Eakinomics: FSOC and the Courts

The Dodd-Frank Act created the Financial Stability Oversight Council (FSOC) and empowered it to designate non-bank financial entities as Systemically Important Financial Institutions (SIFIs). That is as it should be — Congress creates law. At the outset, FSOC followed an entity-based approach to designating SIFIs — for all practical purposes, a focus on the size of entities — and used this to designate the insurers MetLife, Prudential, and AIG as SIFIs. Again, that is how policy should be made — the Administration implements law.

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“Earlier this year the Treasury Department invited AAF to participate in a roundtable discussion with other think tanks and academics as it researched and wrote its report on banks and credit unions, pursuant to Executive Order 13772. At least three other Treasury reports are due for publication this fall. For the next report, in lieu of further roundtables, however, interested groups and individuals are invited to submit written comments on FSOC-specific matters. Below are written comments from AAF President Douglas-Holtz-Eakin and AAF Director of Financial Services Policy Meghan Milloy to Treasury staff regarding FSOC and recommendations for reform.”

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Earlier this year MetLife asked the DC Circuit Court to hold off on issuing an opinion in their court case against the Financial Stability Oversight Council (FSOC) until the Treasury Department completed its report on FSOC as directed by the administration’s Presidential Memorandum from April. The court granted MetLife’s request, but only for 60 days, or until July 11th. That means that unless the court extends the abeyance to the full 180 days, it could deliver a ruling on the case well before the Treasury report is due later this fall. Therefore, the court should extend the abeyance for another 120 days to give Treasury ample time to complete the report so that the court will have the full report and all of Treasury’s research and findings at its disposal while making its decision.

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Metlife, Inc.’s motion to hold appeal in abeyance pending the Secretary of the Treasury’s forthcoming report on the FSOC designation process.

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The Financial Stability Oversight Council (FSOC) hosted its first meeting under the Trump administration this week. This super council of federal financial regulators represents but one of the enormous powers granted to the executive branch by the Dodd-Frank Act. In the Trump administration, it may ironically prove to be the most powerful tool to implement the president’s promise to rethink Dodd-Frank, particularly as major financial services reform legislation likely stalls in the Senate.

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The Financial Stability Oversight Council is a political body masquerading as an analytical one. A dubious creation of the Dodd-Frank Act, it reflects that law’s urge to expand the power of bureaucrats, in turn reflecting the implausible credo that they can control “systemic risk” because they know the financial future better than other people. They don’t.

The expected result of a committee of heads of federal agencies chaired by the Treasury secretary is a politicized process. This was undoubtedly the case with the council’s attempt to designate MetLife as a “systemically important financial institution.” It should not be surprising that a U.S. District Court judge threw out the designation, ruling that it was “arbitrary and capricious,” and “hardly adhered to any standard when it came to assessing MetLife’s threat to financial stability.” In dissenting from the council’s action on MetLife, S. Roy Woodall — FSOC’s statutorily-required independent member with insurance expertise — said the designation relied on “implausible, contrived scenarios.”

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Lawmakers ask for review of Financial Stability Oversight Council and its ability to subject nonbank financial firms to stricter oversight.

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In May of 2015, the House Financial Services Committee (the Committee) began its investigation into the Financial Stability Oversight Council’s (FSOC) process for designating nonbank financial companies as systemically important financial institutions (SIFIs). In February of this year, the Committee released its report detailing its findings, and explaining how it arrived at the conclusion that “FSOC’s nonbank designation process is arbitrary and inconsistent.”

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House Financial Services Committee Republicans said in a report released today that the Financial Stability Oversight Council’s process for designating firms as “systemically important” was “arbitrary and inconsistent.”

Chairman Jeb Hensarling published the findings of the panel’s investigation ahead of Treasury Secretary Steven Mnuchin’s first FSOC meeting on Thursday. The Treasury secretary chairs the panel of top financial regulators. Congress created FSOC in the 2010 Dodd-Frank law.

Hensarling has proposed scrapping the council’s authority to label firms as systemically important financial institutions, a label that carries with it increased oversight by the Federal Reserve. FSOC has been fighting in court to defend its SIFI designation of MetLife, after it was overturned. Prudential Financial and American International Group remain SIFIs.

According to the report, committee staff found that FSOC did not follow its own guidance when it came to designations and “repeatedly evaluated similar aspects of different companies differently.” Committee staff said it appeared that FSOC lacked “sufficient rationale” for its designations.

“The Obama Treasury Department tried to keep Congress and the American people in the dark about how FSOC exercises its sweeping powers,” Hensarling said in a statement. “The release of this staff report brings some much-needed transparency and oversight to FSOC, and the information contained in the documents clearly demonstrates the need for the accountability reforms Republicans have proposed in the Financial CHOICE Act.”

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