Socialize your money and join a credit union

The Thinker by Rodin

So I am at the Gold’s Gym listening to a Marketplace Money podcast. I am hearing all the details of the new credit card law freshly signed by President Obama this week. The law was certainly overdue, given the egregious ways banks lately have been unilaterally raising interest rates, changing credit card terms and tacking on usury fees.

To me the whole credit card debate was moot. I like millions of other Americans do not worry that much about my credit card interest rate or fees. Why? I get my credit card through my credit union. Its credit cards work just as well as the banks’ credit cards, but with better rates and less volatility. I don’t worry that much about my credit card interest rates going up or down because my credit union has no financial incentive to shaft me. This is because when I put money in the credit union, I become part owner of the credit union too. Credit union management is not going to want to tick me and the other members off that much because if they did I can petition that they be replaced. A credit union exists to serve my interests, not theirs.

Now, if I had an account at a bank, like Bank of America, I would merely be a customer. Bank of America would see me as a profit center. It would have every incentive to squeeze every possible dime out of me. Banks nationwide are trying to make up for declining profits and bad loans by squeezing their customers. Investing customers’ money is not very profitable anymore, but they can make customers pay more just so they can use money. Hence, the higher fees and interest rates on credit cards, as well as many other loans they may offer.

For about a quarter of a century my wife and I have put most of our working capital into credit unions. Would I close a credit union account and go with a bank instead? Hell no, not unless I had no other choice. I haven’t worked in the Pentagon since 1998 but I still belong to its credit union. In fact, my relationship with the Pentagon Federal Credit Union has deepened since I left. I not only have savings and checking accounts with them, I also have a personal credit card through them. My wife and I also have our home equity loan with them that we can draw on up to $100,000.  Our credit limit has remained unchanged even with all the financial uncertainty. We also have our mortgage with Pentagon Federal. The only downside is that I no longer want to visit a branch office, since it is twenty miles away. However, I can get my money out through no-fee ATM machines where I work or one a mile from my house. If I have checks to deposit, I just mail them in. It costs me a postage stamp and a couple days.

You may be thinking, “Credit unions are all right for you, because you work some place that offers a credit union. What about the rest of us?” In many communities, you still qualify for membership in one or more credit unions. Check it out. I live in Fairfax County in Virginia. Down the street is a local branch of the Fairfax County Federal Credit Union. What are its qualifications for joining? You simply have to live in Fairfax County.

What are you losing by joining a credit union as opposed to a bank? These days, you lose virtually nothing. Both banks and credit unions are fully insured, just by different institutions. (In fact, credit unions have been markedly more stable than banks during the current financial crisis, probably because they are better managed and more risk averse.) Some communities may not yet be served by a public credit union, so you may have little other choice than to put your money in a local bank. You may also have to drive out of your way to get to a credit union branch office. Banks can now offer brokerage services, although some credit unions have separate companies that also offer brokerage as well as real estate services. Bankers though have proved to be poor brokers, as witnessed by the recent stock market collapse. Most credit unions now offer services that you used to have to go to a bank to get, such as mortgages and home equity lines of credit. After more than twenty-five years of using credit unions, I can state that their checks, ATM and credit cards work just like the banks’.

For many of you, the only question may boil down to: do you want to socialize your money? You are not really socializing your money, but credit unions are similar in concept to a food cooperative. When you join a credit union, you are taking a philosophical stand that you should get maximum value for your money. You are betting that by pooling your money with others you will all make and save more money than you would at a bank, which these days is a very safe bet.

Here is how I look at it. Credit unions like banks really should not be where you put your long-term investments. Yet, some part of your money needs to be invested for the long term. Most of us do this through 401-K accounts through our employers, but many of us also need brokerage services so we can buy stocks, bonds and mutual funds. Long term investing is a different problem than having financial instruments to take care of our ordinary financial needs. Savings and checking accounts, credit cards, loans and mortgages are now just commodities. A credit union though offers a way to keep much more of your money while having access to all these financial instruments. My credit union, for example, does not charge any checking account fees, nor does it assess a charge for sending me a paper bank statement. If I use the right ATM, I do not have to pay for the privilege of withdrawing my own money either. I have no idea how much money I am saving compared to the bank you may be using, but I bet it amounts to hundreds of dollars a year. If you can too, then why would you want to give this money to a bank? Wouldn’t you rather do something else with your money?

Particularly in these turbulent financial times, if you have access to a credit union, consider joining. I expect your experience will be like mine and you will be wondering why you waited so long.

Where did all my money go?

The Thinker by Rodin

Those of you who dared to read your brokerage statements probably have the same question that I did. Where the heck did all my money go? Some of my mutual funds are worth half what they were two years ago. Given the current dropping stock market, I am likely to see further losses in many of my funds.

If I had put my money into AIG stock then yes, I would expect to be able to get just pennies on the dollar. However, I own mutual funds. The whole point of owning mutual funds is to spread out the risk. Some stocks in the portfolio are bound to suffer but it should not matter because other funds will gain. It should all balance out somehow.

The short answer is that the financial industry came down with a bad case of the flu. Pretty much all of them are in the hospital and are being pumped with fluids from the U.S. Treasury and the Federal Reserve Board in the hopes that they will recover. Then they can resume that voodoo that Wall Street used to do so well: showing regular returns for investors.

This begs the question: how did they all come down with the flu and the same time? Here too we sort of know the answers. As best this non-economist can figure out there were two root causes. First, the Federal Reserve Board under Alan Greenspan had a low inflation policy, even at the cost of keeping credit artificially cheap for unusual lengths of time. This had the effect of encouraging borrowing and made it possible for many of us to live far beyond our means. This helped facilitate the second root cause: ever more complex financial securities tied to cheap credit provided to risky borrowers. They became popular because they required no government review. They had the effect of hiding the risk of investing in these securities while giving the cash-rich places to invest money that would otherwise go under a mattress or earn next to nothing in a bank account. They looked reasonably safe because they were packaged like a mutual fund and thus presumed less risky.

Like someone whose diet consists of nothing but nachos and cheese dip, there is eventually a day of reckoning. One day you find your bowels obstructed, your blood pressure high and your cholesterol levels are through the roof. The world now has all this and more. We gorged ourselves mindlessly on bad debt. Our coaches (Congress, President Bush and the Federal Reserve) encouraged us to consume even more nachos and cheese dip. Now we weigh five hundred pounds and can hardly move from side to side in our hospital bed. In fact, the orderlies are having a hard time moving us to change our bedpans.

It is technically possible for a five hundred pound man to get back to a slim one hundred fifty pounds with a diet lasting many years, but the odds are heavily against the patient. Once you are used to a diet of nachos and cheese dip, it is hard to eat salads. You might think though that those who are providing us the food might be at least providing us with healthy food. As best I can tell, when it comes to the financial industry, with some caveats, the answer is you are allowed to serve as much junk food as you want.

I looked up what it took to establish a bank in Virginia, the state where I live. You definitely need a lot of starting capital. You also need five directors who set the bank’s policy. In addition, you need to hire a CEO. Virginia does not specify criteria for such a manager, although it suggests:

a suitable background and adequate training, a strong, well documented record of accomplishment in banking at a comparable level, a capacity for leadership, familiarity with the current banking environment, analytical ability, and a realistic outlook.

State chartered banks in Virginia also are required to undergo a “supervisory examination” no less than every three years. However, the state does not actually audit the bank. In fact, it goes out of its way to calm potential fears of the bank owners:

Although in some instances fraud has been discovered during the course of a supervisory examination, detecting dishonesty is not a primary purpose of an examination. An examination is concerned with a bank’s financial condition, its compliance with the various laws and regulations and the soundness of its operating policies; it cannot be relied on to detect fraud and embezzlement.

Presumably, before a bank charter is approved, Virginia will at least give it a sniff test to see if it smells, but it is clear that in Virginia’s case bank supervision is mostly superficial. Moreover, there are no requirements that I can find that the bank’s managers must have actual banking education. (I was hoping for something more than “I know how to use Quickbooks”.)  On the federal level, most banks choose to be FDIC insured. Presumably, this brings some federal scrutiny, but clearly not enough to keep many of these institutions solvent. Even if the criteria are clear, enforcement can be problematical. Moreover, as the Washington Post reported recently, banks can and do “shop around” for friendlier bank regulators. It suggested that the federal Office of Thrift Supervision is one of the more lax federal banking regulators.

If my limited research is correct, banks can be managed and run by people who aren’t necessarily even qualified bankers. Even if they have experience in banking, it is not clear that they need a level of certification to be a banker. I would think the criteria for any banker would include being an accredited Certified Public Accountant. Presumably, a banker needs to know more than a CPA and should have a broad understanding of financial risk, credit worthiness, assets to debt ratios and the like. Maybe they do but apparently, most were asleep during the lectures in MBA School, as they gorged their balance sheets with dubious toxic assets, which were never accurately valued. Given that so many banks are teetering on the edge of insolvency, it is reasonable to think the problem exists both nationwide and worldwide.

Banking regulation may be scattershot but at least it exists. On Wall Street, apparently all sorts of new and creative financial instruments can be created with no government oversight. The Securities and Exchange Commission has many powers, but Congress limits its powers (and budget). Indeed, until recently we wanted to free Wall Street from the tedium of government oversight. By doing so, it was believed that they would be free to whip up the magic of the free market. I understand that if you do not manage a herd of cattle they tend to overgraze or could come down with ailments like Mad Cow Disease. The same appears to be true on Wall Street. All things being equal, Wall Street will look for ways to line their own pockets first and their shareholders’ second. This appears to be exactly what happened.

Where did all my money (and yours) go? Much of it went to buy stocks and funds at prices that were way too high because they were not accurately and independently valued. Much of it also went into the pockets of swindlers on Wall Street who used the money to buy estates in the Hamptons, private jets, and luxury yachts. The federal government largely looked the other way. We investors largely looked the other way too, assuming that we were “safe” if we spread our risk by doing things like investing in mutual funds. However, primarily it was those we entrusted with managing our money that deliberately looked the other way. They were anxious for a big bonus for making quick profits rather than to looking out for the long-term needs of investors. Take my financial adviser. He is a bright guy. He knows how to find a good bet on a mutual fund. Nevertheless, he like most of them was clueless about the size and scope of our current financial disaster. He should not have been.

Supposedly, animals know when an earthquake is coming and move to safer ground. Our financial industry needs to be like this. Our bankers are fiduciaries of a public trust: our money. They should all be certified to the highest standards, maintain current credentials and demonstrate their financial acumen by showing that their funds are invested prudently. They should take an oath to such effect, go to prison if they do otherwise as well as have their personal wealth returned to their customers in the event they fail.

Similar criteria are needed for fund managers. Before creating any fund, they need to demonstrate to the government that the fund accurately states the risk of ownership. Rating firms similarly need to be impartial; in fact, they should be nationalized. Our money is too important to leave its valuation entirely in the hands of the free market.

In short, these investments belong to those who own them. Fund managers are fiduciaries with a solemn obligation to act prudently in the best interest of the owners. Funds are not funny money; they represent real dollars and reasonable expectations of future income. Since they deserve a high level of scrutiny and oversight, these fund managers need sterling credentials, certifications and regular oversight too. As for new financial instruments, they should get an impartial government examination before they are allowed on the market.

These are the sorts of long-term steps we need to take to ensure we are never caught with our financial pants down again. Anything less means that we will see similar debacles like this again.