September 15, 2014

In Praise of FSOC

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Bankers pulled over for speeding can depend on certain government officials to try to get their tickets cleared: a set of Republicans on the House Financial Services Committee. Bankers whose business model depends on unfair, deceptive and abusive practices have found rhetorical comfort, if not actual relief, from repeated efforts by the committee to disable the Consumer Financial Protection Bureau (the hallmark creation of the Dodd-Frank reform law).

Now, another creation of this Dodd-Frank law meant to check unsafe banking has come under fire from these same Republicans: the Financial Stability Oversight Council (FSOC). On September 17, the panel’s Subcommittee on Oversight and Investigations will engage in a ritual grilling. This ritual will then likely serve to buttress legislation the House will approve on largely partisan lines to disable the FSOC. (There are some Democrats who want bankers to think they’ll try to fix their traffic tickets as well.)

What is FSOC? Why should Americans and responsible members of Congress care?

The Council is a collaboration of top financial regulators with 10 voting members, made up of the:

1. Secretary of the Treasury (chairs the Council),
2. Chair of the Federal Reserve,
3. Comptroller of the Currency,
4. Director of the Consumer Financial Protection Bureau,
5. Chair of the U.S. Securities and Exchange Commission,
6. Chair of the Federal Deposit Insurance Corporation,
7. Chair of the Commodity Futures Trading Commission,
8. Director of the Federal Housing Finance Agency,
9. Chairman of the National Credit Union Administration Board, and
10. an independent member (with insurance expertise) appointed by the President

These regulators meet to discuss emerging problems and recommend actions that would be taken by specific regulators.

Here are some of the benefits of FSOC:

• Addressing fragmented supervision: There are state banks and national banks, with 50 separate regulators for the former, and a different regulator for the latter. If a bank is owned by a bank holding company, that’s under the purview of still another regulator. If the bank holding company owns a broker/dealer such as Merrill Lynch, that’s overseen by another regulator. And another regulator oversees firms that engage in commodity futures. Credit unions, of course, have their own regulator. The FSOC attempts to take a holistic view.
• Helps address gaps: Current regulators are responsible for parts of the financial industry. But the 2008 crash demonstrated that contagion spread from one sector to another. For example, when AIG’s financial products division, supervised by the Office of Thrift Supervision, found itself unable to pay claims on credit default swaps, the problem harmed many banks and broker/dealers making those claims, which were supervised by other regulators. In conceiving the Council, the President explained that it would ‘‘bring together regulators across markets to coordinate and share information, to identify gaps in regulation, and to tackle issues that don’t fit neatly into an organizational chart.’’
• Early warning: The FSOC must identify emerging problems. Its annual report serves as a warning discipline. In the midst of the booming market during the inflation of the house bubble, regulators were either complacent or loath to publicize potential problems. The annual report must contain areas that the Council considers concerning.
• Helps with inter-regulator information: Financial deregulation allowed firms to engage in multiple activities that were once prohibited at a single firm. Yet the regulatory system did not change. As a consequence, one regulator might examine one business at a firm and another regulator might examine another business with little coordination or information sharing. FSOC can help address problems that arise from such parallel oversight.
• Help combat regulatory arbitrage: Financial firms must structure their products to secure supervision from regulators believed to be less rigorous. Such arbitrage played out during the savings-and-loan crisis when developers found that the regulator relaxed standards for lending. The FSOC can recommend better regulations for certain agencies.
• Help press regulators to reform markets? If a regulator is perceived as lax, the FSOC can make recommendations. Already, under direction from the FSOC, the Securities and Exchange Commission finalized rules to strengthen money market funds, where investor runs during the 2008 crisis led to seizure in short-term funding for business provided by these funds.
• FSOC can break up the mega-banks: The Council plays a significant role in determining whether action should be taken to break up those firms that pose a “grave threat” to the financial stability of the United States.
• FSOC can designate non-banks for special supervision: Some firms that fall outside of traditional banking may nevertheless contribute to financial contagion and should be subject to special supervision. Already, the FSOC has designated General Electric Capital Corp., AIG, and Prudential Financial, Inc. The Council may soon designate MetLife, Inc. The Council’s determinations follow a lengthy process involving hearings and the opportunity for a firm to appeal in court.
• Transparency. Many of the FSOC meetings are open to the public. FSOC officials must also appear before Congress. FSOC’s explanations for designating a non-bank as systemically significant are also published.

FSOC isn’t perfect. For example, we believe it should release the transcripts of its closed meetings after a suitable time delay, and of course due to its size it may be an unwieldy body. However, FSOC is a needed super regulator and accountability creator and deserves support.

Bartlett Naylor is the financial policy advocate for Public Citizen’s Congress Watch division.

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