House Financial Services Committee
Subcommittee on Oversight and Investigations
“The Arbitrary and Inconsistent Non-Bank SIFI Designation Process”
Tuesday, March 28, 2017
Key Topics & Takeaways
- Financial CHOICE Act: Several Members of Congress and panelists noted that the Financial CHOICE Act would eliminate the FSOC’s ability to designate SIFIs and create a framework of regulation that does not rely on taxpayer bailouts.
- Committee Report: Several panelists mentioned the report created by the House Financial Services Committee Majority Staff and how it shows the SIFI designation process to be “arbitrary and inconsistent,” often conducted on an ad hoc basis with no clear guidance.
- FSOC Transparency: A common theme throughout the hearing was the FSOC’s transparency, or lack thereof. Subcommittee Chairman Wagner stated that the FSOC is known to be “one of the least transparent entities,” to which AEI’s Kupiec replied that the Committee report makes it clear that transparency is “long overdue.”
- De-Designation: Several Members of Congress and panelists stressed the need for an exit ramp for designated firms, and that there needs to be an ability to be de-designated.
- Dr. Douglas Holtz-Eakin, President, American Action Forum
- Dr. Paul Kupiec, Resident Scholar, American Enterprise Institute
- Professor David Zaring, Associate Professor, Legal Studies and Business Ethics, The Wharton School, University of Pennsylvania
- Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
In her opening statement, Subcommittee Chairman Ann Wagner (R-Mo.) explained that due to the financial crisis, the Dodd Frank Act created a new “super” regulator, the Financial Stability Oversight Council (FSOC), that was tasked with identifying systemic risk. She continued that FSOC then began designating certain entities systemically important financial institutions (SIFIs), which were subject to heighted prudential standards. Wagner discussed the Financial CHOICE Act of 2016, which would create a framework with “smarter” regulation that will end bailouts from taxpayers. She questioned the rationale in FSOC decisions due to the lack of transparency, noting that executive sessions are closed to the public and Members of Congress. Wagner concluded with details from the Financial Services Committee Majority Staffreport, which found the SIFI designation process to be “arbitrary and inconsistent.”
In his opening statement, Subcommittee Ranking Member Al Green (D-Texas) gave an overview of the financial crisis, stressing that while many constituents were opposed to the bailout due to taxpayer dollars being used, it helped the economy recover. He criticized Republicans for wanting to repeal the FSOC, adding that the CHOICE Act would “do more repealing than replacing.”
Subcommittee Vice Chairman Scott Tipton (R-Colo.) referred to the SIFI designation process as “disturbing,” adding that it is often conducted on an ad hoc basis with no clear guidance to justify decisions.
Dr. Douglas Holtz-Eakin, President, American Action Forum
In his testimony, Holtz-Eakin made three points: 1) The staff report showed the “deep weaknesses” in the designation process; 2) The designation process has costs to firms, customers, and the economy as a whole, and it is a mistake to ignore those costs; and 3) So far only insurance companies have been designated as nonbank SIFIs. He explained that the three-stage evaluation process for SIFI designation is applied differently to different firms, stressing that it is “anything but” a systematic process. Holtz-Eakin continued that the SIFI designation costs create an unlevel playing field for the financial services and puts U.S. firms at a disadvantage competing for global markets, costing between $5-8 billion to consumers. Lastly, he explained that the FSOC should move away from designating firms as SIFIs and instead look at an activities-based analysis, and possibly remove the FSOC’s ability to designate.
Dr. Paul Kupiec, Resident Scholar, American Enterprise Institute
In his testimony, Kupiec explained that the FSOC has the power to set “speed limits” for each nonbank financial institution under its jurisdiction, but that the Council does not have to disclose such information. He continued that the Committee report shows that the FSOC has no known methodology or uniform process for designation, and that each decision lacks standardization. Kupiec criticized the lack of processes or arguments in evaluating firms and designation, and doubted the need for an FSOC SIFI designation process, adding that it should either be repealed or “fundamentally reformed.”
Professor David Zaring, Associate Professor, Legal Studies and Business Ethics, The Wharton School, University of Pennsylvania
In his testimony, Zaring made three points. First, he explained that the Committee report subjects the FSOC to after-the-fact review that is inconsistent with flexibility they were given in Dodd Frank. Zaring continued that the report emphasized some of the ten safety and soundness factors more than others, but that there is “nothing arbitrary” about emphasizing certain factors over others. Second, he argued that the report attempts to isolate parts of the analysis and makes the argument about inconsistency based on such aspects, arguing that designation is supposed to be holistic and based on a number of different factors. Last, Zaring explained that the FSOC was given the responsibility of taking a broad view of the safety of the financial system, and that they are the only part of the government with that power. He concluded that it is important the FSOC retains its flexibility to adjust assessments in the future.
Alex J. Pollock, Distinguished Senior Fellow, R Street Institute
In his testimony, Pollock stated that the Committee report shows the lack of fairness in the FSOC designation process. He continued that the Department of Treasury was sent a letter from Republicans on the Senate Banking Committee earlier in the day that states the FSOC’s process for designating nonbank SIFIs “lacks transparency and accountability.” Pollock described conversations he had with a former senior FSOC insider, where said insider stated that meetings never produced new insight in financial issues. He stressed that the underlying problem of the FSOC is its structure, adding that it “acts as a little legislature…that is a bad idea.” Pollock concluded that Fannie Mae and Freddie Mac were “obviously” systemically important and “extremely risky,” but criticized that they have never been studied as possible SIFIs, calling them “pure cases of government shielding.”
Question & Answer
Wagner noted that the Dodd Frank Act tasked a number of prudential regulators as members of the FSOC and asked whether those regulators have been able to identify any risk to the financial stability of the U.S. Pollock replied that they have not identified risk “very well.” Holtz-Eakin added that there is no way to measure systemic risk and therefore you cannot manage it, which is the fundamental flaw in the idea behind the FSOC.
Wagner stated that the FSOC is known to be “one of the least transparent entities” and asked if they should be made more transparent. Kupiec replied that the Committee report makes it clear that transparency is “long overdue.”
When asked by Wagner whether the FSOC should publicize internal processes, allow observers at meetings, and keep detailed minutes, Holtz-Eakin, Kupiec, and Pollock replied yes.
Wagner asked what other actions Treasury Secretary Steven Mnuchin could make to bring more transparency and accountability to the FSOC. Holtz-Eakin replied that the FSOC showed some improvement with their 2015 guidance, and Kupiec added that the Council should move toward specific thresholds and evaluate firms along observable and defined guidelines.
Rep. Emmanuel Cleaver (R-Mo.) asked the panel if they saw the supplemental procedures the FSOC published to increase transparency in the designation process, to which Kupiec replied that it was not done “out of their own good will.” Zaring stated that every company has the opportunity to interact with the FSOC in responding to an inquiry, as well as meet with them and present information.
Rep. Dave Trott (R-Mich.) asked Zaring if he is not in favor of the FSOC having any transparency, to which he replied that the Council provides insight during the designation process.
Green asked about proprietary information that could possibly be released. Zaring replied that institutions provide much information to the FSOC during discussions and that he doubts those companies would want such information released to their competitors and the public.
SIFI Designation Process
Tipton asked if the FSOC considers the existing supervisory process regulating an entity when conducting an assessment. Kupiec replied that they are supposed to consider supervisory regulation in place, but that so far the Council has not taken it into account. He continued that he is not aware of such regulators raising questions about the health and safety of the nonbank SIFIs prior to their designation.
Tipton then asked if the FSOC conducts any cost-benefit analysis as part of the SIFI designation process. Kupiec replied that there are none that he is aware of, and that nothing is stated in their public documents. He continued that he does not believe the FSOC has the capacity to scientifically identify one firm as systemically important and another one not.
When asked by Tipton what experience the Federal Reserve has in insurance regulation oversight, Pollock replied with “very little.”
Green asked for an example of a company that had been designated and then de-designated. Zaring stated that one company was designated as a nonbank SIFI and then they transformed themselves from an institution that relied on runnable assets for financing to a more stable institution that did not, and the FSOC revoked their designation.
Cleaver asked how many firms have been designated as SIFIs, to which Holtz-Eakin replied that four have been.
Rep. Claudia Tenney (R-N.Y.) asked how there can be a clear standard for de-designating if there is not a clear standard for designating. Kupiec stressed that the FSOC does not give designated firms clear guidance on what they can do to not be a SIFI, as there is no specific off-ramp. Holtz-Eakin added that there needs to be an overhaul of the designation process.
Trott stated that the Committee report said that the FSOC treats big companies in the industry differently. Kupiec explained that when looking at the same phenomenon for two different firms, there is evidence in the second stage of designation that opposite conclusions have been made.
Rep. Dennis Ross (R-Fla.) asked if there was any discussion by the FSOC on whether insurance companies were not properly regulated by state insurance regulators, to which Holtz-Eakin replied that there were not.
Ross then asked that if the FSOC is going to “ignore its experts” and indict the state-based system of insurance regulation, if it would impact the free market of insurance sales. Holtz-Eakin noted his worry that it will end up in an uneven playing field, with consumers being hurt the most.
Ross stressed that there is no exit ramp from the designation process, and that firms have to be allowed to have a review and ability to be de-designated.
Fannie Mae and Freddie Mac
Trott asked Pollock about the effect of compliance on the overall economy. Pollock replied that the cost of compliance is substantial and impacts the value of the firm. He continued that the biggest arbitrary decision was not to look at Fannie Mae and Freddie Mac, which were “obvious SIFIs,” adding that they got a “free pass.”
Rep. David Kustoff (R-Tenn.) asked if the FSOC is capable of acting as an independent regulatory agency, to which Holtz-Eakin replied that they could be a better regulator if they had processes in place that were more systematic, uniform, and transparent.
Financial CHOICE Act
Kustoff noted that the Financial CHOICE Act eliminates the FSOC’s ability to designate SIFIs, and asked what additional reforms could be recommended. Holtz-Eakin explained that levels of reform would include making the process by which the FSOC operates more transparent and uniform, with a clear exit ramp from the SIFI status. He continued that limiting the scope to designate nonbank SIFIs and pulling back on the ability to designate at all are other levels of reform.
Rep. Trey Hollingsworth (R-Ind.) noted the government’s involvement in the financial markets, to which Pollock replied that there is “no doubt” part of the crisis was due to the government promoting credit and driving up housing prices. He continued that one of the biggest problems with the FSOC is that it has to think about systemic risk that was created by the government, but that an independent body is needed to make such an assessment.
Hollingsworth asked about the costs associated with the “grey area” of regulation that companies are forced to operate in. Holtz-Eakin replied that it is a “real issue,” and that it is estimated that businesses spend over $800 billion in compliance costs. He continued that the “genuine” economic costs are the business decisions that are impacted due to the designation, as firms are treated differently.
For more information on this hearing, please click here.
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