An Analysis of Public Policy on Credit Union Select Employee Groups

Transcription

1 SPECIAL REPORT An Analysis of Public Policy on Credit Union Select Employee Groups Stephen A. Woodbury Michigan State University David M. Smith Michigan State University William A. Kelly, Jr. University of Wisconsin-Madison Filene Research Institute and The Center for Credit Union Research University of Wisconsin-Madison

2 Summary of Key Findings In a landmark case, the United States Court of Appeals for the District of Columbia Circuit ruled that a federally chartered credit union cannot serve more than one employee group. Locks Out 62.8 Million Workers As a result of the court s ruling, which is under appeal at this writing, U.S. government policy substantially limits the ability of 62.8 million employees of small and mid-sized organizations in the private sector to gain access to the services of federal credit unions. 1 A credit union requires a sufficient number of members if it is to be economically viable. A group of fewer than 500 employees is normally too small to establish its own federal credit union, and it must join with other employee groups if it is to have access to the services of a federal credit union. However, a current court ruling interprets the law as prohibiting federal credit unions from serving more than one employee group. The total number of U.S. workers affected by this ruling is substantial: 62% of the employed labor force in the private sector works for firms employing fewer than 500 workers. Reverses Intent of Federal Credit Union Act of 1934 On average, employees of small and mid-sized firms earn significantly lower wages and are much less likely to receive health and pension benefits than workers at large firms. Therefore, the court s decision effectively reverses one of the purposes of the Federal Credit Union Act, which is to provide people of modest means access to a national system of credit cooperatives. Discourages Customer-Owned Businesses We also find that the research literature on the ownership structure of firms indicates that public policy, in general, should not discourage or suppress the growth and development of noninvestor-owned businesses, including customerowned businesses. Professor Henry Hansmann, of the Yale Law School, has shown that such alternative ownership structures in many cases can be more economically efficient than investor ownership. Laws and regulations that deny employees of small and mid-sized organizations access to federal credit union services are discriminatory. Public policy fails to serve the public good when it arbitrarily restricts consumer access to non-investor-owned financial cooperatives. Background, Data and Analysis This report has two purposes: (1) to evaluate the implications of a recent court interpretation of the Federal Credit Union Act with regard to select employee groups (SEGs), and (2) to make public policy recommendations based on our economic analysis. Background Prior to 1934, traditional financial institutions typically did not extend credit to the average American. The Federal Credit Union Act became law in 1934 and provides for a national system of credit cooperatives to serve people who had little access to credit. This act permitted consumer banks that are organized as depositors cooperatives 2 to operate under a federal charter. The Act also provided that credit unions serve members with a common bond. Select Employee Groups In addition to their original core membership, many credit unions in the U.S. have one or more select employee groups (SEGs) in their field of membership. 3 A SEG is a group of people in a credit union s field of membership who share a common bond, usually based on employment. About 3,600 federal credit unions in the U.S. have at least one select employee group. Among these 3,600, the average credit union has 40 SEGs with an average of 72 members per SEG. 4 Altogether, members in these SEGs constitute approximately 10.5 million of the 44.2 million federal credit union members. 5 SEGs were created in 1982, when the federal regulator of credit unions, the National Credit Union Administration (NCUA), adopted a more liberal interpretation of the language of the Federal Credit 1 Copyright 1997 by Filene Research Institute

3 Union Act. 6 This interpretation allowed federally chartered credit unions to have more than one group; these groups could be unrelated, as long as each group had its own common bond. The immediate impetus for this change was to reduce the cost of resolving insolvent credit unions by merging them with suitable partners without identical common bonds. However, NCUA had an additional motive: a credit union can diversify its loan portfolio and manage economic risks much more effectively if its membership is not restricted to a single group. In the fourteen years after NCUA revised its interpretation of the common bond, the percentage of federal credit union members in SEGs has risen to 23.8% of all federal credit union members in the U.S. 7 On average, the proportion of federal credit union members accounted for by SEGs has grown by about 1.7% annually since Current Legal Status of SEGs In July of 1996, the U.S. Court of Appeals for the District of Columbia Circuit ruled that the NCUA s 1982 interpretation of the law was invalid. Therefore, public policy in the U.S. now prohibits a federal credit union from adding SEGs to its membership base. As of this writing, the Circuit Court s ruling has been appealed to the Supreme Court, and it is likely that this issue will be addressed by Congress as well. Economic Status of Workers by Size of Employer On average, large firms pay higher wages and salaries and more often provide health insurance and pension benefits than do smaller firms. Figures 1 and 2 display data from the March 1996 Current Population Survey (CPS), which the Bureau of the Census conducts each month by interviewing about 50,000 households. 8 Figure 1 shows that employees of firms with 1-9 workers, on average, earn $0.68 for every $1.00 earned by employees of firms with 500 or more workers. This data is by firm, rather than by establishment. Figure 2 shows that employees at these larger firms earn, on average, about $10,000 more annually than do employees in the smallest firms. 9 2

4 Benefit coverage also varies with firm size. Workers at firms with over 500 employees are nearly three times as likely to have health insurance coverage 10 based on their employment than are workers at firms with 1-9 employees. Workers at the larger firms are six times as likely to be included in an employer or union sponsored plan 11 (Figure 3). Finally, the number of workers at small firms is large. Workers at firms with 1-9 employees comprise about one-fourth of the employed labor force, and workers at firms with less than 500 employees make up million, or 62%, of all private sector workers (Figure 4 and Table). Figures 1-4 show a clear relationship between firm size and compensation. Clearly, employees have better pay and benefits, on average, as the size of their employer increases. Chartering Guidelines One of the purposes of the Federal Credit Union Act is to provide credit for people of modest means. However, the current chartering manual of the federal regulatory authority (the National Credit Union Administration) specifies 500 people as the recommended minimum for the number of people in a group applying for a credit union charter. 12 In the more successful cases, about 40% of eligible members ultimately join a credit union, which would be 200 members from a group of 500. Experience indicates that under modern economic conditions, this is a realistic minimum size for a Firm Size Category* Table Sub-total (<500) Total Number of Workers (Millions) * Number of employees. Source: Current Population Survey, March 1996, Bureau of the Census. newly chartered credit union in order to be a viable business. For example, among existing federal credit unions, those with 200 or fewer members contain less than 0.2% of all federal credit union members. 13 This size guideline for new charters means that workers at a firm with 500 or more employees could form their own credit union if they want to have access to credit union services. For this group, which constitutes 38% of the employed population, a judicial or legislative prohibition of SEGs would still leave an option for them to become members of an employee-based federal credit union. However, for the remaining 62% of workers, those at firms with fewer than 500 employees, a new credit union charter is not a viable option. Therefore, current policy, which prohibits federal credit unions from adding SEGs, effectively discriminates against this group of workers, which on average has significantly lower pay and benefits than employees of larger firms. Ironically, this is the group people of modest means which the Federal Credit Union Act intended to have credit unions serve. Workers in these smaller firms still might have access to federal credit union membership through family members who work for larger firms or through communitywide charters in some locales. However, the primary avenue for them to have credit union services the place of employment would be largely closed to them under current policy, which prohibits SEGs. 3

5 The Role of Ownership Structure Professor Henry Hansmann of Yale University notes that a market economy typically exhibits a wide variety of ownership structures, including customer-owned enterprises, of which credit unions constitute one example. Further, the use of alternative ownership structures tends to grow more rapidly in more advanced economies. Since these are often neglected points, we quote at some length: We tend to take it for granted that, in the absence of government intervention, largescale enterprise will be organized in the form of investor-owned firms... Yet investor ownership is not a logically necessary concomitant of free markets and free enterprise. Rather, it is quite contingent, a form of organization that is often but not always dominant given current technologies. Even in the United States, the world s greatest exemplar of corporate capitalism, noninvestor-owned enterprise plays a prominent role in many important industries... The United States is not unusual in this regard. Non-investor-owned enterprise plays a similarly large role in other developed market economies. That role is continuing to expand, and is conspicuously larger in advanced economies than it is in less-developed economies. In evaluating the role of credit unions in particular, Professor Hansmann observes: Credit unions are consumer banks that are organized as depositors cooperatives... Credit unions play a role similar to that played by the original MSLAs (Mutual Savings and Loan Associations): they provide their members with better access to credit than could be obtained from an investor-owned bank. 15 In his economic analysis of credit unions, Professor Hansmann points out that using the place of employment as a common bond produces a number of economic efficiencies: Employment at the same place of work the most usual common bond is evidently an effective means not only of avoiding moral hazard on the part of borrowers, but also of lowering the transaction costs of banking. A workplace-based bank has good access to information about prospective borrowers creditworthiness (through the employee s reputation with fellow employees and with the employer); it has a convenient means of securing repayment (through payroll deductions); and it has effective policing mechanisms (through social pressure from fellow employees and sanctions from the employer). 16 Employers can also benefit from having a credit union for their employees. The credit union ties the employees more tightly to the employer, improves the employees financial situation (and consequently their effective wage), and helps keep the employees out of financial difficulties that may interfere with their work or create bother for the employer (such as garnishment of wages). For these reasons employers have often helped promote the formation of credit unions, for example, by providing free office space and free time off to the employees who administer them. Indeed, Edward Filene, the Boston department store magnate, was the first great advocate of credit unions in the United States and was instrumental in the adoption of the 1909 Massachusetts credit union statute. 17 Despite these economic efficiencies generated by the ownership structure of credit unions, and of employment-based credit unions in particular, the current status of public policy is, in effect, to prohibit their use at firms with less than 500 employees. 18 Public Policy Implications Sixty-two percent of employed Americans work at firms whose relatively small size effectively prohibits them from sponsoring a federal credit union for their employees. On average, these employees earn less, and have fewer benefits, than do employees at larger firms. Therefore, the 1996 judicial ruling has the practical result of denying federal credit union access to groups of workers who, on average, have wages and benefits at the lower to lower middle end of the economic spectrum. At the same time it permits federal credit union access to groups of workers who on average have wages, salaries and benefits at the middle to upper middle end of the spectrum. The Federal Credit Union Act, however, states one of its purposes as follows:...to make more available to people of small means credit for provident purposes through a national system of cooperative credit... [emphasis added] 19 4

6 Though the Act has been amended numerous times, the language cited above has remained continuously in the Act since its adoption in This suggests that the original intent of the Act has remained constant. We note two key points based on this citation: 1. The practical effect of current public policy is to reverse one of the purposes of the Federal Credit Union Act. 2. The language of the act envisions a national system of cooperative credit, which implies an expansive rather than a restrictive intent of the availability of credit union services. What Should Public Policy Be? Professor Hansmann observes that free market economies exhibit many types of ownership structures, and that the use of non-investor-owned structures is increasing in all advanced market economies, not just in the United States. In his work he seeks to illuminate the roles that alternative forms of ownership can and should play He attributes the existence and growth of non-investorowned businesses primarily to the roles which transactions costs and information costs play in determining economically efficient organizational structures. Nothing in his analysis suggests that public policy should limit the use of alternative ownership structures. Indeed, the clear implication of Hansmann s work is that legislative or regulatory suppression of non-investor-owned enterprises would reduce the ability of a market economy to deliver goods and services in the most efficient way. Within that framework, an arbitrary prohibition on how a credit union selects its membership base would be an inappropriate government policy. Conclusions Credit unions are depositor-owned cooperatives, and represent an ownership structure with a valid and legitimate role to play in the market economy of the U.S. as well as in many other countries. The theory of ownership structure provides an established conceptual point of view through which the value of credit unions, as well as other non-investor-owned entities, is recognized as a means to deliver goods and services in a market economy. Investor-owned businesses are the most common, but are not always the most efficient or the only efficient means of organizing ownership structure. As such, public policy should not arbitrarily restrict the development and growth of credit unions or other businesses with an ownership structure different from investorownership. The 1996 court ruling interprets the law in a way which establishes a policy that is intrinsically in error. It restricts access to federal credit unions by prohibiting select employee groups. Moreover, it discriminates against people of modest means, which is the very group that the Federal Credit Union Act was designed to help. By creating a disproportionate denial of access to federal credit union services for the 62% of workers who hold jobs at firms with less than 500 employees, the current prohibition on SEGs reverses the intent of the Federal Credit Union Act. 5

7 Endnotes 1. Since the existing court ruling in this case is still pending within the courts, one could argue that the ruling is not policy. However, until the issue is resolved either judicially or legislatively, it has the practical effect of being policy. 2. Hansmann uses this term to describe credit unions in the context of their ownership structure. Henry Hansmann. The Ownership of Enterprise. Cambridge, Mass.: The Belknap Press of Harvard University Press, 1996, page These additional groups are generally referred to as SEGs, because they are usually employee groups; however, in some cases they may be groups that have a common bond of association or locale. 4. Source: Economics and Statistics Department, Credit Union National Association. 5. December 1996 data. Sources: National Credit Union Administration and Department of Economics and Statistics, Credit Union National Association. 6. The Federal Credit Union Act became law in 1934 to allow for federal chartering of credit unions. 7. The figure for total membership in federal credit unions is from an estimate as of December 1996, from the Economics and Statistics Department, Credit Union National Association. 8. The sample of households interviewed for the CPS is selected in order to represent the population of the U.S. aged 16 and older. The figures presented in this report are based on workers with 1995 earnings who were aged 18 or older and employed in the private sector. 9. For simplicity of exposition, these numbers are descriptive tabulations, rather than adjusted estimates from a wage equation in which some measure of compensation is the independent variable. However, estimates based on compensation equations give essentially the same results. A technical appendix is available from the authors on request. 10. Offered by their employer or union. 11. See note NCUA Chartering and Field of Membership Manual, Revised 7/94, Section 1, page 12. In practice, NCUA prefers to have 2,000 or more, and seldom approves charters for groups as small as Source: NCUA, June 1996 data. 14. Hansmann, pages Hansmann, page The social pressure which Hansmann refers to could be less effective if a large number of multiple groups meant that the borrower was less acquainted with other members. 17. Hansmann, pages In practice, the prohibition usually would extend to firms with fewer than 2,000 employees. See note Federal Credit Union Act, Title 12, Chapter 14, Section 1751, of the United States Code, as revised November Hansmann, page 2. About the Authors Stephen A. Woodbury a labor economist, is Professor of Economics, Michigan State University. He is the co-author of the book, The Tax Treatment of Fringe Benefits. His articles have appeared in the Journal of Labor Economics, Review of Economics and Statistics, Research in Labor Economics, American Economic Review, and Journal of Economic Issues. David M. Smith a researcher in the Department of Economics at Michigan State University, specializes in labor economics and demography. William A. Kelly, Jr. is Director of the Center for Credit Union Research, School of Business, University of Wisconsin-Madison. This report is published by the Filene Research Institute in cooperation with the Center for Credit Union Research, School of Business, University of Wisconsin-Madison. The Filene Research Institute is a nonprofit organization dedicated to scientific and thoughtful analysis of issues affecting the future of consumer finance and credit unions. In addition to conducting research, the Center for Credit Union Research supervises Filene Research Institute projects at other universities and institutions. 6

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