The Financial Stability Oversight Council has undoubtedly suffered a significant setback from the March 30 court decision striking down the panel’s designation of MetLife as a “systemically important financial institution.” But the findings of U.S. District Court Judge Rosemary Collyer shouldn’t be news to FSOC nor to the regulatory agencies represented on the council. It’s not like they weren’t warned.
Indeed, the decision vindicates the factual and legal arguments made for more than the past five years by MetLife and other potential designees, as well as trade associations and other public commenters. Beginning with comments on the council’s 2011 rulemaking on the designation process — and culminating with briefs filed in the MetLife case — critics have consistently pointed out to FSOC that it has limited authority to promulgate formal rules, should not designate firms until the Federal Reserve Board writes prudential regulations for them, is barred from hypothesizing systemic risk without empirical evidence, and must establish a plausible linkage between the threat of systemic financial distress in the market and that of the potential designee.
We have steadfastly asserted that a rigorous analysis of the actual costs of such designation relative to its measurable and foreseeable benefits is a necessary component of avoiding a finding that such designation is arbitrary and capricious. It seems incontrovertible that an agency must appreciate the practical implications, costs and benefits of an action before it can make a decision that it is a “reasonable” course to pursue — and not arbitrary and capricious.
Treasury Secretary Jack Lew released a statement in reaction to the opinion in which he seemed to reargue the underlying policies of SIFI designation rather than the law: “[t]his 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.” He also noted that “[t]he heads of every U.S. financial regulatory agency concurred in this judgment [and that] the court … contradicted key policy lessons from the financial crisis.”
All of this is irrelevant in the face of a legal opinion that simply explains that FSOC didn’t do what well-established administrative law required it to do. Moreover, Judge Collyer reminded everyone that if on appeal (which the government announced it will pursue almost immediately), there is some sort of reconsideration of this designation, there will be an opportunity to consider arguments that she did not need to reach because of the fundamental violations of established administrative law which she found.
Given the politics of the situation, FSOC members and staff who designated MetLife as a SIFI are likely to be long gone before any such appeal reaches a decision point. A new administration will have to deal whatever decision a higher court hands down, and perhaps a new Congress will re-legislate the regulation of systemic stability and the future of FSOC.
From an administrative law point of view, correcting the council’s procedural defects is going to take FSOC some time and thought. For the balance of this current lame duck session, and hopefully thereafter, FSOC should focus on reviewing and revising its approach to systemic stability in the following ways.
First and foremost, FSOC should defer the designation of nonbank financial companies as SIFIs until its appeal in the MetLife case is decided and the Fed adopts the prudential rules that will be used to regulate the systemic risks that are presented by a nonbank company. In the interim period, FSOC should shift its focus away from designations of individual companies, and toward another of its charges under the Dodd-Frank Act: the creation and implementation of a sophisticated informational early warning system that can actually detect, and then help reroute impending global crises.
Going forward, FSOC must actually adhere to the substantive standards that Congress intended as well as the procedural requirements that the Administrative Procedure Act imposes. FSOC cannot rely on unsubstantiated, hypothetical risks to which it then tethers a designation, thus effectively requiring companies to shadowbox through the designation process. The definitions, rules and goals of the process must be clearly set forth, the administrative record must connect the dots between the company and systemic instability, and the company must be given a fair shot at rebutting FSOC’s arguments.
When and if the designation process continues, FSOC must distinguish between large financial companies that are the creators of market risk, and those that invest in, absorb or manage that risk. The designation of nonbank financial companies must also be seen as a dynamic and evolving process. Post-Dodd-Frank, the increased prudential regulation of the top banks in the country, as well as whatever SIFIs are designated, must by definition reduce the levels of risk in the system against which the next generation of potential SIFIs are judged.
Further, designations were not intended by Congress to be forever. FSOC must clearly identify a path out of a company’s SIFI status. This means FSOC initially must articulate the empirical and legal bases upon which a company is designated so that the record reflects the factors that must be addressed in order for the company to de-risk and become undesignated.
Finally, without knowing the consequences, economic costs and market impact of massive global shifts in regulation, there is really no way to ensure that FSOC is not inadvertently planting the seeds of the next financial crisis, instead of averting it. As it reflects on its mission following the MetLife decision, the council should analyze whether its actions could lead to such an unintended consequence. History is littered with financial downturns and market debacles that trace their roots to well-intentioned government regulation. This is the most challenging and complex balancing act that any policymaker and regulator ever has had to undertake, and FSOC is not immune from making those mistakes.