Charter Conversions In Context

A robust financial system should have a variety of financial institution charter options, by type-such as a commercial bank, thrift, credit union; chartering jurisdiction-state or federal; and organizational form- stock corporation or mutual.

It should also provide for the ready ability to move from one option to another, for example, from commercial bank to thrift, from state to federal charter, and, yes, from mutual to corporate form. It should be relatively easy for new competitors to be chartered and enter the market, just as for existing competitors to change charters as circumstances and strategies change. No regulator should be able to prevent an institution from leaving its regulatory domain. This is a required feature in a highly regulated system to protect the core democratic principle of checks and balances. No one, including regulators, should be granted a monopoly.

In addition, we must remember that the depository institutions of all kinds are only one part, and represent indeed a minority of the assets, of the larger money, credit and capital markets which constitute the wider financial system. Depositories need strategic flexibility if they are to compete.

With these ideas as starting point, of course I favor the ability of credit unions to convert to savings bank charters and to stock corporations, if that is their choice, and think it is essential that the NCUA should not be able to prevent them from doing so.

The question of credit union conversions seems to me an interesting issue in financial policy. But what really intrigues me about it is that, while most people would consider it a pretty obscure and technical issue, it engenders debates with a remarkable level of emotion and rhetoric.

So much so, that the opponents of conversions are not content to say, which would be eminently reasonable, "I do not wish to convert my credit union to a savings bank." They go on to a more strident position: "I don't want to let you convert your credit union!"

Why should this be? There are approximately 8,800 credit unions in the United States, according to the CUNA Mid-Year 2006 Report. If 100 of them converted to savings banks, there would be 8,700 credit unions.

If 500 converted, there would still be 8,300. Why is this so threatening?

Mutual or cooperative associations have a long history as part of the financial system. When demutualizations or conversions to stock corporations occur as they have around the world, they generate some classic questions: Who owns a mutual? What does "ownership" of a mutual even mean? Who should benefit from a conversion? These classic questions are very much alive in current credit union debates.

Take the question of the "ownership" of the equity of a mutual by its members. Whatever else you may say about it, it is certainly not ownership in any ordinary sense.

The members cannot sell what they are said to own, or pledge it to secure borrowings, or take it with them if they move their account to another financial institution. It cannot count among their assets and its fair market value is zero.

Members are not treated as owners for purposes of disclosure of executive compensation. The U.S. Government Accountability Office has recently pointed out this lack of transparency concerning credit union executive pay.

However, membership does convey a notable financial option: the right to buy stock on a priority basis should there be a conversion to corporate stock form. Upon such a conversion, every member has the priority right to buy stock at the IPO price before any outside investors can. Economically speaking, this right will most likely be a very valuable element of membership.

Many people resent the idea that speculators become members of mutual organizations in order to profit from buying stock upon conversion. This resentment is understandable, but here is a key point: the speculators' action confirms the economic value of the option automatically held by the ordinary members.

The members who buy stock in conversions at the usually attractive IPO price can profit from what is now their ownership in the normal sense. I believe it should be made as convenient as possible for members to buy stock in small amounts, as appropriate to their circumstances.

Although it is currently not permitted under OTS regulations, I further believe that it should be possible for members of a converting mutual association to be issued negotiable preemptive rights to purchase the stock. If the members do not wish to exercise these rights, they could sell them in the market and realize their value.

A similar idea is that in British mutual building society conversions, members are paid a premium representing their membership interest.

In short, the financial system in general should promote charter flexibility, and in mutual to stock conversions, the members should benefit from their priority right to become stockholders.

Alex J. Pollock is a Resident Fellow at the American Enterprise Institute in Washington, D.C.