Congress and the Obama Administration have less than a month to reach an agreement that prevents America's economy from tumbling over the so-called "fiscal cliff." While credit unions outperformed banks and other parts of the financial sector during the Great Recession, some CUs will feel outsized negative impacts if we go over the cliff.
Recent evidence indicates the economy is starting to gain some traction. Unemployment remains at 8%, home prices are stabilizing and consumer confidence has reached its highest level in more than four years. The fiscal cliff threatens to derail the recovery, increase unemployment and hurt CUs and their members.
The term "fiscal cliff" has become shorthand for a set of tax increases and spending cuts that will begin in 2013 unless Congress acts. The tax provisions include the expiration of tax cuts put in place in 2001 and 2003 and then extended and enhanced in 2010. This includes a partial payroll tax holiday. The expiration will affect rates of federal income, payroll, and other taxes. At the same time, automatic cuts to federal spending-part of the 2011 federal debt ceiling legislation-are scheduled to begin next year. The expiring tax cuts, revenue increases and spending cuts amount to somewhat more than $500 billion.
If fully implemented, the fiscal restraint measures cut the near-term budget deficit by about 30 percent. Ironically, they will have little impact on drivers of the nation’s longer-term budget problems but will have a dramatic, immediate, and negative effect on the economy. The Congressional Budget Office estimates GDP will contract by 0.5 percent in 2013 if the fiscal restraint in current law is implemented. This compares to projected GDP growth of about 1.7 percent in CBO’s non-fiscal restraint scenario. The CBO forecasts an unemployment rate 1.1 percentage points higher. Even if a deal is struck, there may be a negative impact of the economy. Just Friday, preliminary data from the Reuters/University of Michigan consumer sentiment survey suggest consumer optimism sank in early December reflecting rising concerns about the looming fiscal cliff. The index also fell in the summer of 2011 during the height of the debate over raising the federal debt limit.
Recessions are difficult for CUs and their members. Consumer credit unions performed well relative to banks during the Great Recession and continued lending in 2007 and 2008 while banks were reducing credit. Even now, aggregate CU mortgage delinquencies are a fraction of delinquencies in the overall system, and membership and deposits are growing rapidly. Much of this relatively good performance can be attributed to the credit union business model and business practices.
However, this business model increases some credit unions' vulnerability if budget cuts lead to an economic downturn. Slower economic growth and higher unemployment will hurt loan growth, raising delinquencies and generally compressing credit union earnings. A potential decline in consumer confidence-in part reflecting slumping stock prices-similar to what happened during the 2011 debt ceiling stalemate, will also hit credit unions' bottom lines.
The fiscal cliff raises additional concerns for some credit unions because of FOM restrictions. About 17% of all federal charters are government or military charters, and another 11% are education charters. Overall, 28% of federal charters have an FOM that is in some way related to government employment and these credit unions represent 41% of total credit union assets. Not included here are other credit unions associated with government contracting, especially defense contractors, who also face important risks. The map in the chart shows that the share of assets associated with government-linked credit unions varies by state, indicating that potential impact could be strong in some.
Avoiding the fiscal cliff and making meaningful progress toward long-term budget sustainability is a critical priority. Failure to avoid dramatic cuts in 2013 government spending and hikes in tax rates will have widespread negative effects, many of which will directly hurt the credit union sector.
John Worth is chief economist with NCUA, Alexandria, Va.