Credit Unions in the US: Banking Profile
Executive Summary
- Credit unions began their life with a social good function.
- This is different than the profit maximization goals of most banks.
Introduction
What is little discussed is that the banking entities in the US with the highest ratings by their customers are not private banks but credit unions. Credit unions are community banks and unlike a standard private bank, credit unions are set up legally as non-profits. This means they pay back any profits they do accrue to their members. Credit unions are normally set up to serve a targeted customer base, like teachers in a region or the employees of a state. Under a situation where private banking was to be eliminated, credit unions are a likely outcome. However, once again, credit unions receive their money creation capability entirely from the government. And they charge interest rates. As has been explained in other entries, interest rates are only necessary when there is a private central bank and private banks. Credit union employees would be prime candidates to be rolled into a US government banking system.
The Reason for Credit Unions
Credit unions arose due to the limitations of traditional banks in serving the normal person. This is expressed in the following quotation.
Until the 1900s, most commercial banks serviced the wealthy. The poor and middle class (before such terms even existed) put their savings under their mattresses and, should they need credit, were left to the mercy of loan sharks. Eventually, alternative movements began to fill the void, and in time, the state blessed each. Banks with specific missions to help the poor overcame economic obstacles to challenge and ultimately reject the profit-motivated culture of mainstream banks.1 They were movements aimed at wage-workers, small farmers, and the unbanked—and their innovative structures would revolutionize the banking sector. But over time, and largely because of deregulation, these missions changed. Today, those banks once established for the purpose of helping the lower classes are practically indistinguishable from mainstream banks. It is one of the biggest losses of deregulation, and one that is universally ignored—the United States has lost its banks with souls. The credit union was based on the principle of cooperative credit: a group of people would pool their funds and lend them to group members on a rotation or based on need. This is essentially how traditional banks operated—pooling a community’s deposits and lending them out to the same community—but the traditional bank had an owner or shareholders making a profit from the interest paid on loans. Credit unions cut out the owners and the profits in order to serve the poor. Their motto was “Banks of the people, by the people, and for the people.” These cooperative credit unions started as a way to help European farmers purchase land after the breakdown of feudalism. In 1864, Friedrich Wilhelm Raiffeisen created the first one in Germany.
Source: How the Other Half Banks
https://www.amazon.com/How-Other-Half-Banks-Exploitation/dp/0674286065
What Was the Driving Force Behind the Credit Unions?
Though the United States never had a feudal system like Europe, the poor could only access credit through loan sharks and pawnshops that offered interest rates at up to 50 percent of the value of the loan. Many decried the injustices of the system as “legalized robbery.” Early credit union advocates thus aimed to bring “banking facilities to all classes—to the poor man as well as the rich man, to the workingman and the farmer as well as the manufacturer and capitalist.” In 1900, Alphonse Desjardins organized the first credit union in North America in Levis, Canada. Desjardins was frustrated by the lack of banking options for wage-earners in Canada and the high-rate lenders that dominated the market. As a journalist, he had been particularly moved by testimony he had heard while reporting on parliamentary hearings of a low-income worker who had been charged 1200 percent interest on a small loan. Desjardins began studying possible remedies to this growing problem and ran across a mention of the European credit union movement. He decided to start a cooperative, modeled after the German Raiffeisen credit unions, from his own home. He handled all the transactions himself and did not pay himself a salary. Membership was open to anyone in the community who was determined to be in “good standing,” and a committee of members decided which loans to make based on a person’s character and record of financial stability. Desjardins focused on small loans, which came from members’ deposits. During its first six years, the credit union made $200,000 in loans, with zero defaults, and actually earned modest profits, which it distributed to members as dividends. The close group dynamic was the reason behind the low default rate. With such a low default rate, the credit union didn’t need to charge high interest and thus, could successfully lend to the poor.9The credit union movement migrated to the United States a few years later. And its father would be Edward Albert Filene, the son of a Jewish immigrant and the owner of Filene’s department store. Filene was a fair and conscientious employer as well as a wealthy and curious philanthropist. In 1907, he traveled around the world and was shocked by the poverty he witnessed in India and the Philippines. His travels convinced him that these poor villagers needed adequate credit and the ability to own land. He was appalled that they had to borrow money at very high interest just to pay for special occasions, such as weddings.
Passing of the Credit Union Membership Access Act
Six months after the Supreme Court’s decision, Congress passed the Credit Union Membership Access Act (CUMAA)—with near unanimous support—to “ratify the longstanding policy of the [NCUA] with regard to [the] field of membership [in] Federal credit unions” by “specifically authoriz[ing] multiple common bond federal credit unions.” Most significantly, the act exempted credit unions from the Community Reinvestment Act, an act aimed at providing banking access to low-income individuals. The exemption resulted directly from credit union lobbying. To repeat, the credit union industry, created to serve the poor, now fought against a law requiring it to serve the poor.
Source: How the Other Half Banks
What Mainstream Private Banking Thought of Credit Unions
Credit unions were an ideological rejection of mainstream banking—a purposeful system of credit that favored the common good above profits, communities over institutions, and mutual control over hierarchy. The movement was a practical Populist response to the deep-seated antipathy toward concentrated power and control in banking that, by the 1900s, was one of the defining features of the United States. Bergengren built on the Populist rhetoric of the time when he described the credit union as “the schools for the masses” that would beget “financial democracy” or freedom from “the absolute control of those who … are using money solely for their own profit, without the requisite understanding that they have no right to use money except for the common good and social interest of all the people, and that the wholly selfish use of it will bring with it radical movements, revolution and war.” Bergengren was convinced that cooperatives were the way of the future and that “in the long run we cannot develop economic democracy on the principle of dog eat dog and the theory that the shrewdest, the most unscrupulous, the smartest of our number, should survive at the expense of all the rest of us.” He denounced Fascism and Communism, claiming that a truly democratic economy could only be achieved through cooperatives and the “principle of human brotherhood.”
Source: How the Other Half Banks
However, clearly, we are back to the principle of dog-eat-dog, and the shrewdest should survive at the expense of the rest.
How Credit Unions Used Information About Customers to Reduce Risk
A major proposal by payday lending stores is that they need to charge usurous interest rates to turn a profit. However, the early credit unions did not need to do this to be profitable. This is expressed in the following quotation.
Instead of charging high interest to offset the risk of default, the credit union used personal knowledge of an applicant and group supervision of a loan. Congress wrote this innovation into law to create “a cohesive association in which the members are known by the officers and by each other in order to ‘ensure both that those making lending decisions would know more about applicants and that borrowers would be more reluctant to default.’ ” This structure enabled “credit unions, unlike banks, [to] ‘loan on character.’ ” These founding principles allowed the credit union industry to thrive and help its members for many years. In 1935, only 3,372 credit unions existed across the country, with approximately 640,000 members. After the FCUA, the industry grew rapidly, with one hundred new credit unions and 6,000 new members joining each month. After World War II, from 1945 to 1955, the number of credit unions in the United States doubled (from 8,683 to 16,201), and membership tripled (from 2.8 million to 8.1 million).
Source: How the Other Half Banks
As time passed, US credit unions began to shed their original function and to move “up market,” and leaving behind lower-income customers. This is explained in the following quotation.
Today, credit unions are much like mainstream banks. The American Bankers Association argues that credit unions are not fulfilling their mission to serve the underserved.55 Of course, the banks are biased, but the assertion is not unfair. A 2006 Government Accountability Office study concluded that compared to banks, credit unions are more likely to serve middle- and upper-income people than lower-income people.56 Notably, some even claim that credit unions “come in and cherry-pick the most profitable [banking] business and then give nothing back to the community,” a practice far from the original mission of the cooperatives that Filene and then Roosevelt embraced. The lore of the credit union has outlived its reality. For many, the credit union still stands as the answer to everything that is wrong with banking. To be sure, credit unions do differ from banks. Though they are now quite large, none are as large as the Too-Big-to-Fail banks. In addition, their structure limits their appetite for risk. Credit union boards still consist of community members. Even though their mission is to make a profit, they are not willing to make profits at all costs.
Source: How the Other Half Banks
There is now doubt that credit unions are better than normal private banks, but as the quote explains they have diverged from their original purpose.