remain under 0.10%, with very short-term bills often trading at negative yields. Many very big money managers-and individuals as well-are willing to accept no investment return for the safety of PRINCIPAL return. I believe this will intensify in the months ahead as European issues pop up again and again.
An Inadvertent Fright?
Ben Bernanke inadvertently might have started the process of scaring even more money into treasuries in his last press conference. Unsolicited, Bernanke brought up the subject of risk to money market funds from foreign banks. What? The place most Americans feel their money is totally safe? While Bernanke downplayed that risk, his introduction of the topic certainly got my attention and caused a few journalists to take a peek at the books of the nation's biggest money funds. What they found was the 10 largest U.S. money market funds have over 50% of their assets in foreign banks, mostly European. This news probably hasn't made it into the mainstream consciousness, but another scare or two will take care of that.
If so, individuals will no longer trust money funds. So, where do they go? Most individuals don't even know how to buy treasuries, and the yield doesn't make it worth the time to learn. They are more likely than ever to turn to guaranteed deposits at banks and CUs-at any rate.
Most credit unions are dealing with a liquidity problem-too much of it. I believe now is the time to spend even more time in strategizing how to deal with that problem should my dark scenario prove correct. There are a multitude of strategies to consider: 1) Shrink by chasing off deposits. 2) Use the occasional interest rate spike to add interest rate risk. 3) Work hard to develop non-interest income sources. 4) Work even harder to cut expenses. 5) Do nothing. Let the money roll in and hope for the best. This is just a starter set of strategies.
I hope I am wrong. I hope the economy magically takes off. I hope the European debt issues quietly go away. And, I hope the overwhelming consensus that interest rates will eventually increase will prove correct, rendering my forecast worthless.
Frankly, planning for higher rates and loan growth is easy. It's certainly your prerogative to ignore the possibility of low rates for years to come, but even if you give my scenario only a 20% chance of happening, it's imperative you develop Plan B or Plan C to cope with that outcome.
Apparently, no one spent any time in Europe planning for Greece. Don't let that happen to you.
Dwight Johnston leads Dwight Johnston Economics and can be reached at email@example.com or 951-741-5498.