As Congress wrangles over financial reform efforts, the failure and federal rescue of Eastern Financial Florida Credit Union is being used to bolster the case that banks that take deposits from consumers that are insured by the federal government should be prevented from dealing in complex securities.
In a column in a recent Sunday New York Times, Gretchen Morgenson discussed the National Credit Union Administration’s post-mortem on the credit union, which cost the National Credit Union Share Insurance Fund an estimated $40 million.
When Wall Street is accused — as it has been so often these days — of selling risky products to unwitting customers, it usually argues that investors in such exotic stuff are sophisticated adults capable of assessing any hidden dangers.
So it goes with collateralized debt obligations, or C.D.O.’s, which are bonds, loans and other assets that the Street pools together and sells as packages of securities. Purveyors of C.D.O.’s maintain that buyers who lost billions in these mortgage-related instruments were, of course, sophisticated.
The Miramar-based credit union invested in CDOs, but was not very sophisticated, according to the report prepared by the NCUA’s inspector general. The report says the credit union’s board “ignored sound risk management principles” by, among other things, “exposing the credit union’s net worth to a significant amount of risk due to investments in complex Collateralized Debt Obligations (CDOs) without management and the Board having sufficient expertise to understand and manage the risk of the CDOs.”
The credit union purchased nearly $150 million worth of collateralized debt obligations, the bundles of risky mortgages at the heart of the financial crisis, including just under $95 million in early 2007, soon before the collapse of the housing bubble. By the time the credit union was absorbed by Space Coast Credit Union in 2009, the credit union had “essentially charged off” its entire CDO portfolio, “resulting in losses of 149.2 million.”
Read the full report:
From the Morgenson column:
“This situation illustrates yet again why over-the-counter securities and derivatives are not suitable for federally insured banks and other ‘soft’ institutional clients,” said Christopher Whalen, editor of The Institutional Risk Analyst. “Wall Street securities dealers who knowingly cause losses to federally insured depositories should go to jail.”
Credit unions are nonprofit entities and typically do not engage in the risky investing that bank executives did during the credit bubble. Federal credit unions are also limited in the types of securities they can buy. While they can purchase mortgage-backed securities, they are barred from buying C.D.O.’s.
State-chartered credit unions have more leeway to invest in exotic instruments if their home states allow it. Florida, California and Michigan are three such states. But according to the National Credit Union Administration, less than 1 percent of all credit union investments fall into the exotic category.