WASHINGTON—Big U.S. insurers Prudential Financial Inc. and American International Group Inc. would face tougher capital requirements than their peers under new rules outlined for the first time Friday by the Federal Reserve’s point-man on regulation.
Fed governor Daniel Tarullo said the Fed will propose rules “in the coming weeks” that will have higher compliance costs for insurers considered “systemically important” to the U.S. financial system.
That group currently includes AIG and Prudential, but not MetLife Inc., which won a court case overturning its systemic label earlier this year. The government has appealed MetLife’s win.
The Fed gained authority for the first time to regulate insurance companies under the 2010 Dodd Frank law, but has taken more than five years to propose rules for the industry. Mr. Tarullo’s remarks Friday were the central banks most detailed description to date of the pending regulations.
Mr. Tarullo didn’t give all the details of the Fed rules, but he sketched them out in a speech to the National Association of Insurance Commissioners, a group of state regulators. He said the Fed will propose different rules for systemic insurers than for other insurance companies it regulates.
The central bank also regulates a dozen U.S. insurance companies that own banks, including Nationwide Mutual Insurance Co. and State Farm Mutual Automobile Insurance Co.
After my 10-year old daughter caught me reading “Snoopy the Destroyer,” Paul Krugman’s column in the April 11, 2016, New York Times, I had to reassure her that Snoopy was still safe to watch. Krugman may scare little girls with his article arguing for more federal regulation of financial institutions, including MetLife, owner of the Snoopy logo, lest the economy blow up. But consumers and the broader economy should not be scared, due to the work of state insurance regulators.
The idea, as suggested by Krugman, that federal regulators know best would have Charlie Brown saying, “Good grief.”
As Iowa’s state insurance commissioner, I work closely with 55 other insurance commissioners, directors or superintendents through the National Association of Insurance Commissioners (“NAIC”) to supervise the nation’s insurance market. I serve as chair of the NAIC life and annuity (“A”) committee, which sets national policy on matters that affect the life insurance and annuity industry. Through these roles, I know our state-based regulatory system works to protect all American consumers and the financial soundness of the carriers we regulate.
The myth that federal regulators know best has long been dispelled, but it is still front and center today, particularly when those same federal officials are challenged on their decisions.
Alarm bells are going off at the Treasury Department after a U.S. District Court recently threw out the designation of MetLife as a systemically important financial institution (SIFI). Treasury Secretary Jack Lew lashed out at the court in public statements and in the pages of major U.S. newspapers that MetLife, a company that is almost 150 years old, somehow presents a threat to the U.S. unless the company is subjected to additional oversight and federal regulation that accompanies the SIFI designation. Secretary Lew fails to acknowledge that MetLife, Prudential and hundreds of other insurance companies are closely and successfully regulated and supervised by state insurance commissioners, and have been for decades.
Critics of the court’s decision – including Lew – argue that the court did not defer to the “experts” at the Financial Stability Oversight Council (FSOC), which found that MetLife posed a threat to the economy. However, the FSOC itself ignored its own true experts. The FSOC designated MetLife as a SIFI in December 2014 over the objections of the only two independent FSOC members with true expertise and experience in insurance regulation.
What we have learned following the 2008 financial crisis – and what Congress should keep in mind – is that the near collapse of AIG, and the accompanying $180 billion check from taxpayers to save it, was due to suspect federal oversight of AIG, not to any inadequacy in our state-based insurance regulatory system.
AIG was a large, complex financial company. The insurance operations were supervised by the state insurance regulators, while its financial products division was supervised by the Office of Thrift Supervision (“OTS”). It was AIG’s financial products division that became overextended by offering credit default swaps backed by the sizable balance sheet of AIG. OTS did not require AIG’s financial products division to have sufficient capital, and the company was left exposed.
I want to ensure that the economy is protected from a financial crisis as much as anyone, but the thought of federal regulation and supervision of traditional insurance activities does not allow me to sleep easier. To the contrary, we need a coordinated regulatory approach where regulators work together. The federal government’s supervision shouldn’t expand into areas where it lacks expertise and where states are already working effectively. Consumers will bear the costs of this unnecessary overlap and duplication.
The insurance industry is under the watchful eye of state insurance departments, and our track record of solvency regulation of large national and multinational insurers speaks for itself. The NAIC and state insurance departments have updated solvency oversight through transformational model laws that allow state insurance regulators to maintain a close watch on the insurance activities of the carriers domiciled in our respective states.
When Judge Rosemary Collyer rescinded MetLife’s designation, she found that FSOC failed to take into account existing regulatory regimes. In short, the court found that FSOC failed to consider the level of scrutiny that insurance carriers like MetLife face from state regulators.
Through strong statutory schemes and strong financial oversight, state regulators have detailed knowledge of insurance companies and successfully protect policyholders in all 50 states. Insurance companies do fail, as part of a healthy and competitive market, but it is a rare occurrence, because state insurance regulations require that insurance companies hold significant amounts of capital in reserve. Even when a company fails, policyholders are protected through our receivership process.
In addition to the amount of capital a carrier is required to hold, states also maintain strict rules on the kinds of investments an insurance carrier may make with policyholders’ money. If the OTS maintained this same type of oversight and approach, AIG would not have required a massive taxpayer bailout.
Alarmists like Secretary Lew insist that a large insurance company poses a threat to the U.S. economy and thereby requires federal supervision. They claim that Judge Collyer’s decision throwing out MetLife’s SIFI designation undermines broader efforts to reform our financial system in the wake of the 2008 financial crisis. But Judge Collyer’s decision is focused on the process that the Financial Stability Oversight Council used for designating MetLife as a SIFI in 2014, not the broader law.
Dodd-Frank anticipated the fallibility of FSOC designations, as the law allows companies to challenge their designation. I do not blame MetLife for challenging the FSOC.
FSOC continues to dismiss the legacy and expertise of state regulators like myself and has announced that it will appeal the District Court’s decision.
It is puzzling why the federal government believes it can do a better job than on-the-ground state commissioners. As state commissioners, our top priority is protecting policyholders and providing robust oversight.
This allows me to tell my daughter that Snoopy isn’t the bad guy, but she may learn to fear alarmists like Krugman and Secretary Lew as she begins to read past the funny pages.
(Thomson Reuters Regulatory Intelligence) – The U.S. Financial Stability Oversight Council’s recent review of the asset management industry seemed a rather routine piece of regulatory work. But the review released last week comes in a charged atmosphere for the council because of a court decision that rescinded its designation of insurer MetLife as a systemically important financial institution, or SIFI.
The federal court’s decision on March 30 marked the first successful challenge to the authority of the council in SIFI designations, and could lead to more skeptical inspection of its reports.
The asset management review was relatively noncontroversial. It reaffirmed the importance of three key risk areas that the Securities and Exchange Commission has been acting for a year: liquidity and redemption risk, leverage, and companies’ reliance on service providers for data collection and reporting. The council duly recommended more robust risk management practices, clearer guidelines on funds’ limits on liquidity, and possible stress tests and transition planning exercises.
The process for that review, which was already in the works for a year, could be the last taken at face value.
Precarious times for unclear analyses
The inter-governmental Financial Stability Oversight Council, or FSOC, has played a unique and vital role among regulators since its creation under the Dodd-Frank Act. Among its duties it is responsible for analyzing and detecting potential systemic risk areas in the nonbank sector (known as shadow banks) that could pose a threat to the rest of the U.S. financial system.
Through its authority, the council has designated a number of institutions as systemically risky, forcing them to abide by a more onerous set of regulatory requirements — such as higher capital thresholds and “living-will” resolution plans — broadly known as enhanced prudential standards.
On the face of it, the council relies on a methodology that draws upon six criteria used by the Basel Committee, the Financial Stability Board, and the International Association of Insurance Supervisors (IAIS). These are the nature, scope, size, scale, concentration, and interconnectedness in determining systemic risk levels. However, the similarity and clarity of methodology stops there.
Unlike these international regulatory bodies, the council does not apply transparent standards that limit its own discretion, and neither does it provide a roadmap for compliance by affected companies.
Furthermore, the council has not supported its decisions with detailed analyses specifying risk thresholds that warrant regulatory action (or SIFI designation). Nor has it identified specific type of activities or asset classes that may be riskier than others. Consequently, it has not been able to quantify the level of risk.
Furthermore, neither Dodd-Frank nor the council itself has ever clearly defined what constitutes financial distress or market instability. Nor have they designed any path for firms to shed their SIFI designation once they have it, should their risk profile drop due to restructuring.
The opacity that characterize council’s analyses has drawn criticism to the effect that its decisions can be subjective.
“I do not understand why the council does not share the qualitative and quantitative metrics it uses for its analyses,” said Mayra Rodriguez Valladares, managing principal at MRV Associates, over a phone interview with Thomson Reuters GRC.
FSOC’s authority challenged
Until the MetLife court decision, which is subject to a potential appeal, FSOC has enjoyed a significant leeway in its SIFI designation process. UNder Dodd-Frank its authority, methodology and the quality of its analyses in determining what institutions or activities are to be considered systemically risky could be challenged through a judicial review only if its final determination could be proven to be “arbitrary and capricious”.
Yet the court used these very words when it referred to the council’s process for reaching its designation decision, and stated that its decision process was fatally flawed, as it had “refused to undertake an adequate cost-benefit analysis.” Such analysis could also have included the cost of becoming a SIFI, as well as alert the firm about the likelihood that a financial shock could bring it down, and the potential risks the firm’s failure could pose to the broader economy.
The court, in an opinion released April 7, noted that “predictive judgment must be based on reasoned predictions; a summary of exposures and assets is not a prediction.” Indeed, theexposure channel analysis section in the council’s SIFI determination –one of the three transmission channels it identified, along with asset liquidation and critical function channels– amounted to little more than summing up gross potential market exposures, with little regard for mitigating factors like collateral or netting of positions.
The court decision also noted an inconsistency in FSOC’s guidance in reaching its determination on MetLife SIFI designation. FSOC asserted that it did not have to evaluate the possibility of material financial distress in a company. Instead, it based its decision on factors that increase that possibility (namely, leverage, liquidity risk, maturity mismatch among others).
Although imperceptible at the time, cracks in FSOC’s decision making process appeared earlier than the court’s ruling. The only independent member of FSOC with insurance expertise, Roy Woodall, dissented from MetLife’s (and Prudential’s) SIFI designations.
He stated that, “FSOC’s asset liquidation transmission channel analysis relied on implausible, contrived scenarios as well as failures to appreciate fundamental aspects of insurance and annuity products, and, importantly, State insurance regulation.” He voiced similar concern based on same reasoning for Prudential , when he found that the council’s “analysis utilizes scenarios that are antithetical to a fundamental and seasoned understanding of the business of insurance, the insurance regulatory environment, and the state insurance company resolution and guaranty fund systems.”
Secretary of the Treasury Jack Lew defended FSOC’s methodology, most recently, in anopinion piece on Wall Street Journal , saying that it is “not making presumptions or jumping to any conclusions,” and stressed that “data and thorough analysis” guide the Council’s work. Referring to the court decision on MetLife, he added that, the ruling, if not overruled, “would leave one of the largest and most highly interconnected financial companies in the world subject to even less oversight before the financial crisis.”
The Secretary of Treasury officially chairs the 10 voting-member decision-making body of FSOC and holds a critical veto power in the designation process.
… but the King still has clothes
Legal entanglements aside, the SIFI designation still carries weight in encouraging large and potentially systemic institutions to lower their risk profile, even if the designation itself is no longer perceived as irrevocable as it once was.
Of the four non-bank SIFIs designated by the FSOC, three (General Electric, AIG, and MetLife) have made clearly laid down plans shortly after being designated to shed their SIFI stigma by divesting some of their businesses. General Electric has been spinning off quite a number of its units, including GE Capital, since early 2015, effectively removing itself from much of its banking business.
MetLife followed a similar path when it announced that it would divest its variable annuity and life insurance businesses in January 2016 — prior to being awarded the favorable court ruling– in order to avoid tougher capital regulations that come with the SIFI designation. And, AIG stated in January 2016 that it was reorganizing its core property-casualty operations into nine units with the intention to sell them, along with an advisor group and part of its United Guaranty Corp. subsidiary.
Prudential remains the only non-bank SIFI that has not embarked on a significant divestiture plan — it has a strong capital position – although it has discarded its commodities group and real estate brokerage. Despite initially suggesting potential legal action to challenge its SIFI designation, the firm has stopped short of doing so. It is possible, however, that should its rival MetLife win the legal battle, the firm may seek to follow a similar course.
GE petitioned to have its SIFI label removed in late March, but said the move was unrelated to the MetLife ruling.
The final outcome on MetLife may not shake the foundations of FSOC’s authority, nor challenge the reason of its very existence. It is likely that the council will still retain its power in identifying the spots in the financial system that can create systemic risk. Yet in this new brave world brought about in the aftermath of the MetLife court decision, it probably will have to become more transparent, revamping its designation process and its risk assessments by providing better guidance and clarity for the former and keener analysis for the latter.
(Bora Yagiz, FRM is a New York-based Regulatory Intelligence Expert for Thomson Reuters Regulatory Intelligence, specializing in risk. He is a certified Financial Risk Manager. Mr. Yagiz has held positions as a bank examiner for the Federal Reserve Bank of New York, as senior consultant with Ernst & Young and vice president at Morgan Stanley. Follow Bora on Twitter @Bora_Yagiz. Email Bora at email@example.com)
(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Apr. 28. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @thomsonreuters)
In remarkably unusual public statements, Treasury Secretary Jacob Lewhas aggressively criticized U.S. District Court Judge Rosemary Collyer’s legal decision to invalidate the Financial Stability Oversight Council’s designation of MetLife as a systemically important financial institution (SIFI).
Mr. Lew asserts that Judge Collyer overturned FSOC’s conclusion thatMetLife is a SIFI and that her decision contradicted key policy lessons from the financial crisis. He’s wrong. Judge Collyer makes no specific determination as to whether MetLife is a SIFI and certainly does not base her judicial decision on the policy lessons of the financial crisis.
Importantly, Dodd-Frank also provides companies designated as SIFIs with the right to promptly challenge FSOC’s decision in court. MetLife is the only designated company to do so, and Judge Collyer found in its favor on March 30th.The government has already filed an appeal with the D.C. Circuit and the case could ultimately be heard by the Supreme Court.
The Financial Stability Oversight Council is a financial regulatory agency created by Dodd-Frank. It is chaired by Secretary Lew and includes the heads of the eight financial regulatory agencies. One of its principle tasks is to identify financial institutions whose failure could pose a threat to the financial stability of the United States and then designate these entities as SIFIs. The stakes are high for companies designated as systemically important financial institutions because they are subject to enhanced supervision by the Federal Reserve and more stringent capital and liquidity requirements.
Judge Collyer found three procedural failures in FSOC’s designation ofMetLife as a SIFI, each of which was sufficient to overturn FSOC’s determination on its own. Whatever the merits of designating a financial institution as systemically important, such determinations should follow the rule of law.
A court must decide if FSOC has properly assessed whether the failure of the designated financial institution could in fact threaten the financial stability of the United States. Judge Collyer found that FSOC did not do so with the rigor required by law. According to Judge Collyer, “every possible effect of MetLife’s imminent insolvency was summarily deemed grave enough to damage the economy.”
Not only did the Financial Stability Oversight Council not abide by legislative requirements, the judge also found that it violated the process required by its own rules. According to the FSOC’s 2012 rule-making and guidance, FSOC said it would consider the likelihood of a non-bank’s failure as part of the designation process. However, the record clearly shows that FSOC failed to consider MetLife’s vulnerability. When an agency takes an action that is directly inconsistent with its own rule-making, longstanding legal doctrine holds that the action is invalid because it is “arbitrary and capricious.”
Indeed, it was not the court that imposed requirements on the Financial Stability Oversight Council, as Mr. Lew argues, it was the FSOC itself. Of course agencies should be bound by their own rules — if agencies were free to disregard their own rulemakings, then their actions would be entirely unpredictable.
Mr. Lew additionally argues that Judge Collyer’s decision requires thatFSOC conduct a formal cost-benefit analysis as part of a SIFI designation, even though no such analysis is required by the legislation. But JudgeCollyer’s decision does not require a cost-benefit analysis. In JudgeCollyer’s view, Dodd-Frank requires that the Financial Stability Oversight Council consider whether a systemically important financial institution designation would pose a risk to MetLife or to financial markets. This is a far lower standard than requiring that the FSOC measure the costs of designation and make sure that they are less than the benefits.
Judge Collyer’s legal decision would simply require that the Financial Stability Oversight Council follow a regulatory process that provides the public with transparency and certainty, instead of arbitrary determinations. Mr. Lew should make sure that FSOC follows the rule of law. Judge Collyer’s legal decision had nothing to do with the question of whether the SIFI designation approach is a legitimate response to the financial crisis.
• Hal S. Scott is professor of international financial systems at Harvard Law School and director of the Committee on Capital Markets Regulation
The surprise court decision in March to overturn US group MetLife’s designation as a systemically important financial institution (Sifi) could weaken the case for systemic regulation both in the US and abroad.
Even though the Financial Stability Oversight Council (FSOC), which designated MetLife as a Sifi, is appealing the decision and despite the judgement being made largely on procedural grounds, judge Rosemary Collyer has tipped the debate on systemic regulation of insurers back in favour of the designated firms.
Collyer said the FSOC made three main mistakes. First, it did not follow its own rules on how designations would be made, and failed to make clear to MetLife the changes in methodology and explain them. Second, the council fell short in showing how MetLife’s failure could damage the functioning of the financial markets. And, third, it failed to conduct a cost-benefit analysis of the designation.
If unsuccessful in appealing the decision, the FSOC could still change its approach in each of these areas. Yet making such changes and renaming MetLife in the next round of Sifi designations would be far from straightforward.
Collyer criticised the FSOC heavily for failing to prove MetLife could get into the kind of financial difficulty that would create a risk to the financial system – a criticism that goes to the heart of the debate over systemic regulation. Insurers have always argued they are not vulnerable to policyholder runs in the same way that banks might face a rash of customer withdrawals.
The FSOC could change its methodology and say the vulnerability of Sifis does not matter, only their potential to create systemic damage. But such a change would undermine the credibility of the designation process, which has been heavily criticised already.
Alternatively, the FSOC could seek to prove MetLife is vulnerable to a run. But many in the industry think that would be hard or impossible to achieve, particularly after the insurerspins off its variable annuity business.
If the FSOC fails to overturn Collyer’s decision and cannot change its methodology, MetLife would be left designated as systemically important at a global level but not in the US. However, the insurer would be regulated by a supervisor – the New York Department of Financial Services (NY DFS) – that has opposed Sifi designations from the start. The NY DFS would be unlikely to enforce international rules that lack any legal basis at home.
Meanwhile, the deeper damage to the argument for regulating systemically risky insurers might be the reopening of the debate on whether insurers are vulnerable in the same way as banks. For the industry, it is an argument that has never been properly resolved. The MetLife judgement means it cannot be ignored.
Meet the new deities. They apparently sit on the Financial Stability Oversight Council and other regulatory agencies, especially those created by the Dodd-Frank banking “reform” act.
Obama administration officials and Dodd-Frank cheerleaders have been simply apoplectic in their reactions to U.S. District Judge Rosemary Collyer’s carefully reasoned March 30 decision reversing FSOC’s designation of the MetLife insurance company as “systemically important,” or too-big-to-fail. Expect similar reactions to a bill, H.R. 3340, voted out of the House last week that makes FSOC more accountable to Congress by placing its budget under the appropriations process. Similarly, the House Financial Services Committee approved a bill last week, H.R. 1486, that would put Dodd-Frank’s Consumer Financial Protection Bureau spending on budget as well.
The FSOC, a secretive council of federal and some state regulators, was created by Dodd-Frank to designate firms as “systemically important financial institutions” or SIFIs. With the SIFI designation comes the benefit of being officially tagged by the government as too-big-to-fail and having creditors more likely to be bailed out, which can be a competitive advantage and lower borrowing costs. But it can also mean much more red tape and bank-centric regulations that are inappropriate for non-bank firms.
MetLife decided the burdens outweighed the benefits of being a SIFI. It sued in court, and Collyer agreed in her ruling that the government’s actions in designating the company a SIFI were “arbitrary and capricious.”
As I wrote in Forbes, this ruling limiting the FSOC’s powers bodes well for a host of nonbank innovators in the new FinTech sector who are creating new avenues of prosperity for consumers, investors, and entrepreneurs, but could be halted by regulatory overreach. “The ruling limits the government using its power arbitrarily to fit non-bank financial firms into the banking regulation hole,” I concluded.
Yet apparently, when it comes to FSOC and Dodd-Frank, there is a new doctrine of regulatory infallibility. Treasury Secretary Jack Lew did not just express disagreement with the ruling, but in the words of the Wall Street Journal editorial page, treated Collyer’s “reasoned analysis as a judicial micro-aggression.” In his statement, Lew slammed the judge for “overturning the conclusions of experienced financial regulators.”
An echo chamber repeated the chorus and asked how dare a judge presume herself smart enough to rule against a body of so-called experts. Scoffed Andrew Ross Sorkin of the New York Times, “How can any judge with anything short of a doctorate in statistics and economic modeling be tasked with effectively overseeing the decisions of a group like the Financial Stability Oversight Council?”
But it is not the job of judges to prove that they are smarter than the government bureaucrats they are overseeing. Their job is to ensure that in the implementation and enforcement of rules, bureaucrats themselves play by the rules of administrative procedure and the Constitution. And Collyer found multiple violations by FSOC of the rules Congress set out for regulatory agencies in the Administrative Procedure Act.
In the ruling, Collyer called FSOC’s reasoning for MetLife’s designation “fatally flawed.” She noted how FSOC departed from its own procedures and “abandoned the guidance and refused to evaluate MetLife’s vulnerability to material financial distress.”
Collyer didn’t reach the constitutional aspects of the case, but the appeals court might weigh in on this, since the Obama administration has decided to appeal. In CEI’s litigation against Dodd-Frank’s creation of FSOC and the CFPB, we note multiple violations of the Constitution’s rules for separation of powers to ensure government accountability. And the Constitution also contains no exemptions from these rules for bureaucratic “experts.”
In September 2014, the Financial Stability Oversight Council (FSOC), a sort of super-regulatory agency created by the 2010 Dodd–Frank Act, labeled MetLife as a systemically important financial institution (SIFI). It may sound like an honor, but what it really meant was that MetLife was officially designated for special regulation by the Federal Reserve.
Title I of Dodd-Frank gives the FSOC this designation authority on the premise that special regulations can prevent so-called SIFIs from causing a financial crisis.
In January 2015, MetLife announced they would fight the designation in federal court, and they’ve now won the first round of this fight. The U.S. District Court in D.C.rescinded the FSOC’s MetLife designation on March 30 and unsealed its decision on April 7.
Within days, U.S. Treasury Secretary Jack Lew (the Council’s Chair) announced the FSOC would appeal. (The appeal goes to the D.C. Circuit.) In a statement, Lew complained: “This decision leaves one of the largest and most highly interconnected financial companies in the world subject to even less oversight than before the financial crisis.”
That’s an interesting perspective since none of the new capital regulations had been imposed yet.
Regardless, the final resolution of this case has broad implications for other yet-to-be-singled-out financial firms. One major problem with the so-called SIFI designation process is that designated firms are extremely limited in their ability to challenge the FSOC in court.
Section 113(h) of Dodd-Frank limits legal challenges to “whether the final determination made under this section was arbitrary and capricious.” Since the FSOC developed a process for making these designations, winning such a legal challenge had been widely viewed as an uphill battle.
For the record, I thought that there was at least a 50-50 shot the FSOC would prevail in the MetLife case for this very reason. And my fear was that Dodd-Frank ensured the FSOC could set a very low bar for making these designations.
The Dodd-Frank bill authorizes these designations in the name of maintaining financial stability, but it doesn’t define financial stability. Nor does it direct the FSOC to do so.
Unsurprisingly, the FSOC’s final rule and guidance really didn’t define the term either.
Instead, the FSOC simply explained that they would consider a threat to financial stability to exist “if there would be an impairment of financial intermediation or of financial market functioning that would be sufficiently severe to inflict significant damage on the broader economy.”
The guidance then explains three “channels” through which such problems could occur.
All of this amounts to little more than conjecture. The FSOC could claim, for example, that a financial firm’s distress could harm the broader economy if it had to sell its assets quickly at a loss.
The final rules were never really clear on how specific FSOC would be in this process, and that’s really no surprise. To carefully quantify these issues would require the FSOC to specify precisely what level of risk is acceptable, and then identify specific activities and assets that cause too much risk. It would also have to quantify how these risks impact specific counterparties.
It’s impossible to do this in a purely objective way. But even if it could be done objectively, the logical response for a designated firm would be to dump those assets, cease risky activities, and cut ties to specific counterparties.
Naturally, doing so would remove any real justification for the special designation, and that’s the last thing FSOC wants. There wouldn’t be any designations because everyone would avoid anything on the specific list.
Worse, the FSOC would be exposed as a failure if a financial crisis ever occurred because of an item they left off the list.
So an inherent conflict exists in the SIFI designation process because too little specificity could be viewed as arbitrary and capricious. It’s true that the courts tend to give regulatory agencies a great deal of leeway on these matters, but exactly how this would play out was always an open question.
Exactly how vague can the FSOC be to avoid making an arbitrary and capricious designation? We still don’t reallyknow, but the MetLife ruling gets us closer to finding an answer.
If the decision holds up on appeal, the FSOC will certainly have a higher hurdle to overcome when making future designations. But it’s still far from clear how much impact this ruling will ultimately have.
One key factor is that the FSOC can make these designations under either of two standards. The one they chose in this case designated MetLife on the premise that material financial distress at a company could pose a threat to U.S. financial stability.
The other standard lets the FSOC designate a firm when the very “nature, scope, size, scale, concentration, interconnectedness, or mix of the [company’s] activities” could pose a threat to U.S. financial stability.
While this ruling surely has implications for designations under either standard, the fact that the FSOC relied on only one standard sets the stage for future court battles. It’s also possible that the FSOC will issue new guidance on designations, thus mitigating some of the problems it ran into in the MetLife case.
Nonetheless, financial firms that find themselves in the FSOC’s crosshairs are in a better position now than they were prior to this ruling. Simply put, the FSOC will, under current rules, have to be more specific when it designates a firm.
Democrats and many others on the left have expressed outrage that judge Rosemary Collyer threw out the Financial Stability Oversight Commission’s ruling that Metlife is a ‘Financially Important Institution’ and thus deserving of enhanced capital requirements. Andrew Ross Sorkin, writing in the New York Times, echoes the opinions of many by expressing outrage at Collyer’s assertion that the analysis presented was woefully insufficient to make that determination.
Sorkin’s complaint about Collyer’s finding – in an argument that would elicit an indignant New York Times oped response if he weren’t a tribe member – is that she’s apparently not smart enough to make that determination. No judge without a doctorate in statistics and economic modeling, he avers, couldpossibly oversee the decisions of a group of scholars like those who sit on the Financial Stability Oversight Commission. It’s her duty, you see, to defer to their collective genius.
Here’s a possibility for Mr. Sorkin to consider: The rocket scientists who he apparently thinks make up the FSOC – which includes precisely one economist (Janet Yellen) and eight lawyers, incidentally – made an overtly political decision that did not hew to the law that created FSOC and gave it the powers to designate a systemically important institution, and the judge is performing her legally required duties by reining it in.
And while judge Collyer may not be intellectually capable enough of making that determination, perhaps we could reference the one FSOC member who actually has some knowledge about the insurance industry – Roy Woodall, who was appointed by President Obama to be the FSOC independent member with insurance expertise. Woodall disagreed with Treasury Secretary Lew and the other FSOC members on MetLife’s inclusion as a SiFi with a blistering dissent that basically accused the other members of not understanding the insurance market, stating in plain language that he did not believe that the commission’s conclusions are supported by any evidence, “or logical inference.” In short, he more or less accused Lew et al. of making an overtly political decision and not the economically correct one.
Woodall avers that some of Metlife’s non-insurance activities should probably be examined to determine whether they may pose an existential threat to MetLife and have the potential to trigger a financial crisis, but FSOC didn’t bother to do that. It solely concerned itself with its insurance business, which he argues (convincingly) has no credible potential to impact the broader financial markets.
In short, Woodall argues that there is no such thing as a run on life insurance. If people decide en masse to get out of their life insurance policies it wouldn’t cause MetLife to run out of money – life insurance doesn’t work that way. In such an event Metlife would see a decline in revenue and a commensurate decline in obligations (with fewer people insurance it will have fewer deaths to pay out on) and its profits over the long run would fall, if their actuaries had been doing their job correctly, but that’s the extent of it.
He further states in his dissent that he suspects that Lew and his compatriots decided to make MetLife a SiFI because the Financial Stability Board, an intergovernmental entity that primarily comprises the G-20s finance ministers and central bankers, designated MetLife a “global systemically important financial institution.” He suggests that effectively delegating such important determinations to an unelected international board is the antithesis of democracy, and suggests that FSOC either attempt to make future SiFi determinations before the Financial Stability Board does likewise in order to prevent it from putting undue pressure on its own determinations.
Sorkin can’t denigrate Woodall’s brief as easily as he could Judge Collyer’s: Woodall was once Kentucky’s insurance commissioner and practiced insurance law for decades. He also was once president of the American Council of Life Insurers, the trade association for the industry. In short, Roy knows life insurance better than anyone else on the council, so Sorkin is going to need a better reason why Judge Collyer is wrong other than simply saying it’s complicated and she lacks the right training and knowledge to make such a decision.