Dodd-Frank's regulatory speed trap

You probably know those towns that collect lots of revenue from giving speeding tickets to unsuspecting out-of-town motorists. These towns will put up, say, a 65 mph speed limit sign followed around the corner by a 45 mph sign, one perhaps partially obscured by a tree. The result: The town’s cops hand out tons of speeding tickets.

But is safety really the town’s top priority? Of course not. Its priority is to hand out tickets. If safety were the real priority, the town would do everything it could to prevent drivers from speeding in the first place — starting with clear, well-placed signs.

That brings me to Dodd-Frank’s “too big to fail” solution — it’s essentially a speed trap, designed to ensnare more and more firms under greater government control. It was never set up to avoid unsafe behavior in the first place.

Consider this: Dodd-Frank created the category of Systemically Important Financial Institutions (SIFIs) for institutions whose distress could possibly “pose a threat to U.S. financial stability.” By definition, SIFIs are potentially dangerous.

So wouldn’t we want fewer dangerous firms? Of course. You’d want fewer of anything dangerous, be it SIFIs, Zika mosquitos or reckless drivers. But when it comes to non-bank SIFIs, like insurance companies or asset managers, the SIFI regime is a bit like the Hotel California, where “you can never leave.” That’s because the Financial Stability Oversight Council (FSOC) doesn’t communicate to the already-labeled non-bank SIFIs a clear way off the SIFI list.

The only plausible explanation for why FSOC doesn’t provide a specific off-ramp from the SIFI list is that the government wants to keep these firms on the list. That is to say, the system is set up to keep these “dangerous” firms around, instead of telling them how to change their business models so as to be less dangerous.

Case in point: General Electric, which is currently asking regulators to remove GE Capital’s SIFI designation. GE has gone to great lengths to change its business model, selling off over half of its assets. Get this: After spending extraordinary amounts of time and money to get off the SIFI list, GE still doesn’t know what the government’s answer will be.

This is fundamentally different from how normal U.S. agencies operate. When the IRS says there is a problem with your tax return, they tell you what the issue is and how to rectify it. But SIFIs are forced to guess what the government wants. This isn’t how you increase the safety of the financial system.

The flaws in the opaque, arbitrary SIFI regime were noted in March’s court decision that rescinded MetLife’s SIFI designation. But even after the court decision, the Obama administration hasn’t made any attempt to increase FSOC’s transparency. The government is appealing the MetLife case, effectively doubling-down on a flawed approach.

It gets worse. Firms that are being considered for SIFI designation aren’t given clear instructions on how to avoid this designation in the first place.

We have no logical explanation for the government’s conduct except to conclude that the government wants more SIFIs. Now why would they want more firms that they themselves consider a threat to the system? Anyone who’s spent time around the D.C. regulatory world knows one part of the answer: Regulators are inclined to regulate, and you can do more regulating of a SIFI than a non-SIFI.

Main Street Gets Hurt

Here’s another reason the government might be inclined to create more SIFIs, and it’s part of the reason why Main Street should care about this issue: There’s money in it. Designating firms, particularly insurance companies, as SIFIs puts more money into the government’s Orderly Liquidation Fund. And since the fund is made up of fees levied on SIFIs, it’s consumers that end up shouldering the burden.

Setting aside the fact that the SIFI regime doesn’t necessarily make the system safer, Main Street gets hit another way: Reduced competition for business loans. GE Capital, in seeking to shed its SIFI designation, sold off most of its business-lending unit to Wells Fargo. This comes at a time when small businesses, especially in rural areas, are suffering from a lack of capital.

Regardless of how you feel about the notion of government-decreed SIFIs, we should demand a coherent, transparent regulatory regime. If these companies are truly “dangerous,” then the focus should be on increasing safety, rather than writing more “speeding tickets.”