In the aftermath of the financial crisis of 2007-2009, the U.S. Congress created the Financial Stability Oversight Council (FSOC – pronounced “F-Sock”)—a panel of the heads of the U.S. regulatory agencies—“to identify risks to the financial stability of the United States”; “to promote market discipline” by eliminating expectations of government bailouts; and “to respond to emerging threats” to financial stability.
Despite these complex and critical objectives, the law limited FSOC’s authority to the designation of: (1) specific nonbanks as systemically important financial intermediaries (SIFIs), and; (2) critical payments, clearance and settlement firms as financial market utilities (FMUs). Nonbank SIFIs are then supervised by the Federal Reserve, which imposes stricter scrutiny on them (as it does for large banks), while FMUs are jointly overseen by the Fed and the relevant market regulators.
At the peak of its activity in 2013-14, the FSOC designated four nonbanks as SIFIs: AIG, GE Capital, MetLife, and Prudential Insurance. Following the Council’s October 16 rescission of the Prudential designation, there are no longer any nonbank SIFIs. Not only that, but by making a future designation highly unlikely, Treasury and FSOC have undermined the deterrence effect of the FSOC’s SIFI authority. In short, by taking the sock out of FSOC, recent actions seriously weaken the post-crisis apparatus for securing U.S. (and global) financial stability. In the remainder of this post we review the Treasury’s revised approach to SIFI designation in the context of the Prudential rescission…. Read More
In response to the financial crisis of 2007-2009, Congress created the Financial Stability Oversight Council (FSOC), a committee of the chiefs of the U.S. regulatory agencies, chaired by the Treasury Secretary, to monitor and secure the stability of the financial system. Critical to this task is the FSOC’s authority to designate nonbanks as “systemically important financial institutions” (SIFIs).
On November 17, the U.S. Treasury issued a report assessing the FSOC’s designation process. Treasury calls on the FSOC to adopt a strategy that prioritizes the regulation of activities or functions—affecting whole sectors of the financial industry—over regulation based on entity or legal form (such as the designation authority). For the most part, we find this sensible, as this focus reduces the scope for regulatory arbitrage that an entities-only approach may foster (see here).
However, we doubt that activities-based regulation alone will be sufficient to limit systemic risk. Our overall conclusion is that the Treasury’s approach sets the bar for FSOC designation too high, diminishing its deterrence effect on undesignated nonbanks. In the end, a sensible focus on both entities and activities is needed to fulfill one of FSOC’s key objectives—to restore market discipline. Adopting the Treasury’s proposed framework will not meet the goal, set out in the President’s Core Principles for Regulating the U.S. Financial system (see Executive Order 13772), of preventing taxpayer-funded bailouts.... Read More
Last week, a Federal District Court overturned the Financial Stability Oversight Council’s (FSOC) designation of MetLife—the nation’s largest insurer by assets—as a systemically important financial intermediary (SIFI). Until the Court unseals this decision, we won’t know why. If the ruling is based on narrow grounds that the FSOC can readily address, it will have little impact on long-run prospects for U.S. financial stability.
However, if the Court has materially raised the hurdle to SIFI designation—and if its ruling holds up on appeal—“too big to fail” nonbanks could again loom large in future financial crises, making them both more likely and more damaging... Read More