Never in the century-long history of the U.S. credit union industry has there been as pivotal a time as was experienced in the year that began in August 2008. The catastrophic meltdown of the U.S. mortgage market threatened the livelihoods of credit unions and their members, even though the credit union system was not directly responsible for the collapse.
As credit unions continue to regain their footing, it is important now, five years after the crisis began, to recall these momentous events and put NCUA’s response in historical context. Time has allowed us to better understand how the difficult decisions made then set a course for a better credit union future.
Over the decade preceding the economic meltdown, the mortgage market experienced significant changes. Fueled by subprime lending, mortgage debt grew from $5.3 trillion to $14.8 trillion. Steady increases in the number of subprime mortgages led to a corresponding rises in delinquencies and foreclosures. This translated into a decline in the value of the associated mortgage-backed securities. These instruments had paid very attractive rates to investors, including corporate credit unions. In the decade starting in December 1998, the number of corporate credit unions reporting some investments in mortgaged-backed securities increased from 53 percent to 79 percent.
By early 2008, the value of these securities began to plunge, resulting in large defaults and often destabilization in the financial institutions that held these investments. Among the first to fail were Bear Stearns and IndyMac, two entities with an exceedingly high exposure to subprime loans. The troubles quickly spread throughout the financial system.
For credit unions, the Wall Street Journal sounded the opening bell of the crisis on August 11, 2008, when a front- page article detailed the mounting losses on the balance sheets of five corporate credit unions. The story, Mortgage-Market Trouble Reaches Big Credit Unions, highlighted $5.7 billion in unrealized losses for these corporates. That meant these corporates were insolvent.
On July 27, 2008, just two weeks before this bombshell appeared in the nation’s pre-eminent financial newspaper, I had become NCUA’s Chairman. My challenge was two-fold: fix the problems in the corporate sector and keep the entire system stable so that retail credit unions, and the nearly 88 million consumers they served at the time, would remain safe, sound and viable.
As the financial contagion spread, a worldwide liquidity crunch quickly drove down the value of assets, and lenders became unwilling to provide liquidity without additional collateral. As the corporates faced liquidity constraints, credit unions increasingly turned to NCUA’s Central Liquidity Facility (CLF), the mixed-ownership contingent liquidity fund designed to address this kind of situation.
Until then, the CLF was a little-used industry backstop. In the previous seven years the CLF had only made $20 million in emergency loans, and Congress had capped lending capacity at $1.5 billion. As liquidity evaporated, the CLF made more than $1.8 billion in loans in September 2008 alone. And it had requests for additional loans far exceeding the appropriations ceiling.
NCUA had to move quickly and decisively. We had to ask Congress to lift the CLF lending cap, but this action had political implications. By approaching Congress for help, we would send an unmistakable signal that the meltdown had spread to the credit union system.
With the unanimous support of the NCUA Board, I asked Congress to remove the CLF lending cap. While unpopular with some, we had to take action. NCUA asked for and Congress responded by allowing the CLF to lend its legal maximum of $41 billion. In the two years that followed, the CLF infused nearly $21 billion in much-needed liquidity into the system. This liquidity built confidence and stability for an industry straining to maintain normalcy in decidedly abnormal times.
The CLF fixed industry liquidity concerns, but the corporate sector then experienced substantial capital losses. In particular, WesCorp and U.S. Central had sunk to dangerous capital levels, and U.S. Central, at the top of the corporate sector, was on the brink of insolvency due to impaired assets.
In response, NCUA in January 2009 placed a $1 billion note in U.S. Central, drawn from the National Credit Union Share Insurance Fund (NCUSIF). In March 2009, NCUA then conserved the two most troubled corporates, U.S. Central and WesCorp. Simultaneously, NCUA guaranteed all shares in corporate credit unions in an effort to stabilize the system and maintain confidence in retail credit unions. These actions were unprecedented.
We still needed to do more to enable the credit union industry to remain viable and deal with mounting corporate losses. The magnitude of corporate accounts deficits were larger than credit unions could be expected to pay for at one time, without sustaining staggering losses on their own balance sheets, accompanied by a severely diminished ability to serve their members and the possibility of thousands of retail credit union failures. The situation was dire.
In early 2009, NCUA evaluated the financial and legislative landscapes and decided on a bold course—to ask Congress to increase the NCUSIF’s borrowing capacity to $30 billion to shore up the NCUSIF and to create a temporary fund to deal with the corporate losses.
Like the CLF situation, this legislative strategy carried risks. First, Congress could approve the increased borrowing authority in exchange for additional constraints on credit unions. The autonomy and independence of our system’s regulator and insurance fund could have been in jeopardy. Or Congress could have simply refused our request. Also, once NCUA asked for additional borrowing authority, adverse news stories calling into question the safety and soundness of retail credit unions and the federal share insurance that stood behind them might diminish public confidence.
Given the severity of the financial situation, we had to ask. In my view, it was far riskier for the credit union industry to do nothing. My goal was to enable credit unions to move forward without a crippling one-time assessment. I felt it prudent, and achievable, to find a way forward utilizing borrowings, not an outright grant of taxpayer funds, that would enable credit unions to pay their obligations in a measured, gradual fashion.
In May 2009, the Temporary Corporate Credit Union Stabilization Fund was born. After a series of complex negotiations with the leadership of both the House Financial Services and Senate Banking committees, and with industry support, the President signed legislation setting up the mechanism through which credit unions could resolve the crisis in a manageable, yet fiscally responsible manner. Assessments would be made, debts satisfied, and most importantly, credit unions would continue service uninterrupted to a consumer financial marketplace in need of certainty and stability. Moreover, credit unions would pay the cost of the corporate failures; not one penny of taxpayer funds would be lost.
Consumers benefitted from several other NCUA initiatives aimed at assisting retail credit unions. The Credit Union Homeowner Affordability Relief Program enabled credit unions to lower interest rates on the first mortgages of borrowers experiencing financial stress. NCUA also created its Office of Consumer Protection, dedicated to assisting members navigate an often complex landscape of financial rules, a year prior to the broader and more well-known Consumer Financial Protection Bureau’s establishment.
Perhaps most noteworthy, I took steps to improve credit union supervision. Upon becoming NCUA Chairman, I was concerned that the examination cycle, at 18 or even 24 or 30 months for some credit unions, was insufficient. It prevented examiners from dealing with small problems before they became big problems. So, in 2009 the NCUA Board instituted a 12-month examination cycle. We also undertook the painstaking, but essential, task of re-writing the NCUA Examination Manual to better reflect the realities of the changed financial and economic landscape.
Against this backdrop of financial stress and dislocation, there was another need: increased NCUA transparency for credit union stakeholders. To this end we mandated the delivery of monthly NCUSIF and Stabilization Fund financial reports at NCUA Board meetings, posted a weekly online corporate credit union update and scheduled a series of well-received town hall meetings. Given the uncertainties and rapidly changing regulatory landscape, we also regularly communicated with credit union leaders, often through videoconferences.
In retrospect, these steps almost seem routine, but at the time they provided the facts, data and credible information—not speculation—that were essential to credit unions managing through a very difficult situation. To the extent there was a crisis of confidence, I wanted to level with credit unions about the significant problems we jointly faced, as an industry and as a regulator. Equally important, we needed to explain the tools at our disposal and outline solutions. I wanted to let credit unions know that we would not allow the system to fail.
There is no question that the meltdown’s economic disruptions were severe. A real possibility of cascading losses, emanating from the compromised corporate sector, could have spread throughout the system. Yet, in large measure because of the medicine we administered, this contagion was controlled.
Were there difficult decisions? Yes. Were the stakes high, for credit unions and the consumers who depend on them for financial services? Absolutely. However, we never entertained inaction, based on an unrealistically optimistic or incomplete understanding of the condition of corporate balance sheets, as a stopgap solution. Never.
Although inaction would have been a convenient path of least resistance to paper over the problems, it would have been irresponsible. Instead, we took decisive steps to:
- Resolve the corporate failures;
- Create a mechanism through which credit unions could responsibly pay for losses, over a manageable period of time, without incurring untenable up-front costs; and
- Enhance NCUA supervision, transparency and accountability.
NCUA charted a new and better course for credit unions. The bright days ahead for credit unions can trace their lineage directly back to the tough, but necessary, decisions of 2008–2009. As Chairman, I was proud of the part that I played during that historic year and I am grateful for the work that credit unions and the NCUA staff did to make a successful resolution a reality.