the federal deposit insurance fund that didn ’ t put a bite on u.s. taxpayers 陳宇任葉威儀

The federal deposit The federal deposit insurance fund that insurance fund that didn’t put a bite on U.S. didn’t put a bite on U.S. taxpayerstaxpayers

陳宇任陳宇任葉威儀葉威儀

OutlineOutline

IntroductionIntroduction The history and managerial environThe history and managerial environ

ment of credit unionsment of credit unions Estimating NCUSIF net worthEstimating NCUSIF net worth Implications for improving federal dImplications for improving federal d

eposit insurance loss exposureeposit insurance loss exposure

AbstractAbstract

IntroductionIntroduction History and managerial environment History and managerial environment

of credit unionof credit union Opportunities for managers to Opportunities for managers to

benefit from strategic risk-takingbenefit from strategic risk-taking Concerns about weaker controls on Concerns about weaker controls on

risk-taking by corporate credit unionsrisk-taking by corporate credit unions Implications for improving federal Implications for improving federal

deposit insurance loss exposuredeposit insurance loss exposure

IntroductionIntroduction

Compares three different deposit-Compares three different deposit-insurance funds in the United insurance funds in the United States. States.

Managerial and bureaucraticManagerial and bureaucratic The process by which a deposit-The process by which a deposit-

insurance fund becomes insolvent insurance fund becomes insolvent has two interacting partshas two interacting parts


1. How individual institutions lose 1. How individual institutions lose moneymoney– Incompetent and dishonest management Incompetent and dishonest management – Adverse shocks in uncontrollable economic Adverse shocks in uncontrollable economic

variablesvariables 2. how industry losses are transmitted 2. how industry losses are transmitted

to taxpayers and how defective to taxpayers and how defective government supervision may double government supervision may double and redouble a fund’s loss exposure.and redouble a fund’s loss exposure.


This paper examines the issue of This paper examines the issue of whether adverse shocks, whether adverse shocks, information blockages and information blockages and incentive conflicts forced an incentive conflicts forced an implicit taxpayer bailout of the implicit taxpayer bailout of the third U.S. federal deposit third U.S. federal deposit insurance fund.insurance fund.


National Credit Union Share National Credit Union Share insurance Fund (NCUSIF) insurance Fund (NCUSIF) resurrected itself when Federal resurrected itself when Federal Savings and Loan Insurance Savings and Loan Insurance Corporation (FSLIC) and the Federal Corporation (FSLIC) and the Federal Deposit Insurance Corporation Deposit Insurance Corporation (FDIC) moved more and more (FDIC) moved more and more deeply into economic insolvency.deeply into economic insolvency.

History and History and managerial managerial environmentenvironment Self-sufficient mutual organizationSelf-sufficient mutual organization Relies on members’ savings Relies on members’ savings All members of a particular credit All members of a particular credit

union must share an association, union must share an association, occupation or residence.occupation or residence.

History and History and managerial managerial environmentenvironment In 1909, Massachusetts lawmakers In 1909, Massachusetts lawmakers

passed the first U.S. credit union passed the first U.S. credit union legislation which codified the legislation which codified the requirements of a “common bond” requirements of a “common bond” among members. among members.

The common bond constrains the The common bond constrains the typical credit union’s size and typical credit union’s size and growth potential.growth potential.

History and History and managerial managerial environmentenvironment To the extent that scale economies To the extent that scale economies

are available in providing financial are available in providing financial services, so called “human person” services, so called “human person” credit unions.credit unions.

Credit unions are tax exempt Credit unions are tax exempt deposit institutions that are owned deposit institutions that are owned and operated cooperatively by a and operated cooperatively by a specified member community of specified member community of household or institutional customershousehold or institutional customers

History and History and managerial managerial environmentenvironment Earnings come principally from Earnings come principally from

loans made to members and to loans made to members and to other credit unions. other credit unions.

Their major expense is interest Their major expense is interest paid to member-depositors.paid to member-depositors.

History and History and managerial managerial environmentenvironment Higher level credit unions are Higher level credit unions are

called “cooperates”called “cooperates” invest the funds invest the funds deposit instruments or lend them deposit instruments or lend them

on to their memberon to their member

History and History and managerial managerial environmentenvironment A credit union’s net cash flows A credit union’s net cash flows

must be allocated to members by must be allocated to members by favorable pricing for services, as favorable pricing for services, as determined by its board of determined by its board of directors and a few subsidiary directors and a few subsidiary committees.committees.

History and History and managerial managerial environmentenvironment Each institution's board of Each institution's board of

directors is elected on a one-directors is elected on a one-member-one vote basis.member-one vote basis.

Supervisory and credit Supervisory and credit committees are appointed or committees are appointed or elected from the membership.elected from the membership.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking The cooperative structure of a The cooperative structure of a

human-person credit union creates human-person credit union creates reservoirs reservoirs

differ markedly from those of other differ markedly from those of other deposit institutions.deposit institutions.

These differences make it less These differences make it less feasible for managers to pursue and feasible for managers to pursue and to benefit from either corrupt lending to benefit from either corrupt lending or go-for-broke strategies of risk or go-for-broke strategies of risk taking.taking.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Managerial willingness to bet a Managerial willingness to bet a

credit union’s future viability on credit union’s future viability on large risky projects is curbed by large risky projects is curbed by three constraints.three constraints.– Its field – of – membership limitationIts field – of – membership limitation– Its cooperative formIts cooperative form– Private and federal monitoringPrivate and federal monitoring

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Its field – of – membership limitationIts field – of – membership limitation

– Restricts the firm’s product line Restricts the firm’s product line – Inhibits rapid growthInhibits rapid growth– Attempts to distribute a firm’s capital Attempts to distribute a firm’s capital

disproportionately to borrowers, deposidisproportionately to borrowers, depositors, or paid managerstors, or paid managers

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking The cooperative from lessens The cooperative from lessens

personal returns that can be personal returns that can be captured by managers who captured by managers who successfully shift risks to NCUSIF.successfully shift risks to NCUSIF.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Managerial incentives to shift the doManagerial incentives to shift the do

wnside of long-shot risks to NCUSIF wnside of long-shot risks to NCUSIF are further attenuated by difficulties are further attenuated by difficulties managers face in diverting to themsmanagers face in diverting to themselves a sizeable share of the upside oelves a sizeable share of the upside of the firm’s winning bets.f the firm’s winning bets.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Managers whose institutions had Managers whose institutions had

won a risky bet could convert a won a risky bet could convert a NCISOF-insured credit union to NCISOF-insured credit union to stock holder from in one step or stock holder from in one step or two stepstwo steps

Opportunities for managers tOpportunities for managers to benefit from strategic risk-to benefit from strategic risk-takingaking The cooperative structure of credit-uThe cooperative structure of credit-u

nion ownership shares would be replnion ownership shares would be replaced directly with stock shares in a daced directly with stock shares in a different type of institution.ifferent type of institution.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking The credit union would first convert tThe credit union would first convert t

o a differently chartered class of muto a differently chartered class of mutual institution and subsequently petiual institution and subsequently petition its new regulator to demutualize tion its new regulator to demutualize the rechartered firmthe rechartered firm

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Efforts to fuel an expansion in risk Efforts to fuel an expansion in risk

taking by rapid growth in deposits taking by rapid growth in deposits are also limited by the near-are also limited by the near-permanence of the cooperative permanence of the cooperative form.form.

Opportunities for Opportunities for managers to benefit from managers to benefit from strategic risk-takingstrategic risk-taking Private and federal monitoringPrivate and federal monitoring

– Three factors intensify the extent Three factors intensify the extent and quality of the private monitoring and quality of the private monitoring to which the actions and strategies to which the actions and strategies of human-person credit-union of human-person credit-union managers are subject.managers are subject.


– contributed by members and contributed by members and sponsors.sponsors.

– the incentive and the opportunity to the incentive and the opportunity to monitor conflicts of interest and risk-monitor conflicts of interest and risk-taking activities undertaken by taking activities undertaken by professional managers.professional managers.


– The activities of credit-union The activities of credit-union managers and governing boards are managers and governing boards are bonded more extensively by outside bonded more extensively by outside private ‘sureties’ than the managers private ‘sureties’ than the managers of other depositories are.of other depositories are.


– NCUSIF-insured credit unions NCUSIF-insured credit unions coinsure one another. All coinsure one another. All institutions insured by NCUSIF are institutions insured by NCUSIF are jointly and severally responsible jointly and severally responsible without limit for curing and shortage without limit for curing and shortage the fund might develop.the fund might develop.

Concerns about Concerns about weaker controls on weaker controls on risk-takingrisk-taking Credit union offices are prohibited from Credit union offices are prohibited from

borrowing from their own credit union, iborrowing from their own credit union, it is common for a corporate to make loat is common for a corporate to make loans to officers of member credit unionsns to officers of member credit unions

Such loans create incentive conflict that Such loans create incentive conflict that may limit the extent to which client credmay limit the extent to which client credit unions and trade-association board mit unions and trade-association board members monitor a corporate’s risk-takiembers monitor a corporate’s risk-taking strategy.ng strategy.

Concerns about Concerns about weaker controls on weaker controls on risk-takingrisk-taking General Accounting Office (GAO) discGeneral Accounting Office (GAO) disc

erned a need to increase capital at cerned a need to increase capital at corporates and to set maximum limits orporates and to set maximum limits on the ability of corporates to conceon the ability of corporates to concentrate loans and investments is a sinntrate loans and investments is a single credit.gle credit.

Concerns about Concerns about weaker controls on weaker controls on risk-takingrisk-taking GAO also criticized the reliability, GAO also criticized the reliability,

completeness and timeliness of completeness and timeliness of the information system National the information system National Credit Union Administration Credit Union Administration (NCUA) officials use to evaluate (NCUA) officials use to evaluate corporate condition and corporate condition and performance.performance.

Concerns about Concerns about weaker controls on weaker controls on risk-takingrisk-taking The GAO characterized NCUA as ‘reThe GAO characterized NCUA as ‘re

luctant’ to take enforcement actionluctant’ to take enforcement actions against corporates for fear that strs against corporates for fear that strong disciplinary action might reduce ong disciplinary action might reduce confidence in these institutions.confidence in these institutions.

Estimating NCUSIF net Estimating NCUSIF net worthworth

NCUSIF remained solvent on an accNCUSIF remained solvent on an accounting basisounting basisAccounting solvency Accounting solvency needneed not imply not imply economic solvencyeconomic solvencyto determine whether NCUSIF fell intto determine whether NCUSIF fell into economic solvency during the mid-o economic solvency during the mid-1980s1980s market value of net worth = value amarket value of net worth = value another insurer would pay to take over nother insurer would pay to take over NCUSIF’s book of businessNCUSIF’s book of business

Estimating industry net Estimating industry net worthworth Aggregate credit-union net worth:Aggregate credit-union net worth:

– Investments : Treasury securities, Investments : Treasury securities, federal agency securities, and federal agency securities, and deposits in other institutionsdeposits in other institutions

– Loans : real estate loans, auto loans, Loans : real estate loans, auto loans, and unsecured loansand unsecured loans

Estimating industry net Estimating industry net worthworth

Estimating NCUSIF net Estimating NCUSIF net worthworth Loss exposure in MV-insolvent credit unions Loss exposure in MV-insolvent credit unions

= aggregate shortfall in market-value = aggregate shortfall in market-value capitalcapital

Loss exposure in each MV-solvent credit Loss exposure in each MV-solvent credit union is calculated in two stepsunion is calculated in two steps

1)1) Estimate the probability that a given Estimate the probability that a given credit union will be closed in the credit union will be closed in the following yearfollowing year

2)2) Multiply this probability by an estimate of Multiply this probability by an estimate of the closure coststhe closure costs

Model of closure probabilityModel of closure probability

Closure should occur when an Closure should occur when an institution’s net worth falls to the cost institution’s net worth falls to the cost to NCUSIF of absorbing and resolving to NCUSIF of absorbing and resolving its threatened insolvencyits threatened insolvency

Probability of closure is modeled as a Probability of closure is modeled as a function of three ratios: MV ratio, BV function of three ratios: MV ratio, BV ratio, 1/TotalSharesratio, 1/TotalShares

Model of closure probabilityModel of closure probability

ModelModel ofof closure costs closure costs Closure cost is calculated as the sum of reClosure cost is calculated as the sum of re

solution costs and costs of insolvency abssolution costs and costs of insolvency absorptionorption

Resolution costs are represented as a lineResolution costs are represented as a linear function of the book value of an institutiar function of the book value of an institution’s total shares (TotalShares)on’s total shares (TotalShares)

Costs of insolvency absorption are estimatCosts of insolvency absorption are estimated by the market value of a credit union’ed by the market value of a credit union’s capital (MVcap) and the book value of its s capital (MVcap) and the book value of its capital (BVcap)capital (BVcap)

Model of closure costsModel of closure costs

EstimatingEstimating expected expected costcost The expected cost of closing an The expected cost of closing an

individual credit union = the individual credit union = the probability of closure x the conditional probability of closure x the conditional cost of closurecost of closure

Estimating NCUSIF’s net worthEstimating NCUSIF’s net worth

Implications for Implications for improving federal improving federal deposit insurance loss deposit insurance loss exposureexposure NCUSIF recovering its solvency in 1983-89NCUSIF recovering its solvency in 1983-89 Aggregate credit union net worth rooted in Aggregate credit union net worth rooted in

better institutional incentives for maintaining better institutional incentives for maintaining well-diversified and interest-rate hedged well-diversified and interest-rate hedged positions.positions.– Private monitoringPrivate monitoring– Managers’ lesser capacity to appropriate Managers’ lesser capacity to appropriate

institutional gains for themselvesinstitutional gains for themselves

Implications for Implications for improving federal improving federal deposit insurance loss deposit insurance loss exposureexposure Common-bond limitations and the Common-bond limitations and the

cooperative nature of credit unions did cooperative nature of credit unions did not prevent individual institutions from not prevent individual institutions from taking substantial risks.taking substantial risks.

Differences in monitoring and Differences in monitoring and supervisory response patterns explainsupervisory response patterns explain– why particular government-sponsored why particular government-sponsored

deposit insurance funds became insolvent deposit insurance funds became insolvent and others resisted temporary bouts of and others resisted temporary bouts of insolvencyinsolvency

Implications for Implications for improving federal improving federal deposit insurance loss deposit insurance loss exposureexposure Government guarantees on Government guarantees on

deposits increases the frequency deposits increases the frequency and severity of future taxpayer and severity of future taxpayer bailoutsbailouts

Combining a private surety with Combining a private surety with prepayment of government prepayment of government insurance premiumsinsurance premiums

The EndThe End

the federal deposit insurance fund that didn ’ t put a bite on u.s. taxpayers 陳宇任葉威儀

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