Stimulus and More Bailouts

The House passed the $819 billion stimulus package.  The bill extends unemployment insurance benefits, expands access to health care for the unemployed and allocates $125 billion for public education (plus many many extras).  While the size of the stimulus, which almost equals the entire cost of annual federal spending under Congress's discretion, may seem shocking, it is chump change compared to the numbers flying around concerning the "bad bank."  According to the Wall Street Journal, Government officials are discussing spending ANOTHER $1 to $2 trillion to help restore banks to health.  One of the proposals, involves seeding the "bad bank" with $100 to $200 billion in TARP funds and then borrowing as much as $1 to $2 trillion by issuing debt.  If this proposal comes to fruition, I would highly recommend a new moniker: Big Bad Leveraged Bank.  It would be sort of like combining all of the stupidity from the past few years, into one big ugly operation run by the government, and then piling on some leverage for good measure.  Sure this proposal is bound to make bank stocks rally, but it scares the living daylights out of me.

Meanwhile, the bailout du jour involves credit unions.  Federal Regulators guaranteed $80 billion in uninsured deposits and injected $1 billion of new capital into the largest of these wholesale credit unions, US Central Federal Credit Union of Lenexa, Ka.  According to the WSJ, the vast majority of regular credit unions are financially sound, however, a few of the wholesale or "corporate" credit unions were invested in mortgages (uh oh).  The corporates are owned by the retail credit unions and provide services to the retail credit unions.  Consequently, a failure of the corporates would affect the nearly 90 million Americans who hold deposits at credit unions.  As of November, five of the largest institutions posted unrealized losses on their investments of $11.6 billion, up from $9.4 billion just a month earlier and double the level of last May.  When the aforementioned US Central chose to take a $1.2 billion writedown by permanently recognizing some unrealized losses, regulators (The National Credit Union Administration) grew concerned and felt the need to take action.  The $1 billion in new capital into US Central came from the NCUA's $7 billion insurance fund.  Simple math tells me that the insurance fund now has $6 billion left and the industry has over $10 billion in unrealized losses, much of which will likely end up being real.  The NCUA better work fast to get included in the TARP.

    

Rescue Plan For the Credit Unions?

If you thought the automaker rescue plan was the only one in the works, think again.  According to the Wall Street Journal, federal regulators are preparing a rescue plan to shore up the finances of some of the large credit unions.  The plan will tap the $41 billion lending facility that Congress made available to credit-union regulators in September.  Apparently, corporate credit unions are reeling from paper losses (i.e. probably real losses by now) on MBS.  The Chairman of the National Credit Union Administration (NCUA) is not calling the lending facility a taxpayer-funded bailout.  It is instead a short-term "mechanism to stabilize the credit-union system" while regulators work on other steps (i.e. the actual taxpayer-funded bailout.)  A related program also to be announced by the NCUA will provide $2 billion in inexpensive loans to credit unions to reduce mortgage interest rates for homeowners.  

What are corporate credit unions and who cares about them?  Here is the WSJ's quick description:

"Credit unions are member-owned cooperatives that act much like banks, taking deposits and offering loans. At the end of last year, there were about 8,400 credit unions in the U.S. with $775 billion in assets. Most are faring fine financially.

The rescue plan is aimed at shoring up the network of corporate credit unions, which are wholesale-style institutions that provide financing, investment and clearing services to retail credit unions. The retail credit unions are cooperative owners of the corporate credit unions.

As part of their role, corporates take deposits from retail credit unions, then invest that money in longer-term assets. But some of the largest corporates invested in mortgage-backed securities, and lately have suffered paper losses."

So, really, no need to worry about the retail credit unions.  They are faring fine.  The problem is that they all rely on the corporate credit unions, which are apparently blowing out. Retail credit unions are pulling deposits exacerbating an already difficult situation for the corporates. The stabilization plan to be announced has two steps:

• Retail credit unions borrow from a lending facility at a favorable rate (1.5%) and then deposit that money with a corporate credit union with a federal guarantee and a small additional rate of return.
  
• Retail credit unions borrow up to $2 billion at a favorable rate (1.25%) and use the money to subsidize interest-rate relief for troubled homeowners.

Mind you, these are temporary financing measures that don't address the capital issue.  Perhaps a new administration will be more willing to help the plight of the credit unions as Hank Paulson chose to exclude them from the TARP.  A chart from the Journal depicts the mounting losses at the largest corporate credit unions:  

Corporate Credit Unions Face Mounting Paper Losses From Mortgage Assets

The Wall Street Journal reports this morning that five of the largest credit unions are reporting paper losses on mortgage holdings large enough to wipe out all of their equity.  The credit unions respond that the losses are merely temporary and that they fully expect for the market to rebound.  This belief is commonly referred to as "we'll-make-it-back-as-soon-as-we-pull-our-heads-out-of-the-sand" syndrome. In fact, two corporate credit unions, Western Corporate and U.S. Central have have gone so far as to reclassify some of the assets on their balance sheets from "available for sale" to "held to maturity."  Assets classified as "held to maturity" can be carried on the books without reflecting temporary swings in asset prices.

Furthermore, the federal credit union regulator, the NCUA, is planning an accounting rule change to allow corporate credit unions to more clearly highlight the funds they hold from regular credit unions on their balance sheets.  Certain funds from regular credit unions, which are currently excluded from the balance sheet, are apparently a key source of capital.  This begs the question of why they were never included before.  But, when in doubt, just reclassify assets and have your regulator change a few accounting rules to tidy up those balance sheets.  These solutions work perfectly fine in a static world where people aren't panicking about losing their money in the next financial firm failure.  However, when the name of your credit union is reported in a front page story in the Wall Street Journal right next to the words "negative equity", a few of your depositors may decide they don't want to wait around for those paper losses to rebound.  This is precisely how temporary asset price declines can become permanent.  Although credit union deposits are insured up to $100,000, providing some comfort to depositors, this fact didn't help IndyMac one bit.  The last time a corporate credit union failed was in 1995 and the regular credit unions who had their funds with the corporate credit unions eventually recovered their money.  The NCUA's director of the office of corporate credit unions claims that the possibility of a corporate credit union failure is "so remote" that "I can't even imagine that happening."  If one of our regulators thinks there's nothing to worry about, I'm certain he's right.  After all, regulators saw this mortgage mess from a mile away.