NCUA: “The Empirical’s New Clothes”

by Jim Blaine

Derivatives: Part III – “Just Plain Vanilla”

Here’s the key idea underlying the NCUA Board’s proposal to permit large credit unions to trade in derivatives (NCUA Board Action Bulletin – 5/13/2013):

“Credit unions applying for the authority must demonstrate how derivatives will be part of an overall interest-rate risk mitigation plan.”

So, let’s parse that a bit; the sentence has three basic assumptions:

1) Too much interest rate risk (IRR) can be bad for a credit union.
2) Credit unions with too much IRR should try to reduce (“to mitigate”) excessive interest rate risk.
3) Derivatives are the answer… at least for some credit unions; but only if they are large, and only if they are…. and are… and also are… and, and, and…

A severe problem arises with the third general assumption that derivatives are a safe, empirical (“‘ya just can’t miss”),  “answer-to-all-prayers” solution to the issue of CU interest rate risk.  It just ain’t true !!

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