The recently announced acquisition of Nationwide Federal Credit Union by Nationwide Bank, with a premium to be paid to the credit union members, brings a whole new perspective to the credit union conversion issue.

Resident Fellow Alex J. Pollock

Most people think it is obvious that credit unions should be able to convert to saving bank charters if they want to, in spite of the obstruction and opposition of the National Credit Union Administration. This opposition is deep and ideological. It appears to have two sources: In some cases it doubtless reflects sincere belief; in other cases, it may simply mask the normal self-interest of any bureaucracy in protecting the size of its regulatory domain.

One of the most frequent arguments made against allowing credit unions to convert is that credit union members might lose their “ownership” of the mutual credit union. Let us even assume that the members’ “ownership” in an ongoing mutual has economic as opposed to ideological meaning (which may be questioned). As applied to the specific case of the credit union becoming a mutual savings bank, ipso facto another mutual, this argument has no force.

But the real objection is to the next step that may indeed occur: the subsequent conversion of the mutual savings bank to stock form. Then the ownership moves to the stockholders--who will include a large number of the former members, and every member will have had the right to become a stockholder. Is this a bad thing? Economically speaking, this right will most likely have been the most valuable element of membership.

In an ongoing mutual organization, what is the financial value of the much-discussed “ownership”? It can’t be sold. It has no market value. It can’t be redeemed. You can’t borrow against it. You can’t take it with you when you switch your account to another financial institution. Theoretically, you could get a distribution of any remaining net assets upon liquidation of the credit union, but if successful, it will never liquidate.

If it does liquidate, it will be because it is broke, and there will be nothing left to distribute. No accountant or lender would count among your assets any amount representing your mutual “ownership.”

The only possible conclusion is that the fair market value of this “ownership” is exactly zero.

Is there any way the “ownership” could come to have economic value? The answer is yes: through conversion of the mutual to a stock company. This will trigger rights to purchase stock for all the existing members, and these rights are definitely valuable. That is why sophisticated investors make deposits in mutuals which may be converted--in order to obtain such attractive rights. They want to co-invest with the ordinary members.

In the Nationwide case, there is a different and more obvious source of real economic value: Nationwide Bank will pay the members a cash premium. Will members like the idea of getting actual cash in exchange for the nebulous notion of being a mutual “owner”? They will indeed.

There is an interesting analogy here to the conversion of the bulk of the British mutual building societies to stock form during the last decade. Under British law, the member passbook holders, as members, were required to be paid a premium upon conversion. In a number of cases, the members themselves--consistent with giving their “ownership” some real value--demanded that reluctant boards and managements convert to stock banking companies.

Another analogy is to the conversion of mutual insurance companies to stock form, in which the policyholders, as participants in the mutual, receive stock or cash.

A related possibility has recently been proposed by James Wilcox of the University of California. He suggests that credit unions should be allowed to convert directly to banks in stock form, without having to go through the intermediate step of becoming a mutual savings bank, provided that all the credit union members receive stock. This is an interesting idea, but may not fit very harmoniously with the prevailing credit union ideology.

Any credit union wishing to have a smoother conversion to a savings bank charter should find a way--as Nationwide Bank has in a different version of the transition--to make the members’ “ownership” have economic value. This would be some kind of effective charter conversion premium, perhaps through a special dividend or the issuance of an appropriately designed security analogous to the Wilcox proposal.

The combination of an effective conversion premium--plus the value of potential stock purchase rights if the further conversion to stock form does occur--should favorably energize credit union members enough to easily overcome even the self-interested obstructionism of the NCUA.

Alex J. Pollock is a resident fellow at AEI.