A Dodd-Frank Watchdog Still Growls, on a Slightly Tighter Leash
April 5, 2016 by Peter Eavis
At first glance, two events this week suggest that federal regulators are losing ground against “too big to fail” financial institutions.
The 2008 financial crisis revealed that both banks and financial firms that were not banks — like the American International Group — could pose a devastating risk to the financial system and the wider economy. Congress’s primary response came in 2010 with the passage of the Dodd-Frank reform law, a sweeping bill that gave regulators broad powers, including a powerful new tool. They could identify nonbanks that were “systemically important,” and then subject them to stricter regulation.
Some of the nonbanks given that designation, like A.I.G., dutifully complied. But another insurance firm, MetLife, fought back in the courts, and won a big victory on Wednesday. A federal judge struck down the “systemically important” designation for MetLife.
Its effect was immediate. Regulators for the Federal Reserve Bank of New York, who had recently taken residence in the insurer’s offices, had to leave the premises.
On Thursday, General Electric made a regulatory filing to shed its designation as a systemically important firm and to be freed from the Fed’s oversight.
Another big score for the industry?
The week may give the impression of a rollback, but a wider view shows that Dodd-Frank is mostly intact — and exacting slow, steady results.
The act has stamped out many risky practices. The largest banks are operating with substantially higher levels of capital — the financial foundation of a bank. The largest banks appear to be slowly shrinking.
Right now, General Electric can actually be seen as a success story for regulators. Its lending operation slimmed down — it slashed its assets by more than half, or over $250 billion — in response to being designated as systemically important.
President Obama with Senator Christopher Dodd and Representative Barney Frank after signing the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. CreditDoug Mills/The New York Times
As for MetLife, there is some credence to its argument that it’s not a threat to the financial system. It has nearly $900 billion of assets, which makes it a large firm — bigger than, say, Lehman Brothers in 2008. But MetLife also contends that insurance is a more stable business that is not as vulnerable to the sort of runs that can take down a bank.
Notably, the federal court ruling probably does not give traditional banks, like JPMorgan Chase, a pathway to shed stricter regulations.
The Fed has required the largest banks to have significantly higher levels of capital than smaller lenders. But the Fed does not need to go through the Financial Stability Oversight Council when identifying which traditional banks have to operate under these more stringent requirements.
Still, the true impact of the MetLife court ruling won’t be known until it is unsealed, as early as next week.
Even a ruling that disagrees with the council’s methods, rather than its right to identify systemically risky firms, could substantially restrain the council and embolden the anti-overhaul forces to strike elsewhere.
House Republicans, for instance, have said that the Financial Stability Oversight Council, the entity that designates nonbanks, is not transparent and has too much power, a criticism they have also made of the Consumer Financial Protection Bureau, another entity set up by Dodd-Frank (to protect consumers against unfair lending practices).
A ruling that requires the council to jump through a lot more hoops — like performing cost analyses — could slow it down considerably. That might not seem like such a big deal now, when markets appear to be relatively stable.
But imagine a situation like the lead-up to 2008. A.I.G. placed huge and risky bets over a relatively short period, rapidly turning itself into a danger to the system. The council, operating under new restrictions meant to slow it down, might not be able to stop another A.I.G. before it’s too late.
And then the battles over “too big to fail” would be right back where they started.
