The Financial Crisis, Five Years Later
There are certain dates that can never be forgotten because they threatened our nation’s collective sense of security and stability. For instance, the stock market crash of October 29, 1929 or the attacks of September 11, 2001 come to mind.
For many, another catastrophic event was the fall of Lehman Brothers, whose collapse five years ago on September 15 sparked one of the most severe financial crises our nation has ever experienced. By the time the resulting recession ebbed in late 2009, some of the most storied financial services firms and credit unions had disappeared, and Americans lost over $16 trillion in wealth.
In the aftermath, the financial services industry has been forced by statute and regulations to change the way they do business. Since those long and painful days five years ago, we learned many lessons that have guided NCUA policymaking. In particular, we must continue to emphasize the need to:
Reduce Concentration Risks
The multi-billion-dollar failures of five corporate credit unions were caused by large concentrations of private-label mortgage-backed securities (MBS) on their balance sheets. To prevent this from happening again, the NCUA Board finalized a corporate rule in 2010 that prohibited purchases of private-label MBS and established clear concentration limits on other investments. The revised rule also raised capital standards, requiring corporates to build retained earnings and reduce reliance on contributed capital. These changes have helped the remaining corporates become more stable, diversify their portfolios, and better serve their members.
Require Due Diligence
Before the crisis, credit unions often bought loans and securities without fully understanding the underlying assets. It seems simple, but credit unions must know what they are buying and from whom. NCUA’s new loan participation rule, which takes effect September 23, limits the amount of loans a credit union can purchase from a single seller, and requires buyers to carefully evaluate all participations and their originators. This will provide credit unions with the flexibility they need to meet their strategic objectives and diversify their portfolio risk.
Strengthen Risk-Based Capital
The crisis made clear that a one-size-fits-all capital standard is a prescription for disaster. The credit union industry learned this lesson from credit unions that took high risks and then failed during the crisis. Their failures cost the Share Insurance Fund hundreds of millions of dollars. To prevent this from re-occurring, NCUA is developing a targeted approach so credit unions holding higher risks would be required to hold more capital.
Improve Credit Union Governance
During the crisis, some boards may not have fully understood how their decisions affected their credit union’s performance. Some were passive in their decision-making, often accepting management’s proposals without reviewing them thoroughly. To strengthen the role of credit union boards, NCUA established new rules for board governance and financial knowledge. These new rules are intended to ensure that credit union volunteers become even more engaged and have a stake in their credit union’s success.
Anticipate Emerging Risks
The crisis showed that credit unions and regulators must identify emerging risks sooner. For example, credit unions cannot simply reach for higher yields without considering long-term consequences. This is why NCUA issued a rule requiring credit unions to plan for interest rate risk and why we proposed allowing qualified credit unions to use derivatives to manage that risk. We also created the Office of National Examinations and Supervision to focus on credit unions that pose the largest risks to the Share Insurance Fund.
In addition, NCUA will be asking Congress for authority over third-party vendors which could threaten credit unions’ safety and soundness. Let’s not forget that just days after Lehman’s demise, AIG teetered on collapse. The source of AIG’s failure was a small division operating outside of the firm’s traditional operations – and just beyond the reach of regulators. Dangers to the credit union system could be lurking in such regulatory blind spots.
We have come a long way since the dark days of crisis. Today, credit unions are, in many ways, stronger than ever. As long as we embrace these lessons and remain vigilant for risks on the horizon, credit unions can look forward to a brighter future.