Public Citizen letter on SIFI designation

Letter to Financial Stability Oversight Council

June 26, 2023

 

The Honorable Janet Yellen, Chair,

Financial Stability Oversight Council,

Attn: Eric Froman

1500 Pennsylvania Avenue NW

Room 2308,

Washington, DC
20220

 

Authority To Require Supervision and Regulation of Certain Nonbank Financial Companies

RIN 4030

 

Dear Chair Yellen, members of the Financial Stability Oversight Council,

On behalf of more than 500,000 members and supporters of Public Citizen, we provide the following comment on the authority of the Financial Stability Oversight Council to require supervision and regulation of certain nonbank financial companies.[1]

Among the most instructive, albeit painful, lessons that Congress and regulators learned from the 2008 financial crisis is that the failure of certain large financial institutions that are not regulated banks can lead to systemic repercussions. The largest failure of 2008 was that of insurance giant AIG.[2] It wrote a type of bond insurance called credit default swaps. When the mortgage bonds against which AIG underwrote those swaps defaulted in droves, AIG was unable to make good on the claims. The government directed $165 billion in taxpayer dollars to make up the difference.[3] One reason AIG was able to build up this portfolio of unsupportable swap contracts without detection was that, as an insurance company, it was not subject to federal oversight.

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act repaired this supervisory oversight by establishing the Financial Stability Oversight Council (FSOC) Congress assigned FSOC to look for cracks in regulatory oversight. Congress further authorized FSOC to designate any institution as “systemically important,” where its failure would cause systemic repercussions. Statutorily, these are known as “systemically important financial institutions,” or “SIFIs.” Importantly, such designation is not triggered if the  institution falters or fails; rather, they are designated if it is understood that their failure would cause system-wide problems. (The statute declares that a firm shall be designated a SIFI where material financial distress at a firm “could pose a threat” to US financial stability.)

The Obama administration’s Treasury Department designated several firms as SIFIs. The Trump administration’s Treasury Department abruptly dropped these designations. Worse, the Trump Treasury intentionally complicated the procedures by which designation takes place.

With this newly proposed guidance, the Biden administration’s Treasury Department returns procedures to the precautionary status that Congress established with the statute.

The Proposed Guidance seeks to establish what the regulators call “a durable process” for FSOC to designate nonbank financial companies as SIFIs. FSOC adopted guidance in 2012, but this was before it had actually designated any institution. It now has experience, which informs this guidance. The 2019 Trump guidance muddied the waters and created inappropriate hurdles.

This proposal includes three changes. First, it eliminates a statement from the Trump 2019 document that calls for reliance on federal and state regulators to address risks before FSOC considers designation. That 2019 statement ignores the AIG experience, where state regulators failed to identify the risk build up in the insurance giant.

Second, FSOC proposes an analytic framework that includes risks that are either widespread or restricted to a single entity. This includes more public transparency in how FSOC operates.

Third, this proposal drops the 2019 cost-benefit analysis requirement. Dodd-Frank does not require cost-benefit analysis. Industry has long complained that FSOC should not designate a firm that’s not experiencing distress, which they identify as a cost. But the statute explicitly states that current distress is irrelevant. The point is to monitor firms whose failure could cause problems. AIG showed excellent profits before the mortgage meltdown.

Since the 2008 financial crisis, industry has changed. Most mortgages now are issued by non-banks. Private equity is much larger. Blackstone and Blackrock are giant financial institutions; BlackRock manages nearly $9 trillion in assets.[4] The Citadel hedge fund controls more than $62 billion in assets.[5] Clearly, failure of such firms would be traumatic. FSOC should be empowered to designate such firms.

Public Citizen enthusiastically supports this new guidance as a sober precaution. We should not be subject to the shock of a firm once considered stable that suddenly fails for lack of sound supervision.

For questions, please contact  Bartlett Naylor at bnaylor@citizen.org.

 

Sincerely,

 

Public Citizen

[1] Financial Stability Oversight Council, Authority To Require Supervision and Regulation of Certain Nonbank
Financial Companies, Federal Register (April 28, 2023) https://home.treasury.gov/system/files/261/FSOC-2023-Proposed-Nonbanks-Guidance.pdf

[2] Adam Davidson, How AIG Fell Apart, Reuters (Sept. 18, 2008) https://www.reuters.com/article/us-how-aig-fell-apart-idUSMAR85972720080918

[3] David Sirota, Meltdown, Audible (2022) https://www.audible.com/pd/Meltdown-Podcast/B09J733SQR

[4] BlackRock, Annual Report, Securities and Exchange Commission (2022) https://www.sec.gov/ix?doc=/Archives/edgar/data/1364742/000095017023004343/blk-20221231.htm

[5] RIP the Cult of the Tiger Cub, Financial Times (Jan. 23, 2023)