From the Field

Thank You for Speaking:

"Thank you so much
for coming this afternoon..."

"The program drew quite a large crowd! Thanks for your remarks to our gathering; I assure you they had an effect on the several hindered people in attendance."

(... obviously a smashed hit!)

NCUA: "The Empirical's New Clothes"... Derivatives: Part V - "Cause and Counterparty"

It can really get
your goat... can't it!!

Certain you would like to move on and talk about something more interesting and fun than derivatives. If we're honest; most of us would prefer to "take a walk", when confronted by a difficult problem, by controversy and confrontation, or by an insular, indifferent bureaucracy - whether by structure governmental or trade.    Asking to be heard is hard work; arrogance is not required to listen to reason.

Builder or Architect?

As you head into the long weekend, would like to give you just a couple of simple questions to ponder while you're out there on your riding lawn mower, getting those tomato plants in the ground, or just swigging on that third "PBR".

Here 'ya go...

NCUA: "The Empirical's New Clothes" ... Derivatives: Part IV- "The Magic Risk Fairy"

Definition: A derivative is a financial transaction which transfers risk between two parties, usually for a fee. 

There are hundreds of definitions for derivatives, but this one is particularly instructive on one of the key, rock-solid, basic truths of financial derivatives  That core, immutable truth is that a derivative "transfers" risk - it does not eliminate risk! 

Don't Worry! I won't bite you
... but once !

When a credit union does an interest rate "swap" or "cap" transaction, the CU contracts to transfer some internal risk exposure to a "counterparty" - usually to a Wall Street bank.  The five counterparties which dominate the derivatives market are: Citigroup, Morgan Stanley, BofA, Chase, and Goldman Sachs.

NCUA: "The Empirical's New Clothes"... Derivatives: Part III - "Just Plain Vanilla"

"Can You Mitigate This Risk ?"

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 !!

A Capital Markets Group?

But, the worst problem is that "The Deciders" at NCUA have evidently been sprinkled with analytical pixie dust and agreed to drink the derivatives Kool-Aid - as we say in the South - "Whole Hawg"! And,"The Deciders" are reassuring in their assertion that these are simple, no-risk derivative transactions.

But let's look at the actual record to see how deep NCUA's self-assurance really is... you'll see some real-world, bureaucratic "hedging", kind of an "accountability cap", a "responsibility swap"... 

NCUA: "The Empirical's New Clothes"... Derivatives: Part II - Increasing Risks To The NCUSIF

Well, according to the NCUA Board

Unanimous in our full
understanding of derivatives...

Action Bulletin dated May 16, 2013, the NCUA Board was almost breathless with excitement in its unanimous approval (... in this case a "democracy of two") of a derivatives proposal which appears to substantially increase the financial risks to the National Credit Union Share Insurance Fund (NCUSIF).

You should recall, although the NCUA continually forgets, that the NCUSIF belongs to credit unions and is funded by credit unions.  That's why its called the National Credit Union Share Insurance Fund, not Pooh Bear's "Honey Pot".  

The new risks added to your credit union come as a result of the Board's decision to permit large credit unions to trade in derivatives - a reversal of the current, long-held prohibition. What does permitting such an increase in the overall risks to the NCUSIF mean? It simply means that as the principal funder of the deposit insurance pool your risks and those of your members have just increased, also. 

How so?....

NCUA: "The Empirical's New Clothes"... Derivatives: Part I - Ignoring A Scandal

The Major Forces Behind
 NCUA's Derivatives Rule...

A reasonable person can - and should - have several concerns about the latest round of proposed rule-making on derivatives from the NCUA.  But, three concerns should cause great alarm for all federally-insured credit unions:  

1) NCUA's "explanation and reasoning" as to the need for derivatives is facile, light-weight, and does not holdup to even the most superficial scrutiny or analysis - which will probably cause you and your members a financial loss in the future; 
2) NCUA, in promoting the use of derivatives, appears to be defaulting on its fiduciary duty as the administrator of the NCUSIF - which will probably cause you and your members a financial loss in the future; and 
3) Your "trade association", which ever one that might be, will, if recent history is instructive, once again fail the "backbone test" when asked to honestly and openly discuss and advocate on the derivatives issue - which will probably cause you and your members a financial loss in the future.

As we all eagerly await the actual publication of the proposed rule, it's hard to know where to wade in (just way too many "opportunities"!), but...

Derivatives... A Two Party Transaction

Definition:  A derivative is a contract between two parties which specifies the circumstances under which the parties will exchange payments.

Cold-blooded and of forked tongue !!!

One party is an astute, experienced,  highly-commissioned, profit-above-all-else, heartless Wall Street dealer.

The other party is....

From The Field...

"We had a tragic loss of an oppossum in the parking lot this month.  The...."

( ... will just let you use your imagination
 for what comes next! )

Derivatives: Next Steps From Alexandria..... SWAPS & "SWAG" !

Below, graphically displayed, is an overview of the NCUA's new proposed rule on derivatives.  

"Up The Down Staircase...."

With the new rule the Agency, once again, calls out to you to:

 "Reduce your risk, follow us !"  

(... perhaps, or is it just another misstep, yet another regulatory "trip and fall"?)

Derivatives.....Passing the Buck..

Duke Street, Alexandria !!!

Well, y'know it really did come as somewhat of a surprise to many of us that you, one of the committed, hardcore, fearless, philosophical leaders in the warm and fuzzy, not-for-profit credit union movement, had decided to become a "wheeler and dealer" in Wall Street derivatives.  And that, you had been aggressively pushing the folks at NCUA to let you "get in the game"! 

Credit unions represent a huge new opportunity for "derivative dealers"; just imagine, potentially 7,000 new, sophisticated CU "derivative traders" ready "to play" - 

ROLL 'EM, MAN, ROLL 'EM !!!

Nothing like a "sure thang", a "sure bet" to get those investment juices flowing is there !!! And, we've all taken the course and signed the pledge acknowledging our full, "over-21", fully liable, willing-to-go-to-jail understanding that a derivative is a contract between two parties - a buyer and a seller - seeking their individual best, self-interest in terms of RISK.  That both parties are placing risk bets based on a very uncertain future - right?

 ROLL 'EM, BABY, ROLL 'EM !!!

So here are the 3 key features of the new NCUA proposed rule: