the economy and credit unions

The Economy and The Economy and Credit UnionsCredit Unions

James D. LikensCredit Union Executive Society

Southern California/Arizona University of Southern California

Los Angeles, CaliforniaMarch 16, 2010

jlikens@pomona.edj

In Late 2008…In Late 2008…

Global CrisisGlobal Crisis The world going through the most

serious economic downturn since the Great Depression.

Worldwide LossesWorldwide Losses

• $20 trillion of housing wealth disappeared.

• $30 trillion of stock-market wealth evaporated.

Fear and MiseryFear and Misery

House Price Cycles and Banking CrisesHouse Price Cycles and Banking Crises Peak-to-trough Price Declines (left) and Years Duration of Downturn (right)

Source: Reinhart and Rogoff ‘The Aftermath of Financial Crises’

Stock Market Cycles and Banking CrisesStock Market Cycles and Banking Crises Peak-to-trough Price Declines (left) and Years Duration of Downturn (right)

Unemployment Cycles and Banking Crises Unemployment Cycles and Banking Crises Trough-to-PeakIncrease in Unemployment Rate (left) and Years Duration of Downturn (right)

Per Capita GDP Cycles and Banking Crises Per Capita GDP Cycles and Banking Crises Peak-to-TroughPeak-to-TroughPercent Decline in Real GDP (left) and Years Duration of Downturn (right)

If U.S. Were to Experience the If U.S. Were to Experience the AverageAverage• Housing: 2006 2012

• Stock Market: Nov 2007 early 2011

• Unemployment: 2007 4.5% 11.5% in 2011

• Per Capita GDP: Q3 2008 in Q3 2010

• Unemployment: 2007 4.5% 11.5% in 2011

Could the U.S. do better than the average?Could the U.S. do better than the average?

• Unemployment: 2007 4.5% 11.5% in 2011

Maybe. Maybe.

• Unemployment: 2007 4.5% 11.5% in 2011

Maybe. But how?Maybe. But how?

What Needed to Be Done?What Needed to Be Done?

• In normal times consumer spending is two-thirds of the economy.

• In this crisis consumers closed their wallets. They were afraid to spend and many could not get credit even if they wanted to buy things.

• Government needed to increase aggregate demand temporarily to help fill the hole created by the economic crisis.

• Fallacy of Composition

Fiscal PolicyFiscal Policy

TARP $700 billion

$787 Billion Stimulus$787 Billion Stimulus BillBill

Monetary PolicyMonetary Policy

U.S. Treasury YieldsU.S. Treasury Yields

Money Supply (M2)Money Supply (M2)Checking accountsChecking accounts, , savings and small time deposits, overnight savings and small time deposits, overnight repos at commercial banks, and non-institutional money market repos at commercial banks, and non-institutional money market accounts.accounts.

Fed’s Balance SheetFed’s Balance Sheet

Bank Reserves at the FedBank Reserves at the FedDec 07 - Present

100000

200000

300000

400000

500000

600000

700000

800000

900000

1000000

07-12 08-1 08-2 08-3 08-4 08-5 08-6 08-7 08-8 08-9 08-10 08-11 08-12 09-1 09-2 09-3 09-4 09-5

Required Reserves Excess Reserves

Is Economic Policy Working?Is Economic Policy Working?

Stock MarketStock Market

• Unemployment: 2007 4.5% 11.5% in 2011

The U.S. stock market has recovered much of its value. Its recovery began in February 2009.

S&P 500 Stock IndexS&P 500 Stock Index

Gross Domestic ProductGross Domestic Product

• Unemployment: 2007 4.5% 11.5% in 2011

Per Capita GDP is increasing. The recovery began inMarch 2009.

GDP GrowthGDP Growth

Housing PricesHousing Prices

• Unemployment: 2007 4.5% 11.5% in 2011

Housing prices are weak but no longer in free fall.

Case-Shiller Housing Price IndexCase-Shiller Housing Price IndexChange from Dec 2008 - Dec 2009

Boston 0.5%

Chicago -7.2%

Dallas 3.0%

Detroit -10.3%

Denver 1.2%

Las Vegas -20.6%

Los Angeles 0.0%

Miami -9.9%

Minneapolis -2.3%

New York -6.3%

Phoenix -9.2%

San Diego 2.7%

San Francisco 4.8%

Seattle -7.9%

Washington DC 1.9%

Composite 10 -2.4%

Composite 20 -3.1%

UnemploymentUnemployment

• Unemployment: 2007 4.5% 11.5% in 2011

Unemployment is abating. It may be bottoming outright now. But it is still very high and its incidenceis uneven.

-85-11-111-139-216-276

-321-175-128

-161-137-160-122-177-72

U.S. Job LossesU.S. Job Losses

January 2008 – December 2009

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: Bureau of Labor Statistics

Jan 2010: -20,000Feb 2010: -36,000

U.S. Unemployment RateU.S. Unemployment RateJan 2008 – Jan 2010Jan 2008 – Jan 2010

4.9 4.85.1 5.0

5.5 5.65.8

6.2 6.26.6

6.87.2

8.18.5

8.99.4 9.5 9.4

9.7 9.810.1 10.0 10.0

Source: Bureau of Labor Statistics

Unemployed

15 Weeks or More 1.5% 2.8% 5.9% 5.8%

National Civilian

Unemployment Rate 4.4% 7.1% 10.0% 9.7%

Augmented

Unemployment Rate* 8.0% 13.5% 17.3% 16.5%

U.S. UnemploymentU.S. Unemployment

Is Economic Policy Working?

Is Economic Policy Working?Is Economic Policy Working?

Without a doubt!

Why Aren’t We Grateful?Why Aren’t We Grateful?

Economy Is Getting BetterEconomy Is Getting Better

Half FullHalf Full

Economy Is Still WeakEconomy Is Still Weak

Half EmptyHalf Empty

It’s Not Over Until It’s OverIt’s Not Over Until It’s Over

• Dangers remain

• Still lots of foreclosures

• Unemployment remains very high

• Political backlash

• Rage

Look over there…Look over there…

The Federal ReserveThe Federal Reserve

Current Monetary PolicyCurrent Monetary Policy

• A near-zero interest rate policy• Liquidity programs, which are now mostly ended• A quantitative easing through asset purchase

Near-Zero Federal Funds RateNear-Zero Federal Funds Rate

• Policy rates were reduced to near-zero across the Group of Seven in late 2008 and early 2009.

• The FOMC says it will keep the federal funds rate target near-zero “for an extended period.”

• Any upward movement of this rate will be contingent on both inflation and real economic developments.

Liquidity ProgramsLiquidity Programs

• Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility

• Commercial Paper Funding Facility.• Money Market Investor Funding Facility. • Primary Dealer Credit Facility.• Term Securities Lending Facility.• SWAPS with other Central Banks

These programs are temporary

Outright Asset PurchasesOutright Asset Purchases

• More than $1.7 trillion in outright asset purchases of agency debt, agency MBS, and longer-term Treasuries.• Financed by expanding the monetary base, i.e., reserve creation. This expansion is likely to be very persistent. A side effect of this policy is a medium-term inflation risk.

Medium-Term Inflation RiskMedium-Term Inflation Risk

• If private sector expectations that a big expansion of the monetary base will be temporary, as with the liquidity programs, they will not be inflationary.

• Large increases that are expected to be more persistent, as with the asset purchase program, may become inflationary.

• Any inflationary impact will also depend on the speed with which the monetary base is translated into changes in the money supply. This is not occurring very rapidly right now.

• This is new territory.

Federal Reserve InstrumentsFederal Reserve Instruments

• Traditional open market operations set the federal funds rate, which is the interest rate banks charge one another for overnight loans.

• The discount rate which is charged banks for short term loans for liquidity. This is mainly used for signaling the Fed’s intentions.

• Something new. A rate paid banks for holding idle reserves. It will be between the fed funds rate and the discount rate. Currently it is .25% for both required and excess reserves.

What About Long Term Effects?What About Long Term Effects?

Increasing LongevityIncreasing Longevity• In 1900, the average 65-year-old American could expect another twelve years of life.

• By 2000, those numbers had increased to nineteen years for women and sixteen years for men.

• In 1900, the average 85-year-old American could expect an extra four years of life.

• By 2000, those statistics increased to eleven years for women and ten years for men.

Living Longer and BetterLiving Longer and Better

Decreasing FertilityDecreasing Fertility

U.S. Projected Age DistributionU.S. Projected Age DistributionPercentage for Selected Years (U.S. Census)

Age 2000 2025 2050

0 to 9 14.1 13.3 13.3

10 to 24 21.3 19.2 19.0

25 to 64 52.2 49.3 47.0

65 to 79 9.1 13.7 12.7

80 + 3.3 4.5 8.0

Total 100.0 100.0 100.0

Age 2000 2025 2050

0 to 9 14.1 13.3 13.3

10 to 24 21.3 19.2 19.0

25 to 64 52.2 49.3 47.0

65 to 79 9.1 13.7 12.7

80 + 3.3 4.5 8.0

Total 100.0 100.0 100.0

Over 65 12.4 18.2 20.7

U.S. Dependency RatioOver age 64 divided by age 20-64; workers per over age 64

Year Ratio Workers

1985 20.1% 5.0

1995 21.6% 4.9

2005 20.6% 4.9

2010 21.2% 4.7

2020 27.5% 3.6

2030 35.5% 2.8

2040 36.8% 2.7

2060 39.2% 2.6

2080 43.2% 2.3

Source: Social Security Administration

17.60%

13.80%

12.30%

1960 1970 1980 1990 2000 2009

National Health ExpendituresNational Health Expenditures(% of GDP)

Sources: Centers for Medicare & Medicaid; Dept of Commerce; Census Bureau

U.S. Health Care ExpenditureU.S. Health Care Expenditure% Private and % Public

75.362.4 58 59.8 55.9 53.8

24.737.6 42 40.2 44.1 46.2

Public

Private

1960 1970 1980 1990 2000 2007Sources: Centers for Medicare & Medicaid; Dept of Commerce; Census Bureau

% ofTotal U.S.

What Next?What Next?By 2018, U.S. health spending will almost double from last year's sum, soaring to $4.4 trillion and making up 20.3 percent of the overall economy.

Mounting Deficits and DebtMounting Deficits and Debt

• The U.S. faces a impending fiscal crisis.

• It will be caused mainly by Social Security, Medicare and Medicaid.

• This is why health care reform is vitally important.

Adding up the Fiscal ShortfallAdding up the Fiscal Shortfall

• In 2004 the U.S. federal government faced a $51 trillion fiscal gap, i.e., the present value of its unfunded liabilities.

• This amounts to $159,000 each that we can pay off today, or let our kids pay it off with interest when they grow up.

• This is eleven times the official National Debt.

• Of this shortfall, the Medicare gap is $43.6, which is over four-fifths of the total.

Source: L.J. Kotlikoff and S. Burns, The Coming Generational Storm (The MIT Press, 2004)

Every year action is delayed, the price for resolving this problem increases by $1-2 trillion.

Nota BeneNota Bene

The Power of CompoundingThe Power of Compounding

• The $51 trillion estimate for the present value of the unfunded mandate for Social Security, Medicare and Medicaid was published in 2004

• It is estimated that it has now reached $96 trillion.

Why Is This Happening?Why Is This Happening?

• We continue to cut taxes and expand program benefits. This is life in a democracy.

• Some people advocate more spending and support increasing taxes to pay for it.

• Others advocate more spending and advocate cutting taxes to pay for it.

More Likely?More Likely?

• Unless we act the shortfalls in Social Security, Medicare and Medicaid will be met by running deficits.

• Government deficits are financed by borrowing.• This will result in higher interest rates and

crowding out of private investment for other things.

• Today’s young people will be required to pay interest on the debt, which will lead to a large transfer of intergenerational wealth.

Thanks a lot, Grandma?Thanks a lot, Grandma?

Generational Storm?

Let’s work together!Let’s work together!

We’ll get through?

Meantime, Some Short Meantime, Some Short Term ForecastsTerm Forecasts

Major IndicatorsMajor IndicatorsReal GDP: % annual change, chained 2005 $)Real GDP: % annual change, chained 2005 $)Jobless: % of Labor ForceJobless: % of Labor Force

GDPGDP CPICPIJoblessJobless

RateRate

2006 2.7 3.2 4.6

2007 2.1 2.8 4.6

2008 0.4 3.8 5.8

2009 -2.4 -0.4 9.3

ForecastsForecasts

2010 3.0 2.2 9.8

2011 3.1 2.0 9.1

ConsumersConsumers%, year over year, constant 2005 $)%, year over year, constant 2005 $)

DisposableDisposablePersonalPersonalIncomeIncome

ConsumerConsumerSpendingSpending

2006 4.0 2.9

2007 2.2 2.6

2008 0.5 -2.2

2009 0.9 -0.6

Forecasts

2010 1.9 2.1

2011 2.5 2.6

HousingHousing(Millions of units)(Millions of units)

HousingHousingStartsStarts

2006 1.80

2007 1.36

2008 0.90

2009 0.56

ForecastsForecasts

2010 0.70

2011 0.97

Autos and Light TrucksAutos and Light Trucks(Millions of units)(Millions of units)

AnnualAnnualSalesSales

2006 16.5

2007 16.1

2008 13.1

2009 10.3

ForecastsForecasts

2010 11.7

2011 13.2

Interest RatesInterest Rates

3 Month3 MonthTreasuryTreasury

10 Year10 YearTreasuryTreasury

2006 4.7 4.8

2007 4.4 4.6

2008 1.4 3.7

2009 0.2 3.3

ForecastsForecasts

2010 0.1 0.4 0.7 3.6 3.9 4.2

2011 0.8 1.8 2.8 4.1 4.6 5.3

He who hesitates…He who hesitates…

Be there for the members. Go

for their deposits. Make loans

Even if we lose money we

have lots of capital. Capital is for a rainy day,

and it is raining. We can show the world that

credit unions are special. When everyone else

is afraid, we have an opportunity to flourish.

Look before you…Look before you…

Hunker down. Preserve capital. Be conservative. We don’t know what bad stuff is still to come down on us. It’s impossible to assess risk. What are houses worth? Who knows? What is the value of a credit score if the person who appears to be an A or B loses that job? You can burn up capital fast with large charge offs.

We Are Not the SameWe Are Not the Same

Spread AnalysisSpread AnalysisDecember 31, 2009

Rest of U.S. 5.01% 1.79% 3.22% 0.87% 1.64% 3.26% 0.74% 0.39%

AZ,CA,NV,FL 4.94% 1.63% 3.31% 2.07% 1.63% 3.10% -0.23% -0.56%

California 4.82% 1.62% 3.20% 1.88% 1.37% 2.83% -0.14% -0.48%

Inc Funds NIM PLL Other Opex Pre PostInt Cost Fee & ROA ROA

What to do?What to do?

Risk and UncertaintyRisk and Uncertainty

• Risk is uncertainty based on a well grounded

quantitative probability.

quantitative probability.• Risk = (the probability that some event will occur) x

(the consequences if it does occur).

• Risk is uncertainty based on a well grounded quantitative probability.

• Risk = (the probability that some event will occur) x (the consequences if it does occur).

• Genuine uncertainty, on the other hand, cannot be assigned a well grounded probability.

• Furthermore, genuine uncertainty often cannot be reduced significantly by attempting to gain more information about the phenomena in question and their causes

Credit Union ExamplesCredit Union Examples

• Credit Risk (credit scores)• Interest Rate Risk (ALM)• Early Payment Risk (historical experience)• Concentration Uncertainty• Reputation Uncertainty• Sponsor Uncertainty• Regulatory Uncertainty • Macroeconomic Uncertainty

RiskRisk

Our MarketOur Market

• What is the economic outlook in the communities where we operate?

• How financially safe is our field of membership?

Financial AssessmentFinancial Assessment

• Are we profitable?

• If not, how can we stop the bleeding?

• How long will our capital hold out?

• Can we build a profitable book of business moving forward?

Reassessing RiskReassessing Risk

• Are our traditional measures of risk such as credit scores and collateral going to be reliable moving forward?

• How much risk is embedded in our balance sheet?

SurvivalSurvival

• How much is our credit union at risk of not surviving?

• Should we make contingency plans for the possibility we will not be able endure the bad times that still lie ahead?

Big Credit Union IssuesBig Credit Union Issues

UnemploymentUnemployment

• The nation lost 36,000 jobs in February after dropping a 26,000 in January 2010.

• Unemployment nationwide in February 2010 remained steady at 9.7%.

• Unemployment is the last major indicator to recover from recessions. Don’t expect it to get better quickly.

U.S. Unemployment RateU.S. Unemployment Rate

U.S. Initial Jobless ClaimsU.S. Initial Jobless Claims

Uneven ImpactsUneven Impacts

U.S. UnemploymentU.S. UnemploymentBy AgeBy Age

Feb-09 Dec-09 Jan-10 Feb-10

Total, 16 years and over 8.2% 10.0% 9.7% 9.7%

Adult men (20 years and over) 8.4% 10.2% 10.0% 10.0%

Adult women (20 years and over) 6.8% 8.2% 7.9% 8.0%

Teenagers (16 to 19 years) 21.8% 27.1% 26.4% 25.0%

White 7.5% 9.0% 8.7% 8.8%

African American 13.5% 16.2% 16.5% 15.8%

Asian (not seasonally adjusted) 6.9% 8.4% 8.4% 8.4%

Hispanic ethnicity 11.0% 12.9% 12.6% 12.4%

Source: U.S. Department of Labor

Feb-09 Dec-09 Jan-10 Feb-10

Total, 25 years and over 7.0% 0.1% 0.1% 8.3%

Less than a high school diploma 13.0% 15.3% 15.2% 15.6%

High school graduates, no college 8.4% 10.5% 10.1% 10.5%

Some college or associate degree 7.1% 9.0% 8.5% 8.0%

Bachelor's degree and higher 4.2% 5.0% 4.9% 5.0%

U.S. UnemploymentU.S. UnemploymentBy Education Level

At 12.5% California is 5At 12.5% California is 5thth highest in highest in the nationthe nation

U.S. UnemploymentU.S. UnemploymentBy State

Michigan 14.6%

Nevada 13.0%

Rhode Island 12.9%

South Carolina 12.6%

California 12.5%

District of Columbia 12.1%

Florida 11.8%

California UnemploymentCalifornia UnemploymentBy Metropolitan Area

Aug 09 Sept 09 Oct 09 Nov 09 Dec 09

Bakersfield 14.4 14.0 14.5 15.1 15.8

Riverside-San Bernardino 14.6 14.3 14.7 14.7 14.0

Los Angeles-Long Beach-Glendale 12.4 12.3 12.2 11.9 11.0

Los Angeles-Long Beach-Santa Ana 11.8 11.9 11.8 11.4 11.3

Santa Ana-Anaheim-Irvine 9.8 9.5 9.7 9.6 9.1

Santa Barbara-Santa Maria-Goleta 8.6 8.5 8.8 8.9 9.0

San Luis Obispo-Paso Robles 9.5 9.0 9.2 9.5 9.4

Oxnard-Thousand Oaks-Ventura 11.3 11.1 11.2 11.2 10.9

San Diego-Carlsbad-San Marcos 10.6 10.4 10.7 10.6 10.1

Housing ForeclosuresHousing Foreclosures

What’s Happening?What’s Happening?

• In February 2010 foreclosures slowed to their slowest pace in four years, but were still 6 percent higher than a year ago.

• In all, over 300,000 properties, or one out every 418 households, faced foreclosure last month, up 2 percent from January 2010.

• Nevada is the state hardest hit with one out of every 102 households in foreclosure. Arizona and Florida followed, each with one in 163 homes in foreclosure. California was fourth, with one in 195 households in foreclosure.

Foreclosure RateForeclosure RateFebruary 2010

Source: RealtyTrac

James J. Saccacio, chief executive of RealtyTrac, says:

"This leveling of the foreclosure trend is not necessarily evidence that fewer homeowners are in distress and at risk for foreclosure, but rather that foreclosure prevention programs, legislation and other processing delays are in effect capping monthly foreclosure activity -- albeit at a historically high level that will likely continue for an extended period."

Public Policy ImpactPublic Policy Impact

• The federal government has worked to stem the tide of foreclosures through its $75 billion Making Home Affordable program, which aims to reduce the monthly mortgage payments of struggling homeowners.

• Through January, the $75 billion program has resulted in more than 830,000 trial loan modifications, according to the Treasury Department.

““Making Home Affordable”Making Home Affordable”

Paperwork NightmarePaperwork Nightmare

But an executive at RealtyTrac, notes that foreclosures have slowed mainly because banks are overwhelmed by paperwork:

"We're running at roughly six to seven times the level of foreclosure

activity the banks are set up to handle. It's…taking an awful long time

to process the sheer volume of bad loans that are out there.”

Housing StartsHousing Starts

New Home SalesNew Home Sales

ObservationsObservations

• Real Estate Loans/Total Loans has been increasing in part because Auto and Visa balances have been running off faster than real estate at many credit unions.

• DFI, from what I understand, sets limits for fixed rate real estate on the loan portfolio and not assets.

• Some credit unions even with small real estate portfolios are running up against the cap. It would probably be better if DFI were to set limits for Real Estate/Total Assets.

Last Minute FootballLast Minute Football

• Some credit unions are booking fixed rate firsts and extending investment terms in search of yields. This could be damaging in the event short term rates rise even 100 bp within a year.

• CEOs may be making these decisions because they need the income to cover current losses and protect eroding capital.

• The desire to avoid Prompt Corrective Action appears to be affecting such decision making. Increasing rate risk to capture yield is one way to avoid PCA.

ObservationsObservations• Unemployment will continue to be high for at least

another year. California state and local governments are now laying people off.

• Consequently delinquency and loan losses will still be a threat.

• Foreclosures will continue to be a serious problem for credit unions.

• People give up their homes when they can no longer pay. They also give them up strategically when they find themselves under water.

• An NCUA assessment of 30-50 basis points would be a serious blow.

Challenges AheadChallenges Ahead

• The financial world is undergoing profound change.

• The world wide financial crisis has forced adaptation on a scale not seen since the Great Depression and World War II.

• Can we adapt?

Factors Driving ChangeFactors Driving Change

• Technology

• Changing nature of competition

• Household demographic trends

• How important is size?

• Changes in legislative and regulatory environment

It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.

Clarence Darrow

Dinosaurs and AntsDinosaurs and Ants

Can we adapt?Can we adapt?

I Say Yes!I Say Yes!

The greatest mistake that we can make…is to assume that principles which once were true remain true forever.

Edward A. Filene

We Do ChangeWe Do Change

We Have Come So FarWe Have Come So Far

The credit union movement…is a great movement, worthy of great deeds, deserving of great loyalty.

Edward A. Filene

We Are A Movement

We CooperateWe Cooperate

We Have One AnotherWe Have One Another

And Now the Longer ViewAnd Now the Longer View

ScyllaScylla

Increasing LongevityIncreasing Longevity• In 1900, the average 65-year-old American could expect another twelve years of life.

• By 2000, those numbers had increased to nineteen years for women and sixteen years for men.

• In 1900, the average 85-year-old American could expect an extra four years of life.

• By 2000, those statistics increased to eleven years for women and ten years for men.

Living Longer and BetterLiving Longer and Better

Decreasing FertilityDecreasing Fertility

Age 2000 2025 2050

0 to 9 14.1 13.3 13.3

10 to 24 21.3 19.2 19.0

25 to 64 52.2 49.3 47.0

65 to 79 9.1 13.7 12.7

80 + 3.3 4.5 8.0

Total 100.0 100.0 100.0

Age 2000 2025 2050

0 to 9 14.1 13.3 13.3

10 to 24 21.3 19.2 19.0

25 to 64 52.2 49.3 47.0

65 to 79 9.1 13.7 12.7

80 + 3.3 4.5 8.0

Total 100.0 100.0 100.0

Over 65 12.4 18.2 20.7

U.S. Dependency RatioOver age 64 divided by age 20-64; workers per over age 64

Year Ratio Workers

1985 20.1% 5.0

1995 21.6% 4.9

2005 20.6% 4.9

2010 21.2% 4.7

2020 27.5% 3.6

2030 35.5% 2.8

2040 36.8% 2.7

2060 39.2% 2.6

2080 43.2% 2.3

Source: Social Security Administration

17.60%

13.80%

12.30%

1960 1970 1980 1990 2000 2009

National Health ExpendituresNational Health Expenditures(% of GDP)

Sources: Centers for Medicare & Medicaid; Dept of Commerce; Census Bureau

U.S. Health Care ExpenditureU.S. Health Care Expenditure% Private and % Public

75.362.4 58 59.8 55.9 53.8

24.737.6 42 40.2 44.1 46.2

Public

Private

1960 1970 1980 1990 2000 2007Sources: Centers for Medicare & Medicaid; Dept of Commerce; Census Bureau

% ofTotal U.S.

What Next?What Next?By 2018, U.S. health spending will almost double from last year's sum, soaring to $4.4 trillion and making up 20.3 percent of the overall economy.

Mounting Deficits and DebtMounting Deficits and Debt

• The U.S. faces a impending fiscal crisis.

• It will be caused mainly by Social Security, Medicare and Medicaid.

• This is why health care reform is vitally important.

Adding up the Fiscal ShortfallAdding up the Fiscal Shortfall

• In 2004 the U.S. federal government faced a $51 trillion fiscal gap, i.e., the present value of its unfunded liabilities.

• This amounts to $159,000 each that we can pay off today, or let our kids pay it off with interest when they grow up.

• This is eleven times the official National Debt.

• Of this shortfall, the Medicare gap is $43.6, which is over four-fifths of the total.

Source: L.J. Kotlikoff and S. Burns, The Coming Generational Storm (The MIT Press, 2004)

Three Options to Fix Medicare

• Raise federal income taxes, immediately and permanently, by 57 percent.

Source: L.J. Kotlikoff and S. Burns, The Coming Generational Storm(Cambridge, Mass.: MIT Press, 2004), p 162.

• Raise payroll taxes, immediately and permanently, by 79 percent.

• Immediately cut the current level of Medicare by 83 percent and let benefits grow at their projected rate thereafter.

Every year action is delayed, the price for resolving this problem increases by $1-2 trillion.

Nota BeneNota Bene

The Power of CompoundingThe Power of Compounding

• The $51 trillion estimate for the present value of the unfunded mandate for Social Security, Medicare and Medicaid was published in 2004

• It is estimated that it has now reached $96 trillion.

Why Is This Happening?Why Is This Happening?

• We continue to cut taxes and expand program benefits. This is life in a democracy.

• Some people advocate more spending and support increasing taxes to pay for it.

• Others advocate more spending and advocate cutting taxes to pay for it.

More Likely?More Likely?

• Unless we act the shortfalls in Social Security, Medicare and Medicaid will be met by running deficits.

• Government deficits are financed by borrowing.• This will result in higher interest rates and

crowding out of private investment for other things.

• Today’s young people will be required to pay interest on the debt, which will lead to a large transfer of intergenerational wealth.

Thanks a lot, Grandma?Thanks a lot, Grandma?

Generational Storm?

Let’s work together!Let’s work together!

We’ll get through?

Don’t we wish!Don’t we wish!

An Alternative PerspectiveAn Alternative Perspective

Whether paid for by the government, an insurance company, the employer as part of total compensation, or by the household itself:

– A typical family now in their mid 60s will have devoted about 30% of their pre-retirement income to health (16%), retirement (6%) and education of their children (8%).

– A typical family now entering into adulthood in 2110 can expect to spend 52% of their pre-retirement income on health (35%), retirement (3%), and education of their children (14%).

Source: Robert E. Hall, “The Unbearable Forward Burden,” Stanford University And National Bureau of Economic Research, February 18, 2003.

Between Scylla and CharybdisBetween Scylla and Charybdis

What Would Ulysses Do?What Would Ulysses Do?

The Clear ChoiceThe Clear Choice

• We must fix the terrible recession

• Then tackle the long term problems

The EndThe End

He who hesitates…He who hesitates…

Be there for the members. Go

for their deposits. Make loans

Even if we lose money we

have lots of capital. Capital is for a rainy day,

and it is raining. We can show the world that

credit unions are special. When everyone else

is afraid, we have an opportunity to flourish.

Look before you…Look before you…

Hunker down. Preserve capital. Be conservative. We don’t know what bad stuff is still to come down on us. It’s impossible to assess risk. What are houses worth? Who knows? What is the value of a credit score if the person who appears to be an A or B loses that job? You can burn up capital fast with large charge offs.

What to do?What to do?

Risk and Uncertainty

quantitative probability.

quantitative probability.• Risk = (the probability that some event will occur) x

(the consequences if it does occur).

• Furthermore, genuine uncertainty often cannot be reduced significantly by attempting to gain more information about the phenomena in question and their causes

Credit Union ExamplesCredit Union Examples

• Credit Risk (credit scores)• Interest Rate Risk (ALM)• Early Payment Risk (historical experience)• Concentration Uncertainty• Reputation Uncertainty• Sponsor Uncertainty• Regulatory Uncertainty • Macroeconomic Uncertainty

Risk ManagementRisk Management

RiskRisk

How To Decide?How To Decide?

Economic UncertaintyEconomic Uncertainty

• How bad will the economy get? Can we withstand a protracted recession?

• What should we do to allow for the possibility that the present recession will be followed by a sharp rise in inflation?

An economist’s guess is liable to be as good as any one else’s.

Mark Twain

Where Do We Live?Where Do We Live?

The Worst…

Bureau of Labor Statistics

The Best…

Bureau of Labor Statistics

So what about…So what about…

my credit union?my credit union?

So what about…So what about…

We Are Not the SameWe Are Not the Same

Credit Union ROACredit Union ROAYear Ending December 31, 2008

Blue: AZ, CA, FL, NV Yellow: Rest of the States

0.86 0.83

2006 2007 2008

-1.50%

-1.00%

-0.50%

AZ,CA,NV,FL

Rest of U.S.

Return on AssetsReturn on AssetsBefore Stabilization

Return on AssetsReturn on Assets After Stabilization

-3.00%

-2.50%

-2.00%

-1.50%

-1.00%

-0.50%

3AZ,CA,NV,FL

Rest of U.S.

Credit Union ROACredit Union ROAForeclosure States of AZ, CA, NV and FL, By Quarter, Annualized

2008 Q1

2008 Q2

2008Q3

2008Q4

2009Q1*

2009Q1#

Over $1B 0.09% 0.11% 0.02% -0.31% -0.31% -0.61%

$500-$1B 0.12% 0.17% 0.19% -0.12% -0.32% -0.70%

$250-$500M 0.07% 0.06% 0.03% -0.24% -0.33% -0.75%

$100-$250M -0.02% -0.15% -0.39% -0.91% -0.63% -1.09%

$50-$100M 0.02% 0.01% 0.02% -0.21% -0.38% -0.86%

Under $50M 0.07% 0.03% -0.02% -0.33% -0.39% -0.90%

* Before Stabilization # After Stabilization

Credit Union ROACredit Union ROA46 Non-Foreclosure States, By Quarter, Annualized

2008Q1

2008Q2

2008Q3

2008Q4

2009Q1*

2009Q1#

Over $1B 0.21% 0.41% 0.56% 0.55% 0.13% -0.22%

$500-$1B 0.22% 0.38% 0.52% 0.53% 0.09% -0.25%

$ 250-$00M 0.16% 0.27% 0.37% 0.31% 0.00% -0.35%

$50-$100M 0.12% 0.26% 0.39% 0.38% 0.05% -0.41%

Under $50M 0.13% 0.24% 0.37% 0.35% 0.01% -0.49%

Spread AnalysisSpread AnalysisU.S. Credit Unions by Assets Size: First Quarter 2009, Annualized

Over 1B 5.07% 2.19% 2.88% 1.29% 1.04% 2.60% 0.04% -1.31%

500M-1B 5.06% 1.98% 3.07% 0.97% 1.16% 3.33% -0.07% -1.47%

250M-500M 5.06% 1.82% 3.24% 0.88% 1.30% 3.68% -0.01% -1.41%

100M-250M 5.12% 1.79% 3.33% 0.85% 1.21% 3.89% -0.20% -1.84%

50 M-100M 5.13% 1.66% 3.48% 0.57% 1.14% 4.07% -0.02% -1.85%

Under 50M 5.13% 1.48% 3.65% 0.52% 0.87% 4.10% -0.10% -2.13%

Range Income Expense Margin PLL Income Expenses ROA* ROA#

Asset Interest Interest Other Operating

Spread AnalysisSpread AnalysisAZ, CA, NV and FL; Rest of U.S.; All U.S.: First Quarter 2009, Annualized

AZ,CA,NV,FL 5.03% 1.94% 3.09% 2.05% 0.70% 3.11% -1.37% -2.81%

Rest of U.S. 5.10% 1.97% 3.12% 0.73% 1.22% 3.27% 0.35% -1.15%

All in U.S. 5.08% 1.97% 3.12% 1.02% 1.11% 3.24% -0.03% -1.52%

Spread AnalysisSpread AnalysisAZ, CA, NV and FL: First Quarter 2009, Annualized

Over 1b 5.01% 2.08% 2.93% 2.31% 0.77% 2.62% -1.22% -1.53%

500-1b 5.01% 1.92% 3.09% 1.79% 0.78% 3.35% -1.26% -1.65%

250-500m 5.09% 1.74% 3.35% 1.78% 0.76% 3.67% -1.34% -1.75%

100-250m 5.08% 1.64% 3.43% 2.15% 0.34% 4.15% -2.52% -2.99%

50-100m 5.06% 1.67% 3.39% 1.26% 0.29% 3.93% -1.50% -1.98%

Under 50m 5.14% 1.43% 3.71% 1.08% 0.18% 4.36% -1.56% -2.06%

Range Income Expense Margin PLL Income Expenses ROA* ROA#Asset Interest Interest Other Operating

Spread AnalysisSpread Analysis46 Non-Foreclosure States: First Quarter 2009, Annualized

Over $1B 5.07% 2.22% 2.85% 0.90% 1.14% 2.58% 0.51% -0.87%

$500M -1b 5.07% 2.00% 3.07% 0.69% 1.30% 3.32% 0.35% -0.99%

$250-500M 5.06% 1.82% 3.24% 0.88% 1.30% 3.68% -0.01% -1.41%

$100-250M 5.12% 1.79% 3.33% 0.85% 1.21% 3.89% -0.20% -1.84%

$50-100M 5.14% 1.66% 3.49% 0.47% 1.26% 4.09% 0.18% -1.63%

Under $50M 5.13% 1.49% 3.64% 0.46% 0.94% 4.07% 0.06% -1.97%

Our MarketOur Market

• What is the economic outlook in the communities where we operate?

• How financially safe is our field of membership?

Financial AssessmentFinancial Assessment

• Are we profitable?

• If not, how can we stop the bleeding?

• How long will our capital hold out?

• Can we build a profitable book of business moving forward?

Reassessing RiskReassessing Risk

• Are our traditional measures of risk such as credit scores and collateral going to be reliable moving forward?

• How much risk is embedded in our balance sheet?

SurvivalSurvival

• How much is our credit union at risk of not surviving?

• Should we make contingency plans for the possibility that our credit union will not be able endure the bad times that still lie ahead?

No Single Right AnswerNo Single Right Answer

Back at the Credit UnionBack at the Credit Union

• Who is responsible for assessing the risk and uncertainty faced by our credit union?

• The regulators? The auditors? The CEO and Management? The Board of Directors and Supervisory Committee?

Back at the Credit UnionBack at the Credit Union

• Who is responsible for assessing the risk and uncertainty faced by our credit union?

• The regulators? The auditors? The CEO and Management? The Board of Directors and Supervisory Committee?

• Yes. All of us.

Challenges AheadChallenges Ahead

• The financial world is undergoing profound change.

• The world wide financial crisis has forced adaptation on a scale not seen since the Great Depression and World War II.

• Can we adapt?

Factors Driving ChangeFactors Driving Change

• Technology

• Changing nature of competition

• Household demographic trends

• How important is size?

• Changes in legislative and regulatory environment

It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.

Clarence Darrow

Dinosaurs and AntsDinosaurs and Ants

Can we adapt?Can we adapt?

I Say Yes!I Say Yes!

The greatest mistake that we can make…is to assume that principles which once were true remain true forever.

Edward A. Filene

We Do ChangeWe Do Change

We Have Come So FarWe Have Come So Far

The credit union movement…is a great movement, worthy of great deeds, deserving of great loyalty.

Edward A. Filene

We Are A Movement

We CooperateWe Cooperate

We Have One AnotherWe Have One Another

Housing PricesHousing Prices

the economy and credit unions

stockmarket wealth

economic crisis

crisis consumers

normal times consumer

banking crises peak

banking crises trough

real gdp

global crisis

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