[Senate Hearing 114-58]
[From the U.S. Government Publishing Office]
S. Hrg. 114-58
FSOC ACCOUNTABILITY: NONBANK DESIGNATIONS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE TRANSPARENCY AND ACCOUNTABILITY OF THE FSOC'S
SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS DESIGNATION PROCESS FOR
NONBANK FINANCIAL COMPANIES
__________
MARCH 25, 2015
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
MICHAEL CRAPO, Idaho SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
DAVID VITTER, Louisiana CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois JON TESTER, Montana
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina JEFF MERKLEY, Oregon
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
JERRY MORAN, Kansas
William D. Duhnke III, Staff Director and Counsel
Mark Powden, Democratic Staff Director
Jelena McWilliams, Chief Counsel
Elad Roisman, Senior Counsel
Laura Swanson, Democratic Deputy Staff Director
Graham Steele, Democratic Chief Counsel
Dawn Ratliff, Chief Clerk
Troy Cornell, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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WEDNESDAY, MARCH 25, 2015
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESSES
Jacob J. Lew, Secretary, Department of the Treasury.............. 3
Prepared statement........................................... 43
Responses to written questions of:
Senator Vitter........................................... 84
Senator Toomey........................................... 84
Paul Schott Stevens, President and Chief Executive Officer,
Investment Company Institute................................... 26
Prepared statement........................................... 45
Responses to written questions of:
Chairman Shelby.......................................... 87
Douglas Holtz-Eakin, President, American Action Forum............ 28
Prepared statement........................................... 55
Responses to written questions of:
Chairman Shelby.......................................... 87
Senator Vitter........................................... 89
Dennis M. Kelleher, President and Chief Executive Officer, Better
Markets, Inc................................................... 29
Prepared statement........................................... 61
Responses to written questions of:
Chairman Shelby.......................................... 89
Gary E. Hughes, Executive Vice President and General Counsel,
American Council of Life Insurers.............................. 31
Prepared statement........................................... 78
Additional Material Supplied for the Record
Letter submitted by the National Association of Insurance
Commissioners.................................................. 91
Statement submitted by Peter J. Wallison, Arthur F. Burns Fellow
in Financial Policy Studies at the American Enterprise
Institute...................................................... 94
Statement submitted by Aaron Klein, Director of the Bipartisan
Policy Center's Financial Regulatory Reform Initiative......... 100
Report submitted by the Bipartisan Policy Center................. 106
Letter of dissent submitted by Benjamin M. Lawsky, Superintendent
of Financial Services, New York State Department of Financial
Services....................................................... 122
Roy Woodall and John Huff dissents on Prudential................. 127
Roy Woodall and Adam Hamm dissents on MetLife.................... 140
Statement of the National Association of Mutual Insurance
Companies...................................................... 153
Statement submitted by Stephen D. Steinour, Chairman, President,
and CEO, Huntington Bancshares, Inc............................ 159
(iii)
FSOC ACCOUNTABILITY: NONBANK DESIGNATIONS
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WEDNESDAY, MARCH 25, 2015
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 2:01 p.m., in room SD-538, Dirksen
Senate Office Building, Hon. Richard Shelby, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman Shelby. The Committee will come to order.
Today, the Committee will examine how the Financial
Stability Oversight Council, or FSOC, designates certain
nonbank companies as ``systemically important.'' First we will
hear testimony from Treasury Secretary Jack Lew, who chairs the
FSOC. We will then turn to a panel of experts.
Dodd-Frank established FSOC to identify and mitigate risk
to the financial stability of the United States that may arise
from the material financial distress of bank holding companies
or nonbank financial companies. There is no precedent in our
regulatory regime for a Council like this. Further, when you
give such a body extraordinary powers, those powers must be
exercised with requisite care.
The Council has the authority to designate a nonbank
institution as ``systemically important'' and subject it to
enhanced prudential standards and regulation by the Federal
Reserve. This new layer of regulation does not come without a
cost to our economy. Enhanced prudential requirements impose
significant costs on banks and nonbank entities.
Because much rests on an institution's designation, I
believe that FSOC has a heightened duty to be as transparent
and judicious as possible. However, FSOC's previous
designations have been criticized for lacking transparency,
failing to produce clear indicators to guide others, and merely
following the international regulatory bodies. If such
criticism has merit, Congress should be concerned because this
is not how a regulatory regime ought to function.
Our regulators should be transparent, issue clear guidance,
and be free from the undue influence of international bodies.
The Financial Stability Board, or FSB, is one such
international body that monitors and makes recommendations
about the global financial system. The FSB, however, is not a
U.S. regulator, and it is not accountable to Congress or to the
American people.
Nonetheless, two out of the three insurance companies that
FSOC has designated as ``systemically important'' were first
designated by the FSB. I believe this creates a regulatory
conflict because 3 of the 10 FSOC voting members--Treasury, the
Fed, and the SEC--first engage at the FSB level to determine if
a U.S. company is systemically important.
When they return to the U.S. and supposedly engage with the
rest of the Council to consider whether a company is
systemically important, they have for all intents and purposes
already, I believe, made up their minds. I think we must ask if
the influence that the FSB seems to exert over the FSOC's
process is real and whether it is appropriate. FSOC designation
process has little merit if it is merely used to justify an
international organization's determination, rather than engage
in an independent analysis.
Moreover, given that the designation is a determination of
risk to the U.S. financial system, I think it should ensure
that the steps to mitigate that risk are identified and
articulated before a company is designated.
While it has announced a series of steps aimed at
increasing transparency, most critics do not believe that such
efforts sufficiently address the concerns that have been
raised. We must, therefore, ask the following questions:
First, has FSOC clearly disclosed what factors make a
company systemically important and the relative weight it has
assigned to those factors?
Second, is it clear what needs to occur to reduce the
systemic risk of such a company? In other words, does a company
know how to avoid designation to know how to be undesignated?
Third, is the designation process sufficiently open,
objective, data-driven, and free from the influence of outside
organizations? Today's panels will hopefully shed some light on
these questions as the Committee considers whether changes to
this process need to be made.
At this point, without objection, I would like to enter
into the record statements from the National Association of
Insurance Commissioners; Mr. Peter Wallison; the Bipartisan
Policy Center, including its report entitled ``FSOC Reform: An
Overview of Recent Proposals''; Mr. Benjamin Lawsky,
Superintendent of New York State Department of Financial
Services, regarding the MetLife designation; dissents of Mr.
Roy Woodall, independent member having insurance expertise on
that; Mr. John Huff and Mr. Adam Hamm, State Insurance
Commissioners representatives regarding the MetLife and
Prudential designations.
Today's hearing will be compromised of two panels. The
first panel will be the Treasury Secretary, Jack Lew, who also
chairs the FSOC.
Mr. Secretary, at this point we want to welcome you to the
Committee. You are no stranger here. Your written testimony
will be made part of the record, and we look forward to having
a chance to talk with you.
Senator Brown has joined us. Any statement you want to
make?
STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. I am sorry, Mr. Chairman. I did not hear
your opening statement, but it is good to be here. Thank you so
much.
Secretary Lew, welcome, and to the second panel, thank you
also for joining us.
As one of our witnesses on Tuesday pointed out, regulators
did not exactly cover themselves in glory leading up to the
2008 financial crisis. Congress certainly played a role as
well. We had a patchwork financial framework that allowed
financial institutions to evade oversight and often pitted
regulators in a race to the bottom. Nonbanks like AIG and Bear
Stearns built up risks by moving activities to unregulated
space. American taxpayers paid the price in lost homes and jobs
and billions of bailout dollars. My wife and live in a zip code
in Cleveland, Ohio, that had the highest rate of foreclosures
of any zip code in the country several years ago.
Secretary Lew's predecessor, Secretary Geithner, proposed
the FSOC to fill gaps in the regulatory framework and create a
forum for agencies to resolve issues. The idea had the support
of appointees of President Bush and of President Obama.
FSOC is working. If anything, it is working too slowly.
Since FSOC's creation 5 years ago, it has only designated four
nonbanks as ``systemically important.'' By my math, that is
less than one a year. They have designated eight systemically
important financial market utilities without any objections
that I am aware of.
This is a critical responsibility given the increased
importance of clearinghouses under the derivatives clearing
mandates in Dodd-Frank. FSOC provided a forum to force reforms
to the structure of some money market mutual funds. It has been
responsive to consumer and industry groups in their concerns
about transparency. We hear a lot about transparency and
accountability because they are concepts that no one should
oppose.
But I am concerned by proposals that would tie the FSOC's
hands, making it too burdensome for FSOC to designate any
institutions, and taking us back to a time when no entity was
responsible for watching over the entire financial system. That
is why we welcome Secretary Lew to discuss that. I would look
forward to hearing about FSOC's work identifying and addressing
risks, and I appreciate the Chair calling this hearing.
Thank you.
Chairman Shelby. Mr. Secretary, welcome again to the
Committee.
STATEMENT OF JACOB J. LEW, SECRETARY, DEPARTMENT OF THE
TREASURY
Secretary Lew. Thank you very much, Chairman Shelby,
Ranking Member Brown, Members of the Committee. I appreciate
being here and look forward to my testimony today.
As everyone here today remembers well, the financial crisis
caused enormous hardship for millions of individuals and
families and communities throughout the country, and it
revealed a number of central shortcomings in our financial
regulatory framework. We saw the consequences of lax regulation
and supervision at financial firms like Lehman Brothers and
AIG, names that are now written into history as companies whose
failure or near failure contributed to the near collapse of our
financial system.
At the time, the regulatory structure was ill equipped to
oversee these large, complex, and interconnected financial
companies. This outdated structure also meant that regulators
had limited tools to protect the financial system from the
failure of these companies.
As a result, the American taxpayer had to step in with
unprecedented actions to stop the financial system from
collapsing. Congress responded with a historic and
comprehensive set of financial reforms: the Dodd-Frank Wall
Street Reform and Consumer Protection Act, which put in place
critical new consumer protections.
Equally important, this reform guarded against future
crises while establishing as a matter of law that taxpayers
never again be put at risk for the failure of a financial
institution.
To lead the effort to better protect taxpayers, Wall Street
reform created the Financial Stability Oversight Council, for
the first time bringing together in one body the entire
financial regulatory community to identify risks in the
financial system and work collaboratively to respond to
potential threats to financial stability. Over the past 5
years, FSOC has demonstrated sustained commitment to fulfilling
this critical statutory mission in a transparent and
accountable way.
The work has not been easy. We built a new organization and
developed strong working relationships among FSOC members and
their staffs to foster candid discussions, the exchange of
confidential, market-sensitive information, and to encourage
tough questions that must be addressed to make our financial
system safer.
FSOC now convenes regularly to monitor market developments,
to consider a wide range of potential risks to financial
stability, and, when necessary, to take action to protect the
American people against potential threats to the financial
system.
Our approach from day one has been data-driven and
deliberative, while providing the public with as much
transparency as possible regarding our actions and views. We
have published four annual reports that describe our past work
and future priorities. Regularly we have opened FSOC meetings
to the public. We have published minutes of all of our meetings
that include a record of every vote the FSOC has ever taken,
and solicited public input on both our processes and areas of
potential risk.
I and the other members nonetheless recognize that FSOC is
a young organization that should be open to changes in its
procedures when good ideas are raised by stakeholders. Just
over the last year alone, FSOC has enhanced its transparency
policy, strengthened its internal governance, solicited public
comment on potential risks from asset management products and
activities, and adopted refinements to its nonbank financial
company designation process.
I believe that our adoption of these changes to the nonbank
financial company designation process represents the right way
for FSOC to refine its processes without compromising its
fundamental ability to conduct its work.
After extensive stakeholder engagement, FSOC adopted
supplemental procedures last month under which companies will
know early in the process where they stand, with earlier
opportunities to provide input. The changes will also provide
the public with additional information about the process while
still allowing FSOC to meet its obligation to protect
sensitive, nonpublic materials.
And, finally, FSOC will provide companies with a clearer
and more robust annual review process. This will open the door
to more engagement with FSOC following a designation to make
sure there is ample opportunity to discuss and address any
specific issues that a company wants to put before the Council.
These changes strengthen the FSOC process while also addressing
many of the suggestions made from stakeholders.
On a related note, I am pleased to report to this Committee
that the vast majority of key reforms contained in Wall Street
reform are now in place due to the hard work and diligence of
the independent regulatory agencies. Today, because of the
passage of Wall Street reform nearly 5 years ago, the financial
system is more robust and resilient than it was before the
crisis. We have reduced overall leverage in the banking system.
Banks have added over $500 billion of capital since the crisis
to serve as a buffer for absorbing unexpected losses. And the
recently completed annual stress tests cover a wide swath of
institutions, illustrating that our largest banks have
sufficient capital to withstand adverse shock scenarios and
continue to lend to businesses.
The true test of reform should not be whether it prevents
firms from taking risk or making mistakes, but whether it
shapes a financial system strong and resilient enough to
support long-term economic growth while remaining innovation
and dynamic. In working toward this end, Treasury and the
independent regulators continue to carefully monitor the
effects of new reforms. Both the law and the implementing
regulations make clear that there is no one-size-fits-all
approach and that requirements must be calibrated to the
different size, complexity, and risk profile of institutions.
Just as the business environment is constantly evolving,
the regulatory community must be flexible enough to keep up
with the new challenges, including making adjustments where
necessary and remaining vigilant to new emerging threats.
Promoting financial stability and protecting the American
public from the next financial crisis should be an objective
shared by the Administration, regulators, the financial sector,
and Members of Congress regardless of party or point of view.
I look forward to working with you to make certain our
financial system becomes even more resilient and stable, and I
look forward to answering your questions.
Chairman Shelby. Thank you, Mr. Secretary.
Mr. Secretary, in Stage 2 of the designation process, FSOC
applies a six-category framework in its analysis of a nonbank
financial company. Commentators have noted that the public has
no clear understanding of the relative value or weight of these
factors.
What is FSOC doing to provide both the public and the
designated companies with a better understanding of the
relative weight of each factor? And what makes a designation
more likely?
Secretary Lew. Mr. Chairman, as you know, the process that
FSOC uses is a very transparent one. It has been published. The
criteria are out there. And each one is a separate review.
I think it is a mistake to think about a one-size-fits-all
approach because no two large, complex financial institutions
will be exactly the same. So the relative weight of factors
will be different depending on what the composition of a firm
and the nature of the risk is.
In each case, we apply the same review, which is a
deliberative review. It involves details analysis, much back-
and-forth between the firm and FSOC, and in the end hundreds of
pages of analysis published and shared with the company. And we
analyze basically three transmission channels for risk in each
case, and we go through each of those, and if there is a
determination that there is systemic risk, as the statute
requires, we make a designation. But----
Chairman Shelby. Do you go through those risks with who you
are thinking about designating? Or do you just do this
internally?
Secretary Lew. Well, there is a lot of back-and-forth
between the firm and the FSOC, and based on the new procedures
we have put in place, it will be somewhat more formal. But I
want to be clear: Even before the rules change, there was a lot
of back-and-forth between the firms and FSOC already. So it is
not that there was not thousands of pages of data and analysis
provided.
Chairman Shelby. It is my understanding that multiple
members of FSOC have submitted additional recommendations for
improving transparency, which you mentioned, and
accountability. What additional recommendations were submitted
by members but not incorporated, in other words, you considered
and did not incorporate? And what additional recommendations
will FSOC adopt next and when?
Secretary Lew. Well, Senator----
Chairman Shelby. Is that too soon to tell?
Secretary Lew. I was going to say, over the past year we
have made two rounds of changes, which I think represent a
consensus of the changes that we needed to make and actually
reflect the views expressed by many Members of Congress and
parties, stakeholders as well.
We are going to continue to look at ideas that come forward
and have not in any way ruled out taking further action. But I
think that we ought to let the changes that we have made settle
in so that the parties can deal with the system as it now
stands. But we welcome an ongoing discussion, and as I think
the actions show, we have made changes when they seem
appropriate.
Chairman Shelby. Mr. Secretary, it would seem to me that in
order to properly assess if FSOC's designations are, in fact,
reducing threats to our financial system, the FSOC would need
to know what regulations and standards the Federal Reserve will
impose on the designated companies. In other words, how can
FSOC designate a company if the Fed has yet to promulgate rules
to regulate such a company? Do you follow me?
Secretary Lew. I do follow you, but, Mr. Chairman, as the
statute requires, FSOC has to make a determination as to
whether or not there is systemic risk. The task of supervisory
responsibility goes to the Fed. The Fed is in the process of
implementing those rules, and obviously Congress has now
enacted some legislation that gives them greater flexibility to
adopt rules that distinguish between, say, insurance companies
and traditional financial institutions.
So I think that the process is moving sequentially, and as
the firms have to comply, that process will unfold in an
orderly way. But it is the Fed's responsibility going forward.
Chairman Shelby. My follow-up question here would be: How
can FSOC determine that it is reducing systemic risk when it
has, one, neither identified the specific activities that
create systemic risk or, two, has the knowledge of what
regulatory steps would be taken to mitigate such risk?
Secretary Lew. Well, the task of going through the analysis
to determine whether there is a systemic risk is the
responsibility of FSOC. By designating the firm, the firm then
is subject to supervision under the statute by the Fed. I think
that process is one that makes our system safer. I have
confidence that the Fed will take that responsibility very
seriously.
Chairman Shelby. But has the Fed done that yet?
Secretary Lew. They are in the process of working it
through.
Chairman Shelby. So they have not done it yet.
Secretary Lew. No firm has had to go through the process of
actually submitting all of the documentation through the
process. They have been designated, and now there is a time
where the Fed will put in place the rules that they comply
with, and they will then comply.
So I think some of this is a bit--it is a young
organization. We have just designated the firms, and it is
happening in proper order and due course.
Chairman Shelby. Are you building the cart before you buy a
horse here?
Secretary Lew. No, I do not think so, Senator. I think that
the task that was given to FSOC, which no entity in the Federal
Government had prior to the creation of FSOC, was to look
across the spectrum: Where is the risk of the future possibly
going to come from? The designation process was given to FSOC.
The actual regulatory supervision is not--FSOC does not do that
directly. So I think it is working in the right order, and I am
not sure how to take the cart and the horse metaphor, but you
need a cart and you need a horse, and----
Chairman Shelby. Well, what do you need first?
Secretary Lew. You need both.
Chairman Shelby. Yeah, but a cart without the horse is not
going very far, is it?
Secretary Lew. I think I have a lot of confidence that the
Fed has a lot of experience with supervisory matters, and they
are going through this in an orderly way to make sure that it
is done in an appropriate way.
Chairman Shelby. Senator Brown.
Senator Brown. Thanks, Mr. Chairman.
Mr. Secretary, you know this Committee has been discussing
and improving regulation for credit unions and community banks.
I have said that we on this side will support ideas that have
broad bipartisan consensus. One issue as an example is the
written privacy notice requirement if a policy has been
changed.
Today the House Financial Services Committee is marking up
a set of proposals. Tell us what you think about the proposals
they are marking up, particularly those that would roll back
some of Dodd-Frank's consumer protections.
Secretary Lew. You know, Senator, I think that if you look
at the financial crisis and where the kind of root cause of the
financial crisis was, a lot of it started with individuals
entering into mortgages that were being sold to them on terms
that could not be understood by a normal human being getting a
mortgage. And then the financial crisis hit, and all these
mortgages were exploding.
We have created a set of protections for consumers now
which I think will make it almost impossible for that to happen
again. We have much clearer documentation. We have much simpler
documentation. We have more disclosure. We have prohibitions on
some of the most dangerous practices, you know, things that--
the low-doc, no-doc loans and, you know, balloon payments that
you could not really see that were in the documents.
And I think if you take away those kinds of consumer
protections, you are exposing individuals to a great deal of
risk, which is one problem. You are also reopening the
possibility of a broader set of systemic risks.
So I think that these are important things that we have
accomplished through Dodd-Frank and the implementation of Dodd-
Frank, and, you know, the Consumer Financial Protection agency
has done, I think, a tremendous job taking these issues and
putting them in place in a way where actually, as you talk to
people in the industry as well as consumer advocates, there is
a lot of respect for the way a lot of that was done. And I
think, you know, rolling that back would be a mistake.
We have made clear that any amendments to Dodd-Frank that
undermine the core provisions of Dodd-Frank are just not going
to be acceptable, and I certainly hope that as the Congress
proceeds, it is with a spirit for strengthening financial
protection, not weakening it.
Senator Brown. Thank you, and that is why I am hopeful in
discussions on this Committee that we come together in a way
that there really is bipartisan consensus not to score
political points but to really fix some of the more minor parts
of Dodd-Frank on which we have agreement. So thank you for
coming today.
Let me talk about yesterday and some other discussions we
have had. The Committee has talked about the $50 billion
threshold for the Fed's enhanced prudential standards for bank
holding companies. What have you heard from industry? Do you
believe the agencies can tailor these regulations to address
these concerns? Do you believe that we should?
Secretary Lew. Senator, I believe that the law was written
with a great deal of flexibility, and it has been implemented
with a great deal of flexibility. It is not a one-size-fits-all
approach. I think that $200 million financial institutions are
different than $50 billion institutions, which are different
from $2 trillion institutions.
You know, I think if you look at the work that the
regulators are doing, they are open to the ideas of using that
flexibility to provide the kind of nuanced approach that the
law envisioned.
I think it is premature to legislate in this area because I
think there still is regulatory flexibility, and the regulators
have shown a desire and an interest in using that flexibility.
I would also say that we have to be careful to assume that
there is only risk above a certain size. We have seen financial
crises come from large institutions, and we have seen them come
from smaller institutions. And we should not be overregulating
small institutions that do not present risk. But if there are
issues of risk, we ought to not just say that because an
institution is X dollars that risk is not there.
Senator Brown. Thank you. One final issue. Last year, we
discussed concerns that I and a number on this Committee had
about financial deregulation and disarmament, if you will,
through international agreements. I am especially worried that
including financial services in the TTIP, the Transatlantic
Trade and Investment Partnership, could undermine U.S.
financial regulations. Last year and in your testimony before
the House Committee last week, you stood firm in not including
financial services in TTIP. I urge you to continue that
advocacy in international negotiations to preserve our
regulators' authority to do whatever is necessary to make sure
that this financial system, which you have worked so hard to
make safer and sounder, will--you will be consistent in that.
Secretary Lew. Senator, I can assure you that I have
reiterated that view with the new leadership in Europe. They
have changed over who is responsible for this. I met with Lord
Hill recently. So I have reiterated our very strong view that
prudential regulation ought not to be subject to review in a
trade context.
Chairman Shelby. Senator Corker.
Secretary Lew. On the other hand, we do believe market
access is an appropriate issue to be addressed in the trade
context.
Chairman Shelby. Senator Corker.
Senator Corker. Thank you, Mr. Chairman. I appreciate it.
Mr. Secretary, thank you for being here and for your service.
Let me ask you, would you consider Freddie and Fannie or
GSEs to be systemically important?
Secretary Lew. Senator, I think that there is no doubt but
that when you look at the financial crisis in 2007-08, they
were----
Senator Corker. A ``yes'' will work.
Secretary Lew. The question of using a label until it has
been reviewed is one I am going to avoid.
Senator Corker. I do not mean definitionally, but it is
certainly systemically very important. Is that correct?
Secretary Lew. I think there is no doubt that the GSEs were
at the heart of the last financial crisis.
Senator Corker. And at present, we are in essence
controlling 100 percent of them. We are guaranteeing every
single security, our Federal Government is, that they offer. Is
that correct?
Secretary Lew. Well, as long as they are in
conservatorship, yes.
Senator Corker. And as I understand it, the administration
has no plans whatsoever to sell off our preferred shares and
IPO them. You are waiting for Congress to act. Is that----
Secretary Lew. Well, Senator, as you know, we worked
closely, as you and others were developing legislative
proposals in this area. We believe it is important for there to
be legislation, and GSE reform can only really happen properly
through legislation. We are using the tools we have to manage
effectively in the interim, but I think taxpayers are exposed
to the risk still.
Senator Corker. A hundred percent.
Secretary Lew. And GSE reform is the answer to it.
Senator Corker. And every single security they issue, the
taxpayer is on the line for, right? Because we are standing
behind what they are doing. They could not sell a security
without the eagle stamp. Is that correct?
Secretary Lew. Now, I will say that they are under
heightened supervision compared to before the financial crisis,
so the practices are different, and a lot of the laws that we
have put in place and the FHFA oversight is meaningful. But
fundamentally, as long as they are in conservatorship, there is
a guarantee.
Senator Corker. So we certainly have an explicit, explicit,
explicit guarantee because we as taxpayers are guaranteeing
everything they are doing.
Secretary Lew. And I know that I do not need to tell you
this because you put so much time and effort into the issue of
housing finance reform, but the process of defining what
exposure the taxpayer has would limit and contain that risk in
a way that it is not without legislation.
Senator Corker. So, in essence--you sure are taking a lot
of my time with your answers. In essence----
Secretary Lew. I was trying to compliment you.
Senator Corker. Thank you. I do not need it.
[Laughter.]
Senator Corker. So, you know, in essence, while we do not
act, we continue to have a huge liability. And for those who
are worried about guarantees, we have the maximum guarantee we
could possibly have right now because we are guaranteeing every
single thing that they do. And we need to move ahead to deal
with that, or we keep this liability on our books. So I
appreciate that.
Let me ask you another question. Forget yourself. The
FSOC--I know we all debated this FSOC being set up, and I know
that you are getting some questions from the Chairman and
others, questions that I have also about de-designation and all
of those kind of things.
Do you think it would be better, as you sit where you are--
you are part of an administration, have not been exactly high
levels of cooperation between the branches. Would it be better
if we had someone who was not a political appointee as head of
FSOC, somebody that truly was more independent, and when that
calls it over time--forget yourself. I am sure you believe you
are 100 percent independent. But in the future, would it make
any sense for us to consider someone other than the Treasury
Secretary being the head of FSOC? And keep it fairly short, if
you will.
Secretary Lew. If you look back before FSOC, there was no
mechanism to have the kind of conversations we have now. You
look at how much progress we have made in a fairly short period
of time, and you look how central the players are, including
the Treasury Secretary, to this process, I think bringing
somebody independent in to do it is not necessarily going to
lead to a better, more cohesive result.
Coordinating independent regulators is going to be a
challenge for whoever chairs the Commission because they each
have an independent charter and they each have independent
responsibilities. And, you know, I may bring my own unique
perspective to this, having been in a coordinating role in
other jobs. I think it behooves whoever is Chair, whatever
their position is, to be respectful of that independence, but
also driving toward a common understanding of where risks are
and what actions need to be taken. And I am actually pretty
proud of the work that FSOC has done in a short period of time.
So I would not be in a rush to make a change like that.
Senator Corker. If I could just say one last thing, Mr.
Chairman, I believe that America should honor its commitments,
and I think when we do not do that, we undermine ourselves. And
as you know, I have supported us carrying out the IMF reforms
that actually began under George Bush that you all have
followed through with--or actually have not, and that is the
point I want to make. I support those. We have tried to work
with the administration to make those happen and just have
found it difficult to get the administration to make one phone
call in some cases to work out something where Republicans and
Democrats could agree with IMF reforms.
I got a letter from you in the last couple days where you
said--insinuated that we could do away with the NAB, the line
of credit, if we could actually put our quota in place, and I
think that would be very helpful if you all would proffer that
as a real proposal. But I just have to tell you, as I watched
the Asian--the AIIB being formed--I know they have been looking
at it for a decade. I got it. But I just think this
administration's inability--inability--to competently move
ahead and put the Senate and the House in a position to put
those reforms in place, because you do not really pursue it
aggressively, you do not do the things that you need to do to
sell it, I think it damages our country. And I think we are
seeing it play out right now, and I could not be more
disappointed. And even though I agree with you on the reforms,
I just do not think you all are carrying out your
responsibilities appropriately.
Secretary Lew. Mr. Chairman, may I just respond briefly?
Chairman Shelby. Go ahead.
Secretary Lew. Senator, I know that you and I agree on the
critical importance of the IMF reforms being approved. I
obviously do not agree with your characterization of the
administration's efforts. I think we have been pursuing this
zealously. It should have happened a long time ago. It should
never have been tied to unrelated extraneous political issues.
And I think there is a growing understanding now with the Asian
Infrastructure Bank's formation of how much it weakens the
United States that we have been unable to ratify the IMF
reforms, which do not actually commit new resources; it just
shifts resources from the New Arrangement to Borrow into the
capital fund.
I remain optimistic that we can get it done. We are
continuing to press forward. We will continue to press forward.
And I think I have made every phone call anyone has even
thought about, much less suggested. You know, it has not been
for lack of contact. It has not happened yet. It needs to
happen, and it needs to happen in a bipartisan way because it
is in our country's interest. It hurts the United States every
day that it is not ratified.
Chairman Shelby. Senator Warren.
Senator Warren. Thank you, Mr. Chairman. Thank you for
being here, Mr. Secretary.
You know, a company does not need to be a bank to pose a
serious threat to the financial system and to the economy. AIG,
Lehman Brothers, Bear Stearns--we learned that lesson the hard
way during the financial crisis. And that is why Dodd-Frank
gives the Financial Stability Oversight Council the authority
to designate nonbanks as ``systemically important'' and subject
them to extra scrutiny by the Federal Reserve.
Now, the whole point of the FSOC designation process is to
make the financial system safer, and one way it does that is by
imposing higher capital standards and greater oversight on
systemically important companies.
But the other way it can make the system safer is by
providing an incentive for designated companies to change their
structure or their operations so they can reduce the risks that
they pose and change their designation and the amount of
oversight that they require.
In many ways, the second outcome is even more desirable
than the first because it would allow businesses to find the
most efficient way of reducing the risks that they pose to the
economy.
Secretary Lew, do you think the FSOC designation process
currently provides companies with the information and the
opportunities they need to make changes in their business
activities and potentially reverse the designation as
systemically important?
Secretary Lew. Senator, I do. I think if you look at the
designation process, there is a huge amount of information that
goes back-and-forth between the companies and FSOC, and then
there are several hundred pages of analysis which shows where
the risk transmission is and what it is related to.
For most of these firms--let us leave the market utilities
to the side; they are kind of a special case. But for the
complex financial firms that have been subject to designation,
they have inherently complex business structures. So it is not
necessarily an easy thing to unpack what it would take for them
to become--to de-list. But they know--they know what it is that
creates the basis for the designation, and----
Senator Warren. Good. And----
Secretary Lew. ----every year they are reviewed, so it is
not like you are designated and we never look again. It is an
annual review.
Senator Warren. Well, let me just ask then about how
collaborative the process is. Can companies meet periodically
with FSOC staff? Can they appear before the full Council to
discuss possible approaches to deleveraging their risk?
Secretary Lew. Well, to date, the appearances before the
Council have been at an appeals stage after the designation was
initially put before the Council. So it is not an ongoing
contact. There is ongoing contact between the firms and the
FSOC staff, which I think is appropriate.
Senator Warren. All right. And I just want to be clear on
this, because I want to make sure nobody has any doubts about
how this works. Is FSOC willing to reverse the designation of a
company if it finds that the company no longer poses systemic
risk?
Secretary Lew. That is what the annual review process is
all about. Every year you have to make the determination again.
Senator Warren. So use the magic word here: Yes?
Secretary Lew. Yes.
Senator Warren. Yes. Good, good. I know that Dodd-Frank
also permits FSOC to designate specific activities that
companies engage in rather than specific companies as posing
significant risks. Is FSOC open to the possibility of reversing
designation of a company as high risk and instead designating
only certain activities within the company that the company
engages in as risky?
Secretary Lew. Well, I am going to have to say that I am
not sure I understand what the process that you are describing
is. The designation authority applies to the firm. When we are
doing an activity review----
Senator Warren. Well, let me just make sure that we are on
the same wavelength on the question. Dodd-Frank also permits
not just the designation of a whole firm, but not designating
the firm and focusing on a specific portion, a specific
activity that the firm engages in.
Secretary Lew. So in our review, for example, of asset
managers, we put out a public notice where we ask for comment
on our inquiry into an activity review of those firms. We have
not yet completed that, so I do not know what form an action
would take, if there were any action required. I am also not
sure it would be FSOC as opposed to regulatory agency action
that would flow from that.
So I think it is hard to answer the question in a simple
yes-or-no way. We have gone through the designation process for
firms. We have never designated an activity that I am familiar
with.
Senator Warren. All right. It is simply a reminder. Dodd-
Frank gives you a lot of flexibility in these circumstances.
And if you need it, I just want to be sure that you are there
to use it when appropriate.
Secretary Lew. And we think it is very necessary to be
looking at activities, which is why we have opened up in the
asset manager area the activity review, because, frankly,
starting by looking at firms, it seemed like we might miss
where the real risk was if we did not look at the activities.
Senator Warren. So the FSOC designation process is
critically important to ensuring the safety of our financial
system and guarding against another crisis. I think it is
important to recognize that designation can achieve that out by
encouraging companies to change their structure or the
operations. I am glad FSOC is committed to working with
companies to make sure that they can accomplish that
alternative results. Thank you, Mr. Secretary.
Chairman Shelby. Senator Cotton.
Senator Cotton. Thank you, Mr. Secretary, for your time
today. I want to follow up on Senator Warren's line of
questioning about the FSOC designation process. You said that
FSOC can reverse a decision at its--I think you said the annual
review.
Secretary Lew. Each of the designations is subject to an
annual review after designation, so we have to officially act
on that annual review.
Senator Cotton. And you have not done that yet, have you?
Secretary Lew. Well, we have on a number, but it is
obviously very early in the process to be going--we have only
had the first annual review.
Senator Cotton. So rather than the FSOC changing,
modifying, or reversing a decision, what if the designated
institution simply disagrees? What recourse does it have?
Secretary Lew. Well, institutions have multiple points of
recourse. At the point of designation, they can appeal to the
Council itself, and they have recourse to the courts if they
continue to want to pursue their appeals.
Senator Cotton. So as with any traditional agency decision,
an institution designated as systemically important could just
use the Administrative Procedures Act to appeal to a Federal
court?
Secretary Lew. They can go to court to challenge the
determination, yes.
Senator Cotton. Has that happened yet?
Secretary Lew. There is one pending appeal.
Senator Cotton. OK. Thank you.
The Financial Stability Board, are its decisions binding on
the United States?
Secretary Lew. The Financial Stability Board is a
deliberative body that sets goals that countries aspire to, but
it does not make policy for any of the constituent countries.
Each of us has our national authorities that make decisions for
the companies that we are responsible for in the economy that
we are in.
So we make at FSOC the decision to designate a firm. The
FSB cannot designate a firm for us.
Senator Cotton. Is there an instance in which FSOC has
deviated from the FSB's statements or policy----
Secretary Lew. I would have to go back and check.
Obviously, there is a limited amount of history here because
both are relatively new organizations. But I would be happy to
get back to you.
Senator Cotton. OK. So the FSOC has issued a notice asking
for comments about whether asset management activities can pose
systemic risk. I believe that closes out today.
Secretary Lew. I believe today is the deadline.
Senator Cotton. The FSB has moved forward, though, with a
proposal that seems to make a number of assumptions that SIFI
designation of asset managers or funds is a virtual foregone
conclusion. Would you explain, you know, the FSB's announcement
and, given the tendency of the FSOC to follow FSB, whether or
not this is already a foregone conclusion?
Secretary Lew. No. I mean, I can tell you that there is no
foregone conclusion of what the action at FSOC will be. I think
if you look at the course that we have taken as we have looked
into asset management, it has reflected what I think is the
right approach, which is to be data-driven and analytically
driven. As we went through the process of thinking about doing
it on a firm-by-firm basis, we came to the conclusion that we
thought an activities review was the better way to put most of
our current energy. We have reserved the right to go to firms.
We have not said we are going to go one way or the other. But
we indicated that we are putting additional resources into the
activity review. The notice that you are describing was the
outgrowth of that discussion. We have not yet even gotten all
the comments. So I would never prejudge what our action is
until we have done a complete analytic review.
Senator Cotton. OK. While I have you here, I want to ask
you a question about Iran and specifically Iran sanctions.
Ayatollah Khamenei over the weekend said that all sanctions
must be lifted immediately for there to be any agreement with
the P5 plus 1. Could you explain to us the administration's
position relative to that statement?
Secretary Lew. I think that we have been clear that our
sanctions will remain in place until we reach an agreement and
will not be removed unless we reach an agreement that assures
us that Iran will not be able to get nuclear weapons.
Obviously, there is a negotiation going on, so there is not yet
an agreement to describe, and I cannot tell you whether it will
reach a positive outcome. But I can tell you that there will
not be any lifting of sanctions if we do not get an agreement
that assures us that Iran will not get nuclear weapons.
Senator Cotton. Well, he had said that for there to be an
agreement, sanctions must be lifted. In fact, I think his exact
words were, ``The lifting of sanctions is part of the
agreement, not the outcome of the agreement.''
Secretary Lew. Sanctions have always been a means to an
end. The goal is to stop Iran from getting nuclear weapons. The
time at which sanctions will either be suspended or terminated
is subject to negotiation, but it is conditional on reaching a
successful end, which means that Iran cannot have nuclear
weapons. And that is what they are in place for, and they will
not be removed if we do not get that assurance.
Senator Cotton. Subject to negotiations is also subject to
congressional action since this Congress created the sanctions
in the first place?
Secretary Lew. I think the termination could only be done
by congressional action. Obviously, they are implemented
pursuant to Executive authority, and there could be a
suspension without congressional action but not a termination.
Senator Cotton. How long do you think the President has the
authority to suspend those sanctions?
Secretary Lew. I am not aware of its conditions based on a
time basis, as best I understand.
Senator Cotton. All right. Thank you. I am over my time.
Chairman Shelby. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. I am tempted
almost to follow on that line of questioning, but I am not.
As we saw in the financial crisis, risk can build anywhere
in the financial system regardless of the types of entities
involved or the jurisdictional boundaries of regulators. And
the Wall Street Reform Act established the Financial Stability
Oversight Council to identify financial stability risk that may
be building in the shadows and bring them to the light to
improve coordination and fill in any gaps in supervision. And
its most important tool is its power to designate nonbank
financial companies for enhanced supervision and regulation.
And that is a tool that is both powerful but also one that
needs to be appropriately used. So let me ask you some
questions in this regard. I want to follow up Senator Warren's
just to make sure I understood your answer.
Earlier this year, FSOC announced an updated procedure for
considering possible nonbank SIFI designations, including more
engagement earlier in the process when a company is under
consideration. So the question is: When FSOC is considering a
company for possible designation, to what extent does the
updated process allow for a discussion of steps the company can
take if it wants to avoid a designation, for example, by
reducing its size or modifying its activities?
Secretary Lew. Senator, there is enormous back-and-forth
between the firms and FSOC as we go through the analytic
process. I think that the revised procedures formalize some
things in a way that is helpful, but it was the case before we
changed the rules and it is certainly the case going forward.
In the exchange, the analysis of where the risk
transmission channels are is discussed. There are very
different views presented sometimes by the firms in terms of
ways to analyze it. As you analyze where the risks come from,
it also shows you, you know, what it is about the structure of
the firm that is giving rise to the designation.
It is often in the case of a complex financial firm, the
inherent business model, you know, that is the issue. So while
there is a path for understanding it, it may or may not be
attractive to change some of the basic structure.
Senator Menendez. But if it is not just the entirety of a
business model that has to be changed, but if, in fact, a
particular size is the trigger that FSOC is looking at, or if
it is particularly an individual or series of activities, is
there an opportunity for the company, if it chooses to do so--
it may not. It may choose to refute your assertion of them
being systemically risky. But is there an opportunity for them
to modify their activities or size based on its engagement with
FSOC where the Council would take into account those steps----
Secretary Lew. Sure.
Senator Menendez. ----if the company sought to do so?
Secretary Lew. Yeah, I mean, it is not--as I said to
Senator Warren, it is true not just in the initial review
process, but each year there is an annual review of a
designated firm, and if a firm changed its business model, its
structure so that the risk issues had changed, that could give
rise to a de-listing, having the designation removed.
Senator Menendez. Is it possible before--let us say you
have not designated a company yet, and you identify that, in
fact, here is why we are looking to--we may be listing you, can
the company before you get to that point say, ``Well, wait a
minute. If you think X, Y, or Z activity is what is going to
create systemic risk, then I want to be able to change the
course''?
Secretary Lew. I think it would theoretically be possible.
Obviously, as a theoretical matter, it is different than in the
real world.
Senator Menendez. I am not looking for theory. I am looking
to know if, in fact, there is--what is the use of engaging with
a company if it is not to both come to a conclusion as to
whether it is systemically risky, what activities are
systemically risky, and if it wishes to avoid the designation
because of the consequences that flow from that, give it the
opportunity to do so? To me, that is not theoretical. It just
makes common sense.
Secretary Lew. So if I can just take one step back, the
designation is rarely related to one specific marginal
activity. I am not aware of any designation that turns on one
marginal activity. It is looking at the entirety of a complex
financial institution's actions and the risks created.
In the course of that discussion, the firms understand what
it is that is being looked upon as the source of risk. They
have the opportunity to offer evidence, A, to contradict that
view and to challenge it and give rise to us reaching a
different conclusion. And they would also have the ability to
change the nature of their business to eliminate the source of
risk. And the thing that I am trying to be clear about is that
it is not that there is--it would be a mistake, I think, to
have kind of a notion of this being a mechanical, mathematical
process where there is a number that determines where the risk
is. It is a much more complicated review process in there. That
is why there is a several-hundred-page analysis that supports
the designation. It is not just a mechanical, arithmetic
exercise.
Senator Menendez. I get it. I think there is a--one final
question, if I may. To the extent that FSOC is considering
designating an entity as a nonbank SIFI, a company from a
different industry or with a different structure from previous
designees or companies historically regulated by the Federal
Reserve, what step is the Council taking with the Fed to refine
what the consequences of designation would be? And how is the
FSOC working with the Fed to make sure its rules and
supervision are properly calibrated to the risks identified by
FSOC and appropriately tailored to the type of firm that is
being proposed to be covered?
Secretary Lew. Senator, I think that the Fed has a fair
amount--some flexibility within its existing authorities and
with the enactment of legislation, the Collins amendment, they
now have additional authority to come up with capital standards
that are appropriate for insurance companies, say. And I think
it is important that they have the flexibility to do it in a
way that is sensible in supervising institutions that have
different characters. I do not believe that there are--or one-
size-fits-all solutions and the flexibility to treat companies
of different size and of different characters differently is a
good thing.
Senator Brown. [Presiding.] Senator Heller.
Senator Heller. Thank you very much to the Ranking Member.
I am just pleased that there is not a nonsourced inaccurate
chart here today.
Senator Brown. Your jokes are better all the time, Senator
Heller.
[Laughter.]
Senator Heller. Mr. Secretary, thank you for being here,
and thank you for your time.
Secretary Lew. Nice to be here, Senator.
Senator Heller. And thanks for your expertise and for
everything that you do.
Some of the changes that FSOC made recently for these
institutions, obviously like everybody here in this room, they
are certainly hearing a lot from their small banks, their
medium-sized, the regional size, and obviously the big banks
out there. And some of the changes that you did make there, I
think it is moving in the right direction.
Secretary Lew. Thank you.
Senator Heller. And I think others are saying the same
thing, that these are good movements, going the right
direction. Can I ask you just a series of questions to ask you
a little bit more about some of these changes so that when I
get these phone calls, I can answer certain questions?
Secretary Lew. Sure.
Senator Heller. The first one has to do with Stage 2
designation. The changes that you made with FSOC, will it now
provide a financial institution under consideration access to
all that information before the Stage 2 review? In other words,
will they know what the criteria is for Stage 2 review?
Secretary Lew. Senator, I think that the general criteria
are clear to all the firms. They are laid out in the rules that
were adopted by FSOC. They are not kind of simple, quantitative
lines where you are above or below, it is on or off. And I do
not think that would be appropriate because there are no two
firms that present with exactly the same risk profile. So there
are different kinds of firms, and these are complex financial
institutions. So it is an iterative process. It is a
conversation.
What is consistent is that the analysis is done to look at
the different risk transmission channel mechanisms, and the
firms very much understand the analysis that we are doing and
what factors influence that analysis.
Senator Heller. Did the recent changes change any of the
criteria for Stage 2?
Secretary Lew. It changed the process, not the substantive
criteria.
Senator Heller. Can you say the same thing is true at Stage
3?
Secretary Lew. Well, these were just process--these were
not meant to be substantive changes in the sense of what the
standards for review are. It was meant to open--it was to
address the concerns that firms had, that they wanted to have
more interaction in a more formal way earlier in the process.
Senator Heller. Did any of these changes say that FSOC
would provide the primary regulator of any financial
institution its full nonpublic basis for designation before
FSOC actually voted on it?
Secretary Lew. FSOC has its own independent
responsibilities. It consults broadly. It hears from primary
regulators. It hears from interested parties. And in the end of
the process, it issues a public statement that is rather
lengthy. It is like 30, 40 pages of what the basis is. And the
party gets hundreds of pages which they are obviously----
Senator Heller. Is that before or after the designation,
though? Before or after the designation?
Secretary Lew. Well, they see the review in its final form
after, but they are very much aware of the analysis during the
process.
Senator Heller. Some of these changes that you made
recently with the FSOC, are they nonbinding? In other words,
can this change in the future?
Secretary Lew. Obviously, rules that are made can be
changed. We changed them, I think as you indicated, to respond
in what I think is an appropriate way to comments that we
received. I think that the effort to make the process more
transparent is a good one. I do not think there is going to
be----
Senator Heller. I do, too, by the way.
Secretary Lew. And I do not think that there is going to be
any meaningful pressure to go the other way. So while as a
technical matter, you know, just like Congress can change the
law, the Council can change its procedures. But there is no
intention here to be going back and forth.
It is a young organization, 5 years old. It was a good
process from the beginning. It has been made stronger. And, you
know, I would say that the only changes that I would anticipate
are ones that were further refinements and improvements. I just
do not hear any debate about kind of going back.
Senator Heller. I am running out of time, but just real
basically, what I am hearing and what the concerns of these
financial institutions are is that they do not know if there is
an off ramp. In other words, once you are designated, is there
a way to get out? They are not certain that there are criteria
out there today that they can look at--actually, they do not
know what the criteria are to getting designated, let alone how
to get out once they are designated and if they are designated.
Do you believe you are closer to answering that question with
these new changes?
Secretary Lew. Well, Senator, I have tried this afternoon
to answer. I think there is an--there is an annual review
process. That annual review process is one that is serious and
gives rise to the possibility of removing a designation.
Obviously, a firm would have to change the character of the
risk it presents in order for that change to be made. They have
a very clear analysis, hundreds of pages of detail, and if they
choose to change their business to address those issues, that
would be something the Council would review and could lead to a
removal of the designation.
Senator Heller. Mr. Secretary, thank you.
Thank you, Mr. Chairman.
Senator Brown. Senator Warner.
Senator Warner. Thank you, Mr. Chairman. I would like to
thank Senator Tester for letting me jump line.
I want to stay in this same vein, and I want to just for
the record note as well that the original draft of Title 1 and
2--nothing to do with you, Mr. Secretary; I think you have done
a fine job--did have an independent Chair, because the notion
of an independent Chair that had sole focus of trying to bring
this level of collaboration I think would be important.
I do feel what Senator Heller has mentioned, Senator
Menendez has mentioned, Senator Warren has mentioned, and I
want to mention is I do not--I think many of the firms,
particularly the nonbank financials, you know, those of us who
were very involved in Dodd-Frank, there was no intent to create
a Hotel California provision. You know, there was always this
ability, I think as Senator Warren said, to de-designate. And I
personally believe that, again, new organization, new entity
that in these original designations, there was not that lack
of--there was a lack of clarity and information sharing that
would have allowed a firm to make a determination to sever one
type of activity, because as we said earlier, it is not just
size. It is activity. And I think your improvements in the
process potentially take us a step further down that path. My
hope is that we will have some evidence of some firm with this
new collaborative process, you know, being able to make the
choices and exit out early.
But I would ask--what I would say--what I would wonder is
you are saying they have this chance at the end of each annual
review. Has any firm started down--perhaps you do not want to
designate a specific firm, but has any firm said, ``Hey, on the
annual review we want out, and we are going to go about the
following items'' or indicated that intention?
Secretary Lew. Senator, we are so early in the process,
firms have not even yet really been subject to the Fed
supervision. So we are in the first innings of this process.
I think that the test will come over time as firms think
through what the supervisory process means and make the
business judgments as to whether or not they want to change
their business in order to have the annual review reach the
conclusion that they should be de-designated. It was never
meant to be, you know, a process that only could go one way.
And I think even the early designations give the kind of
analysis that firms understand the basis of what they would
have to change in order for the annual review----
Senator Warner. But I think what we, at least this Senator
will be watching, because I do think there are firms who have
indicated that they would like to find a way out, certain firms
have been taking certain actions to appropriately deleverage
and shrink in size.
Secretary Lew. It certainly is possible if they do that,
yes.
Senator Warner. Well, again----
Secretary Lew. And I do not mean to be skeptical about it.
I just----
Senator Warner. I know. There are firms that I think are
affirmatively saying they are going--would like to go through
that process, and hopefully we will see an example of it.
Let me hit a couple of other points since Senator Tester
has been patient. I want to go back again as well to Senator
Corker's point on GSE reform, and I appreciate the
administration's support. I wish we could----
Secretary Lew. I would offer the same compliment, but I got
criticized for taking time when I did it before.
Senator Warner. No, no. I will take it.
[Laughter.]
Senator Warner. But I do think about the fact of the $5
billion a year that would have been committed, close to $5
billion for low-income, first-time, minority homebuyers that
would have been extraordinarily valuable, and the fact that we
would have dramatically removed this risk to the taxpayer. Do
you have any comment about the Inspector General's recent
report about the health of Fannie and Freddie?
Secretary Lew. Look, I think that the potential risk
remains there until we have real GSE reform. I think that we
are much better off now, in a better position now than we were
before, the different kinds of mortgages, different kind of
oversight. But it is not a good permanent situation.
Senator Warner. It is not a good permanent situation, nor--
--
Secretary Lew. And we need legislation to really fix it, as
you know.
Senator Warner. Neither would recapitalization of the
existing entities----
Secretary Lew. You need to recapitalize, you need to define
what the Federal exposure is narrowly, and you need to deal
with----
Senator Warner. I am saying I do not think recapitalization
would make the right--let me go--because I have been--Senator--
--
Secretary Lew. No, I do not think recapitalization of these
firms, but you need to have firms that are capitalized.
Senator Warner. Right. You need private capital in.
Secretary Lew. That is right.
Senator Warner. The last question I would have is as much a
comment as a question. My hope was going to be that FSOC was
going to not only be something that added additional regulatory
structure but in many cases would be that court of last appeal
for regulations when you have conflicts between regulatory
agencies. So far we have not seen much of that. I hope that
would be in its future.
Secretary Lew. You know, I would say this: FSOC does not
have the power to tell independent regulators what to do in
most of their areas of independent authority. But where it has
been given authority to coordinate them, I think we have done
it quite effectively. The Volcker rule came out identical from
five agencies. There were a lot of people who did not believe
that could ever happen. I am not sure it has ever happened
before that five independent regulators passed an identical
rule out.
There are issues that we do not have the power to write a
rule, but you look at something like money market funds, FSOC
intervened, and the regulator with authority has taken action,
and we are in a better place than we were.
I think there are a lot of issues where we have the
ability--half of it is power of persuasion, and we have to be
clear that it is not a power of compulsion. And I think that if
you think about that kind of--the character of independent
regulatory bodies and look at the amount of collaboration and
coordination that is going on now compared to 5 years ago, it
is a world of difference. And that does not mean everything is
exactly where it should be and there is not more work to do.
But I think you should be proud of the FSOC actually doing the
job that you intended for it to day.
Senator Warner. Thank you, and thank you to Senator Tester
as well.
Chairman Shelby. [Presiding.] Thank you.
Senator Tester, you have been patient.
Senator Tester. Thank you, Mr. Chairman. And thank you for
being here, Jack. I appreciate the work you do. And just for
the record--and I know this is not a hearing about Iran, but I
appreciate the administration's willingness to engage on what I
think may be the most important issue facing the world today.
Secretary Lew. Thank you.
Senator Tester. And so please pass that along.
Look, I and others have been concerned about FSOC's
transparency in the designation process, so most of my
questions will--well, I will not say that. Some of them will.
On the businesses that have been designated so far, do they
know why?
Secretary Lew. Yes, Senator, they do know why. I mean, they
have engaged in lots of back-and-forth at a staff level, and in
the end there is a several-hundred-page analysis that describes
where the risk is and the transmission mechanisms or the basis
for the determination.
Senator Tester. So you feel confident that when you
designate a business, they know pretty darn----
Secretary Lew. They may not agree, but they----
Senator Tester. They may not agree, but they----
Secretary Lew. They know why.
Senator Tester. They know why. So by your answer to Senator
Warner's question, we have not been to a point where the
reevaluation has taken place. Correct me if I am wrong.
Secretary Lew. We have only been at the earliest stages.
Firms go to their first anniversary, but it is before they were
even subject to full Fed supervision. So I think we have to
kind of just be cognizant of it being very early in the game.
Senator Tester. I have got that. And from some of--and I am
sorry I was not here the whole time, but some of the previous
questions dealt with numerical metrics. Let me approach the
numerical metrics from a little different way, because I do
not--and correct me if--I do not believe you believe in
numerical metrics as far as designation goes. Is that correct?
Secretary Lew. Well, I do not think numerical metrics would
capture what is unique about each individual firm's complex
structure.
Senator Tester. And then plus, it is my understanding that
you did not think that they could change with the markets
either. Is that correct? If you had numerical metrics, you
would not--and the markets changed, they are very fluid, you
would not be able to keep up with that change.
Secretary Lew. I am not so sure if--since I--I do not think
that we could just draw a hard line and say the number is the
difference between risk or nonrisk, so I do not even get to the
change.
Senator Tester. That is OK. So let me get back to where I
was originally going. On the reevaluation--and so you have got
a business that has been designated. I am not sure the
designation is a plus thing for them. It may be a necessary
thing, but it may not be something that they really like. And
so do they have the ability, when it comes to redesignation,
to--or should I say do you have the ability--if we are not
involved with metrics, what do you use to reevaluate?
Secretary Lew. Well, first, something has to have changed.
I mean, so a firm would have to come in and show what has
changed, and if those changes would have an impact on the
analysis that led to the original designation, we would have to
go through the analysis again and make a fresh determination
that the risk was still worthy of designation.
Senator Tester. OK. So it is your belief that the companies
know why they were designated, and that when the reevaluation
comes around, they would have the ability to change some things
if they wanted to lose that designation?
Secretary Lew. Yes. And what I said, Senator, prior to your
asking the questions, was that it is not the case that it is
just one marginal activity that is the basis for designation.
It is----
Senator Tester. It is multiple----
Secretary Lew. It is the entire complex business structure.
So it would really mean making some--in each of the
designations we have made, some pretty dramatic decisions about
business structure.
Senator Tester. OK. So now we will go back to the original
designations. My staff member told me, I think, that Senator
Warren talked about this, and that was whether companies were
allowed to meet with voting members individually during a Stage
3 designation vote--before that. And I believe you said no.
Secretary Lew. No, we have left the direct meeting with the
Council members to be an appeals process at the end.
Senator Tester. Right.
Secretary Lew. But a lot of contact with the staff
throughout.
Senator Tester. Yes, but they are appealing to the same
people that made the designation, correct?
Secretary Lew. But then they can appeal to the courts if
they disagree. So they have an independent appeals route.
Senator Tester. OK. But let me get back to where I was
going, and I do not have a pre-answer for this, but why not
allow them to talk?
Secretary Lew. You know, the practice of having a lot of
individual conversations that are different conversations while
you are going through the process I think would not improve the
clarity of the review. I mean, there is an orderliness to the
way the information is brought in and analyzed and exchanged.
There is an opportunity for the company to come in. And each of
us on the Council ultimately makes a judgment based on the
shared information that we have.
I do not think that it is common practice in a lot of
regulatory agencies for there to be a lot of individual
meetings of the decision makers with the parties throughout the
process.
Senator Tester. Yeah, I am not sure--and look, Jack, you
are a lot smarter guy than I am. And I am not sure----
Secretary Lew. I would not say that.
Senator Tester. ----that I am advocating for a lot of
individual meetings. But it seems to me communication is really
important. Look at what an anvil Congress is. Why? It is
because people are talking and nobody is listening. And I think
that there is an opportunity not to have a lot of meetings but
at least give them the input before--the opportunity for input
before the designation.
Secretary Lew. So I totally agree with you about the
importance of communication, and the reason we made the changes
was to open the process up so that the companies that were
under review would feel--would have actual knowledge of what is
going on----
Senator Tester. Right.
Secretary Lew. ----and notice and the ability to engage.
Before we made the rules changes, we were doing much of that
informally. We formalized and made it more clear. I think that
is a good thing.
The line between what we do now and the kind of
conversations you are talking about is something we should keep
looking at. I am not saying that it is something you could
never think about. I just think it would be an unusual process
for regulators to do.
Senator Tester. I got you. I think it could be overblown.
But, anyway, I will end where I started. Thank you very much
for your work. I very much appreciate it and look forward to
working with you, whether it is through this Committee or
individually, on making things work right.
Secretary Lew. Thank you, Senator.
Chairman Shelby. Thank you, Senator Tester.
I have a couple of quick questions, and then I hope in a
few minutes we can go to our second panel.
Secretary Lew, I have two quick questions that I would hope
you would answer with a simple yes or no. I do not know if you
would, but I wish you would.
Secretary Lew. Those are usually the hardest questions,
Senator.
Chairman Shelby. Maybe not for you. Do you agree that the
FSOC's designation process should be transparent--you talked
about that--objective, driven by rigorous data, and not
influenced by outside organizations?
Secretary Lew. I believe that a transparent process is
good. I think we should be driven always by data and analysis,
and we should be open to information that is appropriate----
Chairman Shelby. What about influenced by outside stuff
that you do not really find in your analysis?
Secretary Lew. I do not think that any of our process is
subject to influence other than by facts and analysis.
Chairman Shelby. OK.
Secretary Lew. The sources of it obviously come from, you
know, work that is done inside and coming from the parties.
Chairman Shelby. Is the U.S., the United States of America,
under any obligation to implement decisions or determinations
made by the FSB?
Secretary Lew. National authorities retain their authority
to make their own decisions. The FSB is an organization that I
think helps us to bring global standards up to the high
standards the United States has set. But we make our own
policy.
Chairman Shelby. Sure. That is good.
Mr. Secretary, as a matter of policy, which you make, the
Government, do you believe that fewer systemically important
financial institutions is a good thing?
Let me ask it again. As a matter of policy, do you believe
that fewer, rather than more, systemically significant
financial institutions is a good thing? In other words, if you
did not have so many systemically risky, wouldn't the economy
be better?
Secretary Lew. I think that we have the deepest and most
liquid financial markets in the world. We have the widest
variety of financial institutions, and I think we have to make
sure that, regardless of size, our institutions are safe and
sound.
Chairman Shelby. And we want to keep them that way, don't
we?
Secretary Lew. Yeah, and we--so I do not have a
predisposition of the number of firms we need.
Chairman Shelby. OK.
Secretary Lew. But whether you are big or you are small,
you ought to be safe.
Chairman Shelby. Under the current law, it is my
understanding that a firm has the opportunity ``to contest the
proposed designation.'' I think you have indicated that. If
they are unsuccessful contesting the Council's decision, would
you oppose a statutory process to allow a firm, working with
the Council, to avoid the designation before the designation is
made final? In other words, give them a chance to work their
problems out.
Secretary Lew. I think that in its wisdom Congress created
a process for these matters to be decided and resolved and
adjudicated, and that process should stand.
Chairman Shelby. My last question: The designation
decisions have, as we all know, a large impact on the subject
company and the economy. I believe--and I think you would
agree--that such decisions should be justified and supported by
empirical evidence and based on rigorous economic analysis.
Does FSOC conduct any economic or cost-benefit analysis
prior to making a decision?
Secretary Lew. We do rigorous analysis and only designate
firms if the risk determination is made. And I think if you
look at the benefits that come from having systemic soundness,
it is--you just need to look back to 2000 and 2008 to see what
it costs the economy, what it costs taxpayers, working
families, when the system collapses. That is hard to take into
account on a case-by-case basis, but that is the reason that
Dodd-Frank was enacted. It is the reason FSOC was created.
Chairman Shelby. Is there any reason that you can think of
that FSOC could not share all this information with the public,
subject to confidentiality concerns of the company?
Secretary Lew. Well, we share quite a lot of information--
--
Chairman Shelby. I know that.
Secretary Lew. ----with the public, and I think we have
made great efforts to share as much as we can without shutting
down a process that requires that we deal with confidential
supervisory information. I think transparency is an important
goal, but I think in supervisory matters, confidentiality has
always been respected and needs to be in this process as well.
Chairman Shelby. Thank you, Mr. Secretary, very much.
Secretary Lew. Thank you, Mr. Chairman.
Chairman Shelby. If we can, I would like to go to the next
panel. First, we will hear the testimony of Mr. Paul Schott
Stevens. He is the president and CEO of the Investment Company
Institute. Mr. Stevens is a well-known lawyer and previously
served in senior Government positions at the White House and
the Defense Department.
Second, we will hear from Mr. Douglas Holtz-Eakin,
president of the American Action Forum, no stranger to the
Congress. He is an economist, a professor, a former Director of
the Congressional Budget Office, and former Chief Economist of
the President's Council of Economic Advisers.
Next we will hear from Mr. Dennis Kelleher, president and
CEO of Better Markets. Mr. Kelleher has held several senior
positions in the U.S. Senate, most recently as the Chief
Counsel and Senior Leadership Adviser to the Chairman of the
Senate Democratic Policy Committee.
Finally, we will hear from Mr. Gary Hughes, executive vice
president and general counsel of the American Council of Life
Insurers. Mr. Hughes has been at ACLI since 1977 and has served
as general counsel since 1998.
Gentlemen, we welcome you to the Committee. Your written
testimony will be made part of the hearing record, without
objection, and we will start with you, Mr. Stevens, to sum up
your testimony.
STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, INVESTMENT COMPANY INSTITUTE
Mr. Stevens. Thank you, Chairman Shelby, Ranking Member
Brown, and Members of the Committee. I am grateful for the
opportunity to appear here today to discuss the transparency
and accountability of the FSOC.
ICI and its members do understand the importance of
appropriate regulation, and we support U.S. and global efforts
to enhance stability in the financial system. To this end,
however, the FSOC process must and should be understandable to
the public, based on empirical analysis that takes into account
all the factors specified in the Dodd-Frank Act, and well
grounded in the historical record. Such a process would allay
any concerns that U.S. stock and bond funds or their managers
pose risks to the financial system that require SIFI
designation.
Indeed, throughout the 75-year history of the modern fund
industry, these funds have exhibited extraordinary stability in
comparison to other parts of the financial system, and
certainly they did so throughout the recent financial crisis.
Now, is such an open, analytical review in the offing?
Unfortunately, the FSOC's current designation process raises
several serious concerns in that regard.
First, like other observers, we are concerned that the FSOC
is ignoring the range of tools given to it by the Dodd-Frank
Act and instead is seeking to use its designation authority
broadly. Congress envisioned SIFI designation as a measure
designed for rare cases in which an institution poses outsize
risk that cannot be remedied through any other regulatory
action. The Council's record to date raises serious questions
in our mind about its adherence to this statutory construct.
Second, in none of its nonbank SIFI designations has the
FSOC explained the basis of its decisions with any
particularity. The opacity of the Council's processes and
reasoning really means that no one--not the designated firm,
other financial institutions, other regulators, the Council, or
the public--can understand what activities the FSOC believes
are especially risky. This is an odd result as the very object
of the exercise is to identify and eliminate or minimize major
risks to the financial system.
Third, instead of the rigorous analysis one would expect in
connection with significant regulatory action, the FSOC's
approach to SIFI designation is predicated on what one member
of the FSOC itself has called ``implausible, contrived
scenarios.'' Together, the opacity of the process and this
conjectural approach to identifying risks have made SIFI
designation appear to be a result-oriented exercise in which a
single metric--the firm's size--dwarfs all other statutory
factors, and mere hypotheses are used to compel a predetermined
outcome, i.e., that designation is required.
Presumably, systemic risk must consist of more than just a
series of speculative scenarios designed to justify expanding
the jurisdiction of the Federal Reserve over large nonbank
institutions.
Fourth, the consequences of inappropriate designation would
be quite severe, particularly for regulated funds and their
investors. The bank-like regulatory remedies set forth in Dodd-
Frank would penalize fund shareholders, distort the fund
marketplace, and compromise funds' important role in financing
a growing economy. It also would institute a conflicted form of
regulation. A designated fund or manager would have to serve
two masters, with the Fed's focus on preserving banks and the
banking system trumping the interests of fund investors who are
saving for retirement or other long-term goals.
The Fed's reach actually could be extremely broad. The
Financial Stability Board recently proposed thresholds for
identifying funds and asset managers that it expects
automatically would be considered for SIFI designation. Under
these thresholds, more than half--and let me emphasize, Mr.
Chairman, more than half--of the assets of U.S.-regulated
funds, almost $10 trillion, could be subject to ``prudential
market regulation'' by the Federal Reserve. Similarly, more
than half of the assets in 401(k)s and other defined
contribution plans could be designated for Fed supervision. We
do not believe that any Member of Congress anticipated that the
Dodd-Frank Act could give the Fed this extraordinary authority.
Now, how can Congress address these concerns? What we
recommend is quite straightforward.
First, the FSOC's recent informal changes to its
designation process are a good first step, but more is
required. To assure greater predictability and certainty in
that process, Congress should codify these changes in statute.
Second, Congress should require the FSOC to allow the
primary regulator of a targeted firm an opportunity to address
the identified risks prior to final designation. Primary
regulators have the necessary authority and greater expertise
and flexibility to address these tasks.
Third, a firm targeted for SIFI designation also should
have the opportunity to de-risk its business structure or its
practices. Such an off-ramp from designation may be the most
effective way to address and reduce identified systemic risks.
And, finally, Congress should revisit the remedies proposed
for designated nonbank firms, particularly regulated funds and
their managers. Let me emphasize we do not believe that funds
or fund managers merit SIFI designation, but if the FSOC
chooses to designate them nonetheless, then Congress should
look to the SEC and not to the Federal Reserve to conduct
enhanced supervision and oversight.
Mr. Chairman, thank you. I look forward to your questions.
Chairman Shelby. Dr. Holtz-Eakin.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION
FORUM
Mr. Holtz-Eakin. Thank you, Mr. Chairman, Ranking Member
Brown. It is a privilege to be here today.
Let me make comments in basically three areas: process
improvements, many of which will be familiar from the
discussion that has preceded; the desire for greater analysis
and metrics infused into this process; and, third, the
possibility that if the FSOC is unable to make satisfactory
progress in those two areas, it may be useful for the Committee
to scrutinize the basic mission of the FSOC once again.
The FSOC was created as a macroprudential regulator. Such a
regulator's job is to identify systemic risks, measure them
appropriately, implement regulation and other steps that will
reduce those risks without excessive costs to the economy, and,
thus, undertake the basic cost-benefit analysis embedded in
regulation.
The process that the FSOC is using right now does not
seemingly convey to the participants that information. Firms do
not know how they became systemically risky, how much systemic
risk they pose, and what factors in their operations
contributed to that systemic risk. They accordingly have no
way, as was just mentioned, to change their activities and de-
risk prior to designation. They are fated, once the examination
begins, to be in or out one way or the other.
I think that the steps that have been taken so far in
February were good steps, but additional transparency is really
needed so there is an understanding about what is going on,
that there has to be an ability to de-risk. I think that in
assessing risks, it would be useful for the FSOC to incorporate
more of the information provided by the primary regulator and
defer to their expertise, where appropriate, and it seems not
to be done in this case. We have seen the insurance company
examples. And I think there has to be a meaningful exit from
designation as a SIFI. The annual review is thus far on paper.
It has not yet been implemented in a way that we know there is
a meaningful exit ramp, and that should be in there.
The second major thing is to actually bring some
quantification to the risks posed by institutions and their
activities. The first step in that would be to focus on
activities as opposed to simply institutions and their size so
that we know what activities translate into systemic risks,
have them quantify those based on the historical record of risk
in marketplaces and liquidity and the other factors that will
be important, and that risk analysis should be presented to all
participants in a meaningful way so that we have some sense of
magnitudes and know when things are more and less risky.
Now, my final point is that if the FSOC, a systemic risk
regulator, cannot identify to participants in the process what
is a systemic risk and where did it come from, cannot measure
it in a meaningful fashion and convey what is a large and small
systemic risk, we cannot possibly know if it is really reducing
systemic risk in an efficient fashion, and that is its job. And
if we have a regulator that increasingly has command over large
pieces of our capital markets that may or may not be fulfilling
the basic mission of Congress, I would encourage this Committee
to come back in future years and consider whether it is worth
having such a thing.
I am deeply concerned that the combination of an
ineffective FSOC and the use of the Federal Reserve as the
primary regulator by the FSOC will endanger the Fed itself. It
has been the finest monetary authority on the planet. Bringing
it into this new role where it has not the expertise and not
the experience may lead it to come under just increasing
external scrutiny and interference, and damaging the
independence of the Fed is not something that we think would be
the right outcome of an attempt to make the financial markets
safer.
Thank you for the chance to be here today, and I look
forward to your questions.
Chairman Shelby. Mr. Kelleher.
STATEMENT OF DENNIS M. KELLEHER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, BETTER MARKETS, INC.
Mr. Kelleher. Good afternoon, Chairman Shelby, Ranking
Member Brown, and Members of the Committee. Thank you for the
invitation to testify today. It is a privilege and honor to
appear before the Committee.
Too often when talking about financial reform, too many
focus on the trees--a particular regulation or industry or
firm--and ignore the forest--why we have the law, the
regulation in the first place. That context is essential to
understand where we are and what, if anything, we need to do.
Here we have a Stability Council to prevent destabilizing
surprises and massive bailouts. When we talk about surprises,
everybody thinks of AIG, which I will get to in a minute. But
what about Goldman Sachs and Morgan Stanley, almost collapsing
and bankrupt within days? That was totally an unexpected
surprise, but that is what happened in 2008.
On Friday night, September 19, Morgan Stanley called the
President of the New York Fed, Tim Geithner, and indicated they
would not open on Monday, September 22, 2008. Adding to that
shocking surprise, Morgan Stanley told Mr. Geithner that
Goldman Sachs was ``panicked'' because it felt that if Morgan
Stanley does not open, ``then Goldman Sachs is toast.''
The possibility of Morgan Stanley and Goldman Sachs being
bankrupt and collapsing into failure on Monday, September 22,
2008, was a very big surprise, and the result to prevent that
were massive bailouts by the U.S. Government and taxpayers.
But that was not the only surprise. Also in early September
2008, AIG came to the Federal Government asking for a huge,
indeed unlimited bailout. To everyone's surprise, AIG had
gambled with hundreds of billions of dollars of derivatives and
lost big, and was bankrupt because it did not have the money to
cover its gambling losses. So it came to the Federal Government
and the U.S. taxpayer with its hand out. It and its
counterparties, all the biggest banks on Wall Street, including
Goldman Sachs, said, ``You have to bail out AIG or the entire
financial system will collapse.''
No one knew it, but AIG was so interconnected with the
system that its failure could bring down everything and
potentially cause a second Great Depression. So the U.S.
Government repeatedly bailed out AIG, ultimately amounting to
almost $185 billion.
There were other, even bigger surprises. The $3.7 trillion
money market industry was also on the verge of collapse at
about the same time as AIG, Morgan Stanley, and Goldman Sachs.
That, too, surprised everyone. The result was the same. The
United States Treasury bailed out the money market fund
industry by putting the full faith and credit of the United
States behind the $3.7 trillion industry.
Those are only three examples of many, many surprises and
too many bailouts in 2008 and 2009 that no one anticipated.
The Stability Council was created to prevent similar future
surprises and bailouts, and that is incredibly important. Why?
Because the crash and the bailouts that started with Lehman
Brothers, AIG, and money market funds that led to Morgan
Stanley and Goldman Sachs and all the other too-big-to-fail
firms exploding into the worst financial collapse since the
Great Crash of 1929, caused the worst economy since the Great
Depression of the 1930s. Indeed, only massive taxpayer and
Government bailouts prevented a second Great Depression.
Ultimately, that crash and the economic wreckage are going to
cost the United States more than $10 trillion, as detailed in a
study Better Markets did on the cost of the crisis.
The tens of trillions of dollars reflect massive suffering
across our country. Just one example. In late 2009,
unemployment and underemployment reached 17 percent. That means
that almost 27 million Americans were either out of work or
working part-time because they could not find full-time work.
And then, of course, there were the lost savings, homes,
retirements, small businesses, and so much more.
Preventing that from ever happening again is why there is a
Dodd-Frank financial reform law, why there are regulations, why
there is a Stability Council, and why its mission is so very
important.
In closing, that is why, when we think about FSOC and
accountability, we think about accountability to the American
people, accountability to those 27 million Americans thrown out
of work, accountability to the tens of millions who lost their
savings, their retirements, their homes, and so much more. We
ask: Is FSOC doing enough fast enough to protect the American
people from known and potential threats to the financial
stability of the United States? Yes. Deliberatively,
thoroughly, carefully, pursuant to as open and transparent a
process that has real accountability built in, but the focus
has to be on identifying those threats, responding to them,
eliminating them, or minimizing them to the greatest extent
possible, and protecting the American people.
Thank you, and I look forward to your questions.
Chairman Shelby. Mr. Hughes.
STATEMENT OF GARY E. HUGHES, EXECUTIVE VICE PRESIDENT AND
GENERAL COUNSEL, AMERICAN COUNCIL OF LIFE INSURERS
Mr. Hughes. Thank you, Mr. Chairman, Ranking Member Brown.
We appreciate the opportunity to comment on the FSOC process.
ACLI is the principal trade association for the U.S. life
insurance companies, and we include among our members the three
insurers that have been designated as systemically important.
We have heard today that FSOC has already made improvements
to its process, but we do believe that additional reforms are
necessary to assure that the process is really transparent and
fair and that it fills the overarching purpose of the Dodd-
Frank Act.
Questions that we heard today I think hit the right note
here. We should all be striving for a financial marketplace
where there are no institutions that pose systemic risk. And to
that end, FSOC should embrace a process that employs the
correct metrics to assess a companies potential risks and
outlines clearly and concisely the factors that will result in
designation.
If systemic risks are identified, the company should be
given full access to the information upon which FSOC's
conclusions are based, and then given the opportunity to
challenge any assumptions it believes are in error and, if it
wishes, restructure its activities so as to fall on the
nonsystemic side of the line. Only then should FSOC make a
final designation and trigger Fed oversight, and companies
should always be given the necessary information and the
ability to exit designated status if changed circumstances
warrant.
Unfortunately, the current FSOC process seems more focused
on designating companies as systemic than on working
constructively with potential designees to avoid having to make
such designations in the first instance. And with all due
respect to Secretary Lew, I think there was nothing that I
heard from him that would change our view that the bias tilts
in that direction.
With that in mind, let me summarize our suggestions for
improving the FSOC process.
First, FSOC should institute additional procedural
safeguards on the front end of the process, and we offer six
suggestions in this regard.
One, afford companies that receive a notice of proposed
determination full access to the record upon which FSOC's
determination are based, and, importantly, that record must
provide a sufficient level of detail to enable the company to
fairly understand and react to FSOC's analysis and conclusions.
Two, required that FSOC staff initially recommending a
company for designation is not the very same staff adjudicating
the company's administrative challenge to a potential
designation.
Three, in the case of an insurance company, afford greater
weight to the views of the FSOC voting member with insurance
expertise and accord deference to the insurer's primary State
insurance regulator.
Four, providing a company with more than 30 days to
initiate a judicial review of a final determination.
Five, staying Federal oversight pending such a judicial
review.
And, six, ensuring that FSOC determinations are made
independent of international regulatory actions.
Our second overall point: Once a company has been
designated as systemic, there should be a more robust and
transparent process for potential de-designation. FSOC should
provide the company with a clear indication of the factors that
would lead to de-designation, enabling the company to
understand precisely what changes to its risk profile would be
necessary to be deemed nonsystemic.
Third, as is the case with asset managers, we believe FSOC
should be required to pursue an activities-based approach with
respect to insurance, focusing on the specific activities and
practices that may pose systemic risk.
Fourth, FSOC should be required to appropriately apply the
material financial distress standard, as set forth in Dodd-
Frank. The authorizing statute enumerates 11 factors that could
have a bearing on the company's vulnerability to material
financial distress. Yet in the case of the insurance
designations, FSOC simply made a going-in assumption of
material financial distress and then concluded that such
distress could be communicated to the broader financial system.
And, finally, FSOC should promulgate the regulations
required by Section 170 of Dodd-Frank. These regulations, done
in conjunction with the Federal Reserve, could shed additional
light on what metrics, standards, or criteria you would operate
to categorize a company as nonsystemic.
Mr. Chairman, we believe the best interests of the U.S.
financial system will be served by an FSOC designation process
that is more transparent and fair than at present, and the
reforms we suggest are intended to achieve these objectives. We
pledge to work with this Committee and others for that end.
Thank you.
Chairman Shelby. Thank you, Mr. Hughes.
I will ask the following question of all of you. The goal
of the FSOC's process I believe should be not to merely expand
the regulatory jurisdiction of the Federal Reserve, but to
actually reduce systemic risks to our economy. As the
Bipartisan Policy Center pointed out in its statement for the
record, it would be troubling if no real process emerges to
realistically allow a company to become undesignated.
I will start with you, Mr. Stevens--well, I will ask all of
you. Do all of you agree, yes or no?
Mr. Stevens. Yes, I do agree, Mr. Chairman.
Chairman Shelby. Mr. Holtz-Eakin.
Mr. Holtz-Eakin. I 100 percent agree.
Mr. Kelleher. I agree with the headline, not the details.
Chairman Shelby. Mr. Hughes.
Mr. Hughes. I agree completely.
Chairman Shelby. Do you believe that FSOC has provided a
clear road map for what a designated company should do to
reduce its systemic risk and no longer be designated?
Mr. Stevens. It would probably be best to ask the companies
themselves, but I would be very surprised if their answers were
``yes.''
Chairman Shelby. Dr. Holtz-Eakin.
Mr. Holtz-Eakin. I do not believe that it has.
Chairman Shelby. Mr. Kelleher.
Mr. Kelleher. It cannot.
Mr. Hughes. Well, that is a good question, and we have had
the opportunity to talk to some of the companies that have been
designated, and I think they would explain that, no--you know,
somebody mentioned--I think it was the Secretary--that there
are hundreds of pages of documents floating around. There are.
But in reading those hundreds of pages of documents going back
and forth between FSOC and the individual companies, there is
not clarity on the specifics of why a company got designated.
And I think you would find a very high degree of frustration
among the companies that have been designated that they are not
sure of the exact reasons why they have been designated; they
are not sure of the exact steps they could take if they wished
to become de-designated.
So, with all due respect to the Secretary, this is not just
a situation where companies disagree with conclusions. They do
not have enough information to challenge the conclusions that
have been drawn.
Chairman Shelby. Don't the bank regulators at times, when
they are evaluating the safety and soundness of a banking
institution, kind of give them a warning of what they need to
do to their capital standards and everything, Dr. Holtz-Eakin?
Mr. Holtz-Eakin. Absolutely. There is a regular
interchange, and it is often quite quantitative in nature, so
there is no ambiguity----
Chairman Shelby. And a lot of them, because of that, work
off their problems and become strong again, do they not?
Mr. Holtz-Eakin. Yes, they do.
Chairman Shelby. Is that fair?
Mr. Kelleher. Well, of course, those regulators, the
banking regulators, have supervisors and hundreds and hundreds
of people in those banks on a regular basis to provide that
advice and feedback long before something like an FSOC process
happens.
Chairman Shelby. Well, some of these--I am just the using
the analogy of the bank regulators letting the bank work off
problems and get strong. And I guess should the FSOC provide a
better explanation to the public when it disregards such
expertise? I am speaking of--the MetLife designation received a
scathing dissent by its primary regulator. The Prudential
designation was adopted despite the strong dissent by FSOC's
resident insurance experts. That is troubling to me. Mr.
Hughes?
Mr. Hughes. Yeah, I think your comment sort of begs the
question of to what extent, if at all, is FSOC looking to the
primary regulators of these firms for input and advice.
Chairman Shelby. Or totally ignoring them.
Mr. Hughes. Yeah, and insurance is an interesting case, and
it is the only segment of financial services that does not have
a voting seat on FSOC as a regulator. I mean, there is an
individual that has insurance expertise. None of the primary
regulators that the three companies designated were at the
table when the FSOC decisions were made.
Chairman Shelby. Dr. Holtz-Eakin, if we create a regulatory
regime to address systemic risk without identifying what
creates systemic risk, we force companies to guess what might
trigger additional regulatory concern. In other words, they are
kind of in the dark. I believe companies must then manage their
business models to the worst-case scenario rather than ordinary
business. Generally, such uncertainty creates additional cost
for them and for our economy, causing companies not to invest
in new business opportunities or infrastructure.
My question is this: Should we be concerned that such
uncertainty is stifling our economic growth? You are an
economist. Are there real costs associated with our regulatory
framework and specifically with uncertainty in FSOC's
designation?
Mr. Holtz-Eakin. There is increasing evidence that you can
trace a straight line between policy uncertainty and economic
performance. There has been excellent work done by, for
example, Steve Davis at the University of Chicago on this
topic. The FSOC is an example of this. It is a large, powerful
regulator that people have very little understanding about how
it makes its decisions, uses what criteria, and as a result--
and where it will show up next, in what part of the financial
landscape. And that cannot be in and of itself a good thing for
growth.
Chairman Shelby. Mr. Hughes, insurance products--you know
this well--especially long-term insurance contracts such as
life insurance, face a much different probability for runs and,
thus, failure than one would typically fear with banks. We have
heard concerns that FSOC's designation process treats these
insurance contracts similar to bank assets, but they are
different.
Would you discuss the likelihood of a so-called run on
insurance products such as life insurance and what such a run
would have to look like in order to cause systemic risk?
Mr. Hughes. Well, I think you are absolutely correct that
the dynamics of a insurance company are much different than
those of a commercial bank, certainly in terms of the types of
products and the likelihood of money going out the door. I know
one of the dissents to one of the designations pointed out,
quite correctly, that insurance regulators have the absolute
authority to prevent people from turning in their policies, if
that is warranted. But I think the experience of the recent
economic crisis is very telling in this respect. In fact, it
was just the opposite of a run. The products were so desirable
in terms of the guarantees they made that, notwithstanding the
crisis, people were holding onto those products no matter what.
Chairman Shelby. Senator Brown.
Senator Brown. Thank you, Mr. Chairman. I do not think the
FSOC designation is quite the black box and mysterious process
that some have made it out to be. You know, we start off with
metrics, Step 1 and Step 2, six categories, and while we do not
necessarily--I think the companies give this information. I
assume it is proprietary. We have not seen it, but it is
perhaps a little more specific, and companies are a little more
aware than maybe we like to think they are.
Let me start with Mr. Kelleher, if I could. We hear from
industry that new rules for banks, Basel III, for example, will
force some activities into the ``unregulated'' shadow banking
sector. The industry made similar arguments before the crisis,
sort of the time period you were laying out for us, when they
used charter shopping to engage regulators in a race to the
bottom.
Talk about, if you would, Mr. Kelleher, the role that FSOC
plays in ensuring that there are strong standards across the
board, that there is a level playing field even for
institutions that attempt to operate more in the shadows.
Mr. Kelleher. There are two key roles that FSOC plays in
connection with the shadow banking system and the other
problems you have identified. Number one, and most importantly,
FSOC was, in fact, created to ensure that we did not have
another shadow banking system grow up. In the past, as you both
know well, we had banking regulation, and then what everybody
did is they moved their activities or their forum in a way so
that they did not fall narrowly within banking regulation. And
that was the shadow banking system, also known as the
unregulated finance system.
So we have a banking regulatory system that identifies
banks and bank holding companies for heightened prudential
standards and otherwise, as you have heard over the last week
in your hearings. And the other arena, which used to be called
``the shadow banking system,'' we have FSOC, which is supposed
to be able to identify known and emerging risks as well as
designate nonbank financial firms that pose a threat to the
financial stability of the country. That is aimed directly at
the shadow banking system.
The second piece of your question about charter shopping
and the problems one has with siloed regulators is by having a
council of regulators, you force them to look at the broader
landscape and also to be less captured, not in the pejorative
sense of the revolving door but cognitively captured about
where you sit is where you stand. And I actually think it is an
example of how the FSOC is working well to see that the
insurance regulators actually laid out their dissents and
dissented, but nonetheless the collective wisdom of FSOC saw
and understood the threat that came out of that arena and
designated insurance firms nonetheless having gone through the
process. And, by the way, they did get roughly 400 pages
detailing the designation.
Senator Brown. Thank you. Mr. Kelleher, your testimony
discussed some of the so-called reform proposals. Talk about
some of those coming from the House these days or that the
House is looking at now.
Mr. Kelleher. Well, you know, most of the reform proposals
at the end of the day are burden delay and future litigation.
What we ought to be doing is building up a robust designation
process, an FSOC council that really does its job, and I am a
little surprised that Doug and others have not taken credit for
the dramatic steps forward that FSOC has taken most recently on
the transparency and process side, because about half of your
recommendations are now incorporated in FSOC's procedures.
Now, everybody does not get everything they want in this
town. I think 50 percent is pretty good. But most of these
things, whether it is cures, off ramps, kind of a formalistic,
one-size-fits-all, quantitative formula, relying on a primary
regulator, almost every single one of those so-called reforms
are really a step back to procedures that were in place prior
to the crisis, and in many respects enabled the crisis.
Senator Brown. All right. Thank you.
Mr. Kelleher, in your experience with financial regulators,
have you ever encountered a regulator that was willing to
receive input and criticism from stakeholders and then modified
its policies in response to that criticism, as FSOC did in
February?
Mr. Kelleher. You know, I think it is unprecedented. We
have gone around and tried to look at this to find an agency
that has been criticized, constructively or otherwise, and then
gone through an elaborate process to bring the critics in,
listen to them, get detailed inputs, and then actually change
their process in very meaningful ways in part by, as I said,
adopting many of the recommendations of those who had the
input. Not only is it unprecedented, I think it shows that this
Committee is actually working the way exactly as it is
designed. It is not even 5 years old. It is not exactly running
around designating everybody who walks by Treasury. In 5 years,
we have got four companies. Two of them were no-brainers--AIG
and GE. OK. The others, frankly, I think we are going to find
out, when the MetLife litigation is done, that they were no-
brainers, too.
So what we have is a Council that is doing its job. It is
listening to people. It is incorporating changes and making
meaningful changes. I think we ought to let them do their job,
let the changes set in, and let us see where we are in a year
or two, complemented by robust congressional oversight, which
you all have been doing. They are doing well. They are trying
to do better. And Doug and others who are making some good
suggestions are having a meaningful impact.
Senator Brown. Thank you.
Thank you, Mr. Chairman.
Chairman Shelby. Senator Warren.
Senator Warren. Thank you, Mr. Chairman. Thank you all for
being here today.
Seven years ago, giant financial institutions like AIG and
Lehman Brothers--institutions that were not banks--were at the
center of the financial crisis. Congress recognized that while
there were regulatory agencies responsible for overseeing
specific banks or specific parts of banks, we did not have a
single group that was responsible for looking out across the
entire system, including the nonbanks, and spotting the risks
that they presented. That is why Congress created FSOC and why
Congress gave FSOC the power to designate nonbanks as
systemically important if they met certain basic criteria.
Now, there has been a lot of discussion today about
potential flaws in the designation process, and I just want to
focus on a few of those. I have heard people who represent the
insurance industry claim that certain kinds of companies, like
insurance companies, simply cannot pose the kinds of systemic
risks that banks do.
Mr. Kelleher, do you think that large insurance companies
can pose systemic risk?
Mr. Kelleher. Well, I do not think there is any question
that large insurance companies can pose systemic risk. I mean,
we only have to look at AIG and see what happened there, which
was, after all, an insurance company. And let us remember,
MetLife, before it sold off its deposits a couple years ago, it
was one of the largest bank holding companies in the United
States at the time. So insurance companies, the big, large,
complex, global insurance companies, certainly can be, and they
should be, if appropriate, according to the criteria, subject
to the designation process and designation if, after that
process, they are deemed to meet the criteria.
Senator Warren. Thank you.
Now, another argument I have heard today is that the
designation process is flawed because it does not weigh the
costs and benefits of designating a company. Mr. Kelleher, do
you think that imposing some kind of cost-benefit analysis is a
workable approach here?
Mr. Kelleher. The so-called cost-benefit analysis is almost
always translated into an industry-cost-only analysis, and we
have seen that at the other agencies and other places where the
industry has tried to impose what they call ``cost-benefit
analysis.''
It really takes into account too often, and as designed,
industry's quantifiable costs where, you know, they exaggerate
them and they pile them up a mile high with virtually no basis
and say the sky is going to fall, it is going to cost us $62
billion, or some fabulous number. What they never do is to take
into account the often unquantifiable, sometimes quantifiable
benefit to the public.
For example, what is the benefit and how do you quantify
the benefit of avoiding a second Great Depression or, for
example, 27 million Americans out of work in October of 2009?
And we could go through the list--and it is a long list--of the
economic wreckage inflicted on the American people by the last
financial collapse. That is FSOC's duty to prevent that
happening again.
How you quantify it and how you quantify it, as Secretary
Lew said, on a case-by-case basis is virtually impossible, and
that is why it is so grossly inappropriate to be trying to
apply industry-cost-only analysis on financial regulation and
protecting the American people.
Senator Warren. Thank you, very much. I agree with this. I
have often wondered how the regulators would calculate the
benefits of avoiding another financial crisis--a financial
crisis that sucked, what is it, $14 trillion out of the U.S.
economy?
Mr. Kelleher. Probably more.
Senator Warren. Probably more. All right. Let us do the
third one then. I have heard that the designation process is
not transparent, and I am all for increased transparency, but I
assume the Council must balance transparency against disclosing
confidential or potentially market-moving information.
Mr. Kelleher, do you think FSOC has struck roughly the
right balance with recent changes to the designation process?
Mr. Kelleher. I should start by saying Better Markets
stands for transparency, accountability, and oversight. There
are few things that we prioritize more than transparency, and
we have actually been very critical of FSOC over time for their
lack of transparency. But I will say that they have made
tremendous strides recently. I think that they actually did a
good job before, and they were not transparent about it; and,
therefore, that is what raised a lot of the questions. They are
now moving to a much more transparent process and a more
involved process that I think is only going to strengthen those
processes.
Reasonable people can disagree where on the line you have
transparency from total public transparency to protecting
confidential information and deliberative ability of the
Council. But it looks to me that they are both at the right
place and moving in the right direction. And as I say, adopting
many of the criticisms as part of their procedures now to open
it up I think is a pretty clear signal and an unprecedented
signal, as I said to Senator Brown, that we have a Council that
is really committed to getting this right and being maximally
open.
Senator Warren. And I take it, Dr. Holtz-Eakin, that you
would agree that they have at least moved in the right
direction.
Mr. Holtz-Eakin. Certainly. In both my written and oral
statements, I said so.
Senator Warren. Good. Thank you.
The FSOC designation process is obviously a work in
progress. I think the Council has generally gotten it right and
has demonstrated a willingness to work with members of the
industry and others to improve aspects of the process, and I
trust that that will continue.
Thank you, Mr. Chairman.
Chairman Shelby. Dr. Holtz-Eakin, would you like an
opportunity to respond to Senator Warren's question on cost-
benefit analysis--I have been bringing that up a long time--
since you are an economist?
Mr. Holtz-Eakin. Well, certainly. I mean, we require
benefit-cost analysis in lots of other regulatory settings
because it is information that should be imbued in the process.
That does not mean that measuring benefits and costs is easy.
In many cases it is not. Measuring environmental benefits is a
notoriously difficult task. Measuring increased human safety in
the workplace is a notoriously difficult task. None of this has
stopped the agencies from undergoing the discipline of having
to write down the things that might be benefits, the things
that might be costs, and making a good-faith effort to add them
up. The FSOC should do the same.
Chairman Shelby. Thank you, gentlemen.
You have a question?
Senator Brown. Could I follow up on that? Dr. Holtz-Eakin,
do you think we could have quantified--or how would we have
quantified in 2006 and 2007 or even the earlier years in that
decade on some of the things that some of the regulators did?
Could we have quantified the cost to society of what happened
in 2008 and 2009? Do you think as we did some of those
deregulation activities or some of the regulation activities
that you could have really figured out--you could have figured
out the cost to the companies, to be sure, but could you have
figured out the cost to society which I guess would be on the
benefit side of the equation very accurately?
Mr. Holtz-Eakin. Recessions avoided are benefits. There is
no question about that. But in any circumstance you can
certainly do a disciplined job of adding up the costs, economic
costs, not just industry costs. And I would suggest to Dr.
Kelleher that if the FSOC is going to have good processes and
everything else, and he has great faith in that, they can get a
good process on calculating economic costs.
So let us suppose they do that. Well, then, we will know
how big the benefits have to be at a minimum in order to for
something to be worthwhile, and getting that order of magnitude
right is important to know, I think. And then you can in formal
ways do analysis of what economic performance looks like with
and without access to intermediation and credit, which is
exactly what happened in 2008 and 2009. We had an enormous
liquidity crunch, and it dried up the ability for people to get
financing. You can translate that into declines in investment
and employment. You can look at the costs.
Senator Brown. Yes, it is just hard for me to think that,
without being laughed at, if any public interest lawyers or the
agencies would have said here is what potentially could happen
if we weakened or deregulated some of the things OCC did or the
Fed, that we possibly could have predicted that, and that is
why I am a little bit jittery about this whole structured cost-
benefit, even though I think we should do cost-benefit in a
whole lot of ways. I just do not think that--there needs to be
some caution and the other side needs to be weighed perhaps a
little better than it has been.
Mr. Holtz-Eakin. I take your point. I would just point out
that there are a lot of things that presumably FSOC is supposed
to do that my experience on the Financial Crisis Inquiry
Commission suggests it is just not going to work. So take the
AIG example. The fundamental problem with AIG is that the CFO
testified under oath that he as the chief risk officer and the
chief liquidity risk officer was unaware that their contracts
required them to post collateral if the underlying securities
declined in value. There is no way the FSOC is going to be able
to identify in advance utter managerial incompetence. That is
joke to run a major company and not understand your own
contracts and you are unable to comply with them. There is
nothing about the FSOC that is going to stop that.
And so for big structural things that you can quantify, do
benefit-cost, you should do it, but do not--I am just far less
sanguine that somehow this entity is going to be so nimble that
it is going to find all these things. It just will not.
Mr. Kelleher. Well, of course, its job is not to find those
things. What the real analysis is----
Mr. Holtz-Eakin. Well, in your testimony you suggested
exactly that, but it will not.
Mr. Kelleher. But the real question is--let us say that in
2005 AIG was then subject to cost-benefit analysis and a
designation process. First of all, we know no one anticipated
AIG happening, the money market fund failure happening,
anticipating any of that. So the ability to anticipate the cost
and benefit associated with designating any one of those firms
before the last crisis we know for a fact is actually
impossible.
So AIG would not have been designated because you would
not--it would never have been designated if you had a cost-
benefit analysis requirement in 2005. It has got nothing to do
with managerial competence or incompetence. And one person did
testify as to that, Doug, but you well know that there is much
other testimony as to why it is AIG failed, and it was not
merely missing the collateral calls.
Chairman Shelby. Earlier, some of you were here, I believe,
when Secretary of the Treasury Lew--I asked him if he would
oppose a statutory process to allow a firm working with the
Council to avoid the designation before the designation was
made final. Surprisingly, he said he would oppose such a
process. That was my understanding.
Assuming that is what he said--and I think it was--why
would the administration not support a process whereby we would
have fewer systemically risky firms? Do you have any idea?
Mr. Stevens. Well, as you know, Mr. Chairman, our testimony
indicates that allowing a firm at that point to de-risk, that
is, to address those circumstances, activities, aspects of its
business model that are raising outsize risk to the financial
system will probably be the quickest and most effective way of
dealing with the risk that the Council perceives rather than
supervising it through the Fed and admiring the problem any
further. We absolutely believe that is a reasonable
additional----
Chairman Shelby. I do, too.
Mr. Stevens. ----requirement or authority under the
statute.
Chairman Shelby. Doctor, do you agree with that?
Mr. Holtz-Eakin. I agree with that, and there is an
additional benefit in that other firms watching the process can
now have visible demonstrations of what it takes to avoid
designation, modify their activities in advance, and generate a
safer system.
Chairman Shelby. Mr. Kelleher.
Mr. Kelleher. Two thoughts. First of all, I think that the
companies being looked at have a much better, deeper, and
actually nuanced understanding of why they are raising the
risks, what those risks are, and why they are getting
designated.
What these requests really are getting to is they would
like a road map that is basically a one-size-fits-all check-
the-box so that they can try and get out of the designation.
What we need, though, is what we have, which is a process that
allows us to evolve as risks evolve, business activities and
markets evolve. And I am surprised that some of the entities
and people actually suggesting that a Government agency should
work with a private company almost in a consulting capacity to
suggest how they could modify their business practices to
reduce their risk.
The company knows what the risks are. If they choose to
make those business decisions and de-risk, then they can ask to
be de-designated, and there is a full process for de-
designation.
Chairman Shelby. But banks, they do it all the time.
Mr. Kelleher. With all due respect, Mr. Chairman--and you
know better than I know the process for supervision of banks,
and the way the Fed and the FDIC supervise banks literally on a
daily process and an ongoing process, that with thousands and
thousands of employees, they are in a position to look at the
loan book and how the loan book is working and how to give
advice as to where the risks are coming under the CAMEL
reports. That is not the role of FSOC, and that is not the role
of FSOC as decided by the Congress and executive branch when
they passed the law. To put the FSOC in the business of working
with private companies to help de-risk them strikes me as a
rather dramatic change and maybe unprecedented for a Government
agency.
So I am often surprised when I see my friends who are often
accused to be of a different political persuasion than I am
suggesting such involvement in the private sector.
Mr. Stevens. Mr. Chairman, I have tried to be brief, but
could I add one further thing?
Chairman Shelby. Absolutely.
Mr. Stevens. I was struck by Secretary Lew's comment, and
what I conclude from it is that the resistance to the idea of
de-risking, either by the primary regulator or by the firm, is
that the FSOC would not know exactly what to tell them as to
how to go about that. And that is the reason for the lack of
specificity in their determinations, and it is, frankly, the
reason that--what this really boils down to is size is the
single metric. That is the metric that is coming out of the
Financial Stability Board with respect to funds of the sort
that our members offer: $100 billion, you are systemically
important; $1 trillion by a manager, you are systemically
important. The analysis will end and begin there.
Chairman Shelby. Mr. Hughes, I did not give you a chance on
that.
Mr. Hughes. Yeah, I heard the same thing when the Secretary
testified, and I guess I am sitting here scratching my head a
little bit as to why a goal of this entire process should not
be to have a system where there are not systemically important
institutions. And if an organization like FSOC can put itself
in a position to work with those institutions to de-risk
further--I mean, you gave the example of MetLife de-banking.
Obviously that was not enough from the perspective of FSOC. And
I do not understand the problem with if the goal is to have no
institutions that are systemically important, which I think it
should be, why wouldn't FSOC work with these institutions? And
I think that the answer is, well, these are nonbanks, they are
very complex, so, gee, we will just assume that they have
material financial risks and then we will take it from there.
That is not the right approach.
Chairman Shelby. Is it lack of knowledge on their part of
insurance companies?
Mr. Hughes. Well, you know, you mentioned that FSOC voted
with its collective wisdom. With all due respect to the members
of FSOC, there is not a whole lot of deep insurance expertise
on the Council. And we have been working with the Federal
Reserve on capital standards. To their credit, they are on a
steep learning curve, but there is still a long way to go.
So the frustration is that people with insurance expertise
said, ``We do not agree with the decision,'' and then the
collective wisdom----
Chairman Shelby. That is why they dissented, did they not?
Mr. Hughes. Correct. And then the people that do not have
the depth of knowledge said, well, let us just say they are
systemic and----
Chairman Shelby. Well, I think we all want strong insurance
companies, strong banks. We want all of that.
Dr. Holtz-Eakin.
Mr. Holtz-Eakin. I do not think it is fair to call this a
consulting exercise. You know, firms are aware of their risks.
They know their portfolio risk, their liquidity risk, their
counterparty risk. They know their leverage. It is in their
business interest to have a full command of those risk
management tools.
Chairman Shelby. Absolutely.
Mr. Holtz-Eakin. What they do not know is the magic potion
where you mix those up and deliver one ounce of systemic risk.
And all they are asking is for some guidance on that so that
they can reduce the risk the FSOC is tasked with controlling.
That could be qualitative. It could say out of those six
categories, this is the most important, this is second, this is
third. It could be quantitative. But it cannot be zero.
Chairman Shelby. Well, I think they should not be able to
game the evaluation, you know, of designation, but they should
know what the criteria is to where they can operate a sound and
safe institution. Do you all agree with that?
[Witnesses nodding.]
Chairman Shelby. Gentlemen, thank you very much for your
testimony and your patience here today. The Committee is
adjourned.
[Whereupon, at 4:07 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF JACOB J. LEW
Secretary, Department of the Treasury
March 25, 2015
Chairman Shelby, Ranking Member Brown, and Members of the
Committee, thank you for inviting me here today to discuss the
Financial Stability Oversight Council's nonbank financial company
designations process.
As no one here needs reminding, the financial crisis caused great
hardship for millions of individuals and families in communities
throughout the country, and revealed some central shortcomings of our
financial regulatory framework. We witnessed the effects of lax
regulation and supervision for financial firms like Lehman Brothers and
AIG. These names have already been written into history as companies
whose failure, or near failure, helped contribute to the near-collapse
of the financial system. At the time, the regulatory structure was ill-
equipped to oversee these large, complex, interconnected financial
companies. This outdated structure also meant that regulators had
limited tools to protect the financial system from the failure of these
companies. As a result, the American taxpayer had to step in with
unprecedented actions to stop the financial system from collapsing.
Congress responded with an historic and comprehensive set of
financial reforms--the Dodd-Frank Wall Street Reform and Consumer
Protection Act--to put in place critical reforms for taxpayers,
investors, and consumers. The aim of this reform is to guard against
future crises while making sure taxpayers are never again put at risk
for the failure of a financial institution.
To lead the effort to better protect taxpayers, Wall Street Reform
created FSOC. FSOC is the first forum for the entire financial
regulatory community to come together, identify risks in the financial
system, and work collaboratively to respond to potential threats to
financial stability. Over the past 5 years, FSOC has demonstrated a
sustained commitment to working collaboratively to fulfill its
statutory mission in a transparent and accountable manner. This work
has not been easy; we built a new organization and developed strong
working relationships among FSOC members and their staffs to allow the
types of candid conversations, exchange of confidential, market
sensitive information, and tough questions that will make our financial
system safer.
Today, FSOC convenes regularly to monitor market developments, to
consider a wide range of potential risks to financial stability, and,
when necessary, to take action to protect the American people against
potential threats to the financial system. Our approach from day one
has been data-driven and deliberative, while providing the public with
as much transparency as possible regarding our actions and views. We
have published four annual reports that describe our past work and
future priorities; regularly opened FSOC meetings to the public;
published minutes of all of our meetings that include a record of every
vote the FSOC has ever taken; and solicited public input on both our
processes and areas of potential risk.
I and the other members nonetheless recognize that FSOC is a young
organization that should be open to changes to its procedures when good
ideas are raised by stakeholders. Just over the last year alone, FSOC
has enhanced its transparency policy, strengthened its internal
governance, solicited public comment on potential risks from asset
management products and activities, and adopted refinements to its
nonbank financial company designations process.
I believe that our adoption of these changes to the nonbank
financial company designations process represents a prime example of
the way FSOC should go about refining its processes without
compromising its fundamental ability to conduct its work. Last year,
prior to making any changes, FSOC conducted extensive outreach with a
wide range of stakeholders. The FSOC Deputies Committee--senior staff
who coordinate FSOC activities--hosted a series of meetings in November
with more than 20 trade groups, companies, consumer advocates, and
public interest organizations. We also solicited input from each of the
three companies then subject to a designation. FSOC discussed the
findings from this outreach and proposed changes during a public
meeting in January.
FSOC adopted a set of supplemental procedures last month. These
changes address the areas that stakeholders were most interested in and
formalized a number of existing FSOC practices regarding engagement
with companies. Under the new procedures, companies will know early in
the process where they stand, and they will have earlier opportunities
to provide input. Additionally, the changes will provide the public
with additional information about the process, while still allowing
FSOC to meet its obligation to protect sensitive, nonpublic materials.
And finally, FSOC will provide companies with a clearer and more robust
annual review process. This will open the door to more engagement with
FSOC following a designation to make sure there is ample opportunity to
discuss and address any specific issues that a company wants to put
before the FSOC. These changes strengthen the FSOC's process while also
addressing many of the suggestions made from stakeholders.
Despite our responsiveness and willingness to engage with
stakeholders in this case and others--but perhaps due in part to our
successful pursuit of our mission--some opponents of reform have been
trying to undermine the FSOC, its members and its ability to respond to
potential threats to financial stability. Many of the arguments levied
at FSOC are not based on the actual record, and opponents object to our
efforts to bring regulators together to work collaboratively to monitor
risks and protect the U.S. financial system. But Congress gave FSOC a
clear mission to address the kinds of risks and regulatory gaps that
resulted in the financial crisis, and we are doing what Congress asked
us to do, using the tools Congress gave us.
I am pleased to report to this Committee that the vast majority of
key reforms contained in Wall Street Reform are now in place, due to
the hard work and diligence of the independent regulatory agencies. We
have made substantial progress since the law's enactment almost 5 years
ago toward shaping a financial system that is safer, more resilient,
and supportive of long-term economic growth. I would like to take a
moment to briefly highlight some key milestones that illustrate the
scope and significance of Wall Street Reform.
Regulators now have tools to address the riskiness of the
largest, most complex firms--whether banks or nonbanks--in a
manner that is commensurate with their systemic footprint.
In addition, resolution planning and the orderly
liquidation authority--a tool that Members on both sides of the
aisle in this Committee helped craft--give us the ability to
allow any financial firm to fail without putting the rest of
the financial system at risk, and--just as importantly--without
imposing costs on U.S. taxpayers.
The previously unregulated swaps market, notionally valued
at around $600 trillion dollars, has been fundamentally
transformed through the introduction of a comprehensive
regulatory regime that is making these markets safer and more
transparent.
The Volcker Rule, which was adopted in late 2013 and is
scheduled to take effect this summer, prohibits banks from
speculative short-term trading and fund investing for their own
accounts. This important rule will reduce both the incentive
and ability of banks to take excessive risks, and limit
conflicts of interest.
And with creation of the CFPB, we now have a financial
regulator dedicated to looking out for consumers and protecting
them from deceptive, unfair, and abusive practices by mortgage
originators, payday lenders, and debt collectors, to name a
few. To date, CFPB enforcement actions have resulted more than
$5 billion in relief to 15 million consumers who have been
harmed by illegal practices.
Other recently completed reforms include: implementing
enhanced prudential standards for the largest U.S. bank holding
companies and for foreign banking organizations operating in
the United States; new rules requiring banking organizations to
hold sufficient liquidity buffers; establishing financial
sector concentration limits, which set a cap on growth by
acquisition for the largest financial companies; risk retention
requirements for asset-backed securitizations; and enhanced
leverage requirements to strengthen and backstop firms' risk-
based capital standards.
Finally, enhanced prudential standards continue to be
applied in a manner that focuses the most stringent
requirements on those few firms that pose the greatest risks to
financial stability, including a proposed capital surcharge
that is proportional to the risks posed by the largest and most
complex banks. Also, there is a proposal for a new minimum
standard for total loss-absorbing capacity (TLAC). This
proposed standard would strengthen the capital framework to
help ensure that the largest and most complex banks have
sufficient capital to absorb losses, and would help facilitate
an orderly resolution in a manner that minimizes any impact on
financial stability if the bank fails.
Today, because of Wall Street Reform, the financial system is in a
more robust and resilient position than it was prior to the crisis. We
have reduced overall leverage in the banking system. Banks have added
over $500 billion of capital since the crisis to serve as a buffer for
absorbing unexpected losses. The recently completed annual stress tests
cover a wider swath of institutions, and illustrate that our largest
banks have sufficient capital to withstand adverse shock scenarios and
continue to lend to businesses.
In fact, despite suggestions by some that Wall Street Reform would
impair our economic growth, the exact opposite has been true. While
banks have adjusted to more prudent rules, they continue to increase
lending to small businesses and families, helping to fuel the creation
of 12 million jobs over 60 straight months of job growth--a record that
our economy, with a safer financial system, continues to build on. This
progress is both real and consequential.
The true test of reform should not be whether it prevents firms
from taking risk or making mistakes, but whether it shapes a financial
system strong and resilient enough to support long-term economic growth
while remaining innovative and dynamic. In working toward this end,
Treasury and the independent regulators continue to monitor carefully
the effects of new reforms and to ensure that they are properly
calibrated to the size, complexity, and risk profiles of individual
institutions. Just as the business environment is constantly evolving,
the regulatory community must be flexible enough to keep up with new
challenges--including making adjustments where necessary and remaining
vigilant to new emerging threats.
No law is perfect. But let me be clear: we will vigilantly defend
Wall Street Reform against any change that increases risk within the
financial system, weakens consumer, investor, or taxpayer protections,
or impedes the ability of regulators to carry out their mission. Amid
these discussions of technical fixes and tweaks to Wall Street Reform,
we must not forget what we learned from the financial crisis: our
financial firms are constantly evolving, and we must remain alert and
responsive to new challenges in a dynamic system, toward the ultimate
goal of maintaining the safety, soundness, and resiliency of our
financial system.
We must also not forget who will pay a steep price if Congress
rolls back critical safeguards, weakens oversight, and waters down
appropriate rules of the road. It will be companies that play by the
rules and serve their customers well. It will be small businesses who
need access to credit to grow their businesses and create jobs. It will
be working men and women trying to save for their children's education,
a downpayment on a home, and their own retirement.
Promoting financial stability and protecting the American public
from the next financial crisis should be an objective shared by the
Administration, regulators, the financial sector, and Members of
Congress, regardless of party. I look forward to working with this
Committee, and with Congress as a whole, to continue to make progress
in creating a more resilient and stable financial system.
______
PREPARED STATEMENT OF PAUL SCHOTT STEVENS
President and Chief Executive Officer, Investment Company Institute
March 25, 2015
Executive Summary
Designation of systemically important nonbank financial
companies is only one of several regulatory tools given the
FSOC by the Dodd-Frank Act. Designation of a nonbank financial
company as systemically important is intended to and should be
used only as a last resort, when the FSOC has found, after
thorough analysis based on all the criteria specified in the
Act, that a firm poses significant, articulable risks to the
stability of the financial system that cannot be remedied
through other means.
ICI supports U.S. and global efforts to address abuses and
excessive risk in the financial system, but we are concerned
that the FSOC is seeking to exercise its designation authority
quite broadly and to the exclusion of other mandates. The
opacity of the designation process only exacerbates this
problem.
The FSOC's recent informal changes to its designation
process are welcome but fall well short. These changes should
be codified in statute to provide greater certainty and
predictability to the process. In addition, Congress must act
to require the FSOC to give both primary regulators and
companies under consideration for designation an opportunity to
address identified systemic risks prior to designation. Such
steps would support the FSOC's mission both by reducing risks
in the financial system and by reserving SIFI designations and
the exceptional remedies that flow therefrom only to those
circumstances in which they are clearly necessary.
In none of its nonbank designations thus far has the FSOC
chosen to explain the basis for its decision with any
particularity. Instead, it appears to have relied on a single
metric (a firm's size) to the exclusion of the other factors
cited in the Dodd-Frank Act. It also has theorized about risks
instead of conducting the kind of thorough, objective,
empirical analysis that should underlie its decisions. The FSOC
should be explicit about the systemic risks it identifies
arising from a firm's structure or activities, and the results
of any analysis that might lead to designation should be made
public. This would be beneficial on all sides--it would help
market regulators and firms address such risks, and it would
promote public understanding of and confidence in what the FSOC
regards to be systemically risky and why.
We support the FSOC's review of the asset management sector
as the Council fulfills its mandate under the Dodd-Frank Act.
We are hopeful it will conclude, as we believe it must, that
SIFI designation is unnecessary and inappropriate in the case
of funds and their managers. The history of the recent
financial crisis demonstrates that, compared to other parts of
the financial system, U.S. stock and bond funds exhibited
extraordinary stability. Unlike banks, fund managers act solely
as agents. This means that fund investors--not fund managers--
bear the risks and rewards of the fund. Funds use little or no
leverage. Their structure, the way they are regulated and
managed, and their overwhelmingly retail investor base--these
and other factors all help explain why, in the 75-year history
of the modern fund business, stock and bond funds have never
posed risks to the financial system at large.
We also support the role of the SEC as the regulatory body
best equipped to address any concerns about financial stability
with respect to funds and fund managers. While we believe there
is no basis for designating them, recent proposals out of the
FSB point to the prospect that the FSOC may soon consider
designation for many large U.S. funds and their managers. If
any of these entities was designated, the consequences would be
highly adverse to investors and the capital markets.
Application of the bank regulatory remedies set forth in the
Dodd-Frank Act to designated stock and bond funds or their
managers would raise costs on and jeopardize the interests of
fund shareholders, greatly distort the fund marketplace,
introduce a highly conflicted model of regulation, and
compromise the important role that funds play as a source of
financing in the economy.
I. Introduction
My name is Paul Schott Stevens. I am President and CEO of the
Investment Company Institute (ICI or Institute), and I am pleased to
appear before the Committee today to discuss the transparency and
accountability of the Financial Stability Oversight Council (FSOC or
Council) and particularly its processes for designating nonbank
financial companies as systemically important financial institutions
(SIFls).
ICI is the national association of U.S. registered investment
companies, including U.S. mutual funds, closed-end funds, exchange-
traded funds (ETFs) and unit investment trusts. ICI seeks to encourage
adherence to high ethical standards, promote public understanding and
otherwise advance the interests of funds, their investors, directors
and managers. ICI members today manage approximately $17.5 trillion in
assets and serve more than 90 million investors. These investors rely
on stock and bond funds to help achieve their most important financial
goals, such as saving for college, purchasing a home, or providing for
a secure retirement.
The Institute traces its origin back to 1940 and passage of the
landmark Investment Company Act and Investment Advisers Act, statutes
that the Securities and Exchange Commission (SEC) has administered to
great effect and that have provided a comprehensive framework of
regulation for our industry. ICI members are both investors in the
capital markets and issuers of securities. We understand the important
role of appropriate regulation in protecting our investors, promoting
confidence in our markets, and ensuring the resiliency and vibrancy of
the financial system overall. For these reasons, ICI has been an active
supporter of U.S. and global efforts to address issues highlighted by
the global financial crisis. We also have been a strong proponent of
improving the U.S. Government's capability to monitor and mitigate
risks across our Nation's financial markets.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
Dodd-Frank Act), by design, provides an array of tools, in addition to
SIFI designation authority, to the FSOC and other regulators. For
example, the FSOC has a risk monitoring role and has the authority to
identify gaps in regulation and make recommendations to financial
regulators. \1\ The broad scope of these other authorities should allow
the FSOC to reserve SIFI designation for those circumstances--thought
to be quite rare when the Dodd-Frank Act was enacted \2\--in which the
risks to the financial system as a whole are both large and quite
plain, and nothing less than designation will suffice to address them.
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\1\ 12 U.S.C. 5322(a)(2).
\2\ See Testimony of Chairman Ben S. Bernanke, before the
Committee on Financial Services, U.S. House of Representatives, July
24, 2009, available at http://www.federalreserve.gov/newsevents/
testimony/bernanke20090724a.htm (stating that the ``initial number of
newly regulated firms [SIFIs] would probably be relatively limited'').
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The record of the Council's activities to date, however, suggests
that the FSOC may be ignoring this statutory construct and, instead,
seeking to exercise its designation authority quite broadly. The highly
opaque process of the FSOC leading to designation has only exacerbated
the problem, raising serious concerns about whether its determinations
have adequate factual bases, take public comment into sufficient
account, and can be subject to appropriate oversight. Without engaging
more meaningfully with the public and with entities under review, the
FSOC has appeared to be in headlong pursuit of designations based on
foreordained conclusions rather than on rigorous and objective
empirical analysis.
To truly advance financial stability, the FSOC's process must be
open to the public, analytically based and grounded in the historical
record. The history of the recent crisis demonstrates that America's
stock and bond funds exhibited extraordinary stability. In particular,
it is important for the FSOC to consider carefully how different stock
and bond funds and their managers are from banks. Unlike banks, fund
managers act solely as agents, which means fund investors--not fund
managers--bear the risk of any loss, or the benefit of any gain, in a
portfolio. Moreover, registered funds use little to no leverage. The
structure of these funds, the ways in which they are comprehensively
regulated and managed, and their overwhelmingly retail investor base--
these and other factors all help explain why, in the 75-year history of
the modern fund industry, stock and bond funds have never experienced a
``run'' of the sort to which banks are subject.
As discussed below, we hope the FSOC's recently announced changes
to its SIFI designation process will increase communications and
interaction with firms that are under review. More, however, needs to
be done. These recent procedural changes were instituted informally and
should be codified in statute. In addition, Congress should amend the
Dodd-Frank Act to ensure that an institution targeted for designation
and that institution's primary regulator have the opportunity to
address and mitigate any ``systemic risks'' the institution may pose
prior to final SIFI designation. Bipartisan legislation introduced in
the 113th Congress by Reps. Dennis Ross (R-FL) and John Delaney (D-MD),
and four cosponsors, the ``FSOC Improvement Act of 2014'', would codify
these and other good Government reforms to the SIFI designation
process. Ultimately, this reasonable, bipartisan approach would enhance
the ability of the FSOC to ameliorate systemic risk.
In addition, we believe it is imperative for Congress to revisit
the remedies that follow upon SIFI designation in the asset management
sector, and certainly so in the case of registered funds or their
managers. The remedies currently provided for in the Dodd-Frank Act--
i.e., imposition of bank-style capital requirements and prudential
supervision by the Federal Reserve--not only are unnecessary but are
altogether inappropriate in the case of registered funds and their
managers. They would inflict substantial harm on fund investors and
retirement savers, distort the fund marketplace, and impede the
important role that funds play as a vital source of funding in our
capital markets. As noted, we do not believe that funds or fund
managers merit SIFI designation. But, if a fund or fund manager were
deemed to be systemically important, Congress should look to the SEC,
and not the Federal Reserve, to conduct appropriately enhanced
oversight of its activities.
In Section II below, we outline our concerns about the FSOC's SIFI
designation process, explain the limitations of the recent changes to
the process that have been adopted by the FSOC, analytically why
further action is necessary. In Section III, we explain why the lack of
specifics in the FSOC's designations undermines the utility and
fairness of the process. In Section IV, we set forth the basis for our
concerns that the FSOC determinations be grounded in empirical data and
historical experience, rather than the theory and conjecture as seems
to be the Council's approach to stock and bond funds and their
managers. In Section V, we discuss the ongoing FSOC process with regard
to asset managers. Finally, in Section VI, we conclude with an
explanation of the many worrisome consequences of inappropriately
designating funds and asset managers, which would harm investors and
financial markets.
II. The FSOC's SIFI Designation Process Should Be More Transparent and
Accountable
The FSOC's SIFI designation process has been the subject of
widespread criticism. Members of Congress from both parties have
submitted numerous letters and statements expressing their own
concerns. In 2014, for example, a bipartisan group of five Senators
stated that one of the greatest problems with the SIFI designation
process ``is a lack of transparency and accountability.'' \3\ The
Government Accountability Office (GAO) likewise has urged the FSOC to
make changes to its process, including ``improv[ing] communications
with the public.'' \4\ Last year, several trade associations formally
petitioned the FSOC to make changes to the SIFI designation process,
including allowing entities undergoing review to receive more
information and interact more extensively with the Council and its
staff. \5\
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\3\ See ``Letter to The Honorable Jacob J. Lew, Secretary, U.S.
Department of the Treasury, Chairman of the FSOC, from Sen. Mark Kirk
(R-IL), Sen. Thomas Carper (D-DE), Sen. Patrick Toomey (R-PA), Sen.
Claire McCaskill (D-MO), Sen. Jerry Moran (R-KS)'', dated Jan. 23,
2014, (stating that ``we strongly urge the FSOC and other governing
bodies not to base any policy or regulation actions grounded on the
information in the OFR study . . . . The OFR study mischaracterizes the
asset management industry and the risks asset managers pose, makes
speculative assertions with little or no empirical evidence, and, in
some places, predicates claims on misused or faulty information'').
Senator Mark Warner has also noted that SIFI designation analysis
``should follow a rigorous and transparent process, using reliable
data, so that regulators and the marketplace can be armed with the best
information possible.'' ``Letter to The Honorable Jacob J. Lew,
Secretary, U.S. Department of the Treasury, Chairman of the FSOC, from
Sen. Mark Warner (D-VA)'', dated May 9, 2014. House Financial Services
Chairman Jeb Hensarling also noted that, with the exception of the
national security agencies dealing in classified information, the
``FSOC may very well be the Nation's least transparent Federal
entity.'' ``Statement of Chairman Jeb Hensarling before House Financial
Services Committee, Hearing on `The Annual Report of the Financial
Stability Oversight Council' (June 24, 2014). See also ``Letter to The
Honorable Jacob J. Lew, Secretary, U.S. Department of the Treasury,
Chairman of the FSOC, from Rep. Carolyn B. Maloney (D-NY), Ranking
Member, Subcommittee on Capital Markers and Government Sponsored
Enterprises'', dated July 29, 2014. In a letter to Federal regulators,
Chairman Hensarling and others also commented that the ``lack of
transparency and due process injects needless uncertainty and
instability into our financial markets.'' ``Letter to The Honorable
Jacob J. Lew, Secretary, U.S. Department of the Treasury, Chairman of
the FSOC; The Honorable Janet Yellen, Chair, The Federal Reserve
System; and The Honorable Mary Jo White, Chair, SEC, from Rep. Jeb
Hensarling (R-TX), Chairman, House Financial Services Committee, and
the respective Subcommittee Chairmen'', dated May 9, 2014.
\4\ See GAO, New Council and Research Office Should Strengthen the
Accountability and Transparency of Their Decisions (Sept. 2012),
available at http://www.gao.gov/assets/650/648064.pdf; GAO, Continued
Actions Needed To Strengthen New Council and Research Office (Mar. 14,
2013), available at http://www.gao.gov/products/GAO-13-467T; GAO,
Further Actions Could Improve the Nonbank Designation Process (Nov.
2014), available at http://www.gao.gov/assets/670/667096pdf.
\5\ The American Council of Life Insurers, the American Financial
Services Association, the Association of Institutional Investors, the
Financial Services Roundtable, and the Asset Management Group of the
Securities Industry and Financial Markets Association, ``Petition for
FSOC Rulemaking Regarding the Authority To Require Supervision and
Regulation of Certain Nonbank Financial Companies'', (Aug. 19, 2014),
available at http://fsroundtable.org/rulemaking-petition-fsoc/.
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In response to these repeated calls for change, the FSOC in
November 2014 convened meetings with interested parties to discuss
potential procedural reforms and thereafter, in February 2015, issued
``supplemental procedures'' to revise its SIFI designation process. The
changes include, among other things, earlier notice to and opportunity
to submit information by companies and their primary regulators under
Stage 2 active review; meetings with the FSOC's Deputies Committee to
allow companies in Stage 3 to present relevant information or
arguments; a commitment to grant requests for oral hearings from
companies in Stage 3; notices explaining a decision not to rescind a
designation; and oral hearings for designated companies once every 5
years. \6\
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\6\ FSOC, ``Supplemental Procedures Relating to Nonbank Financial
Company Determinations'' (Feb. 4, 2015), available at http://
www.treasury.gov/initiatives/fsoc/designations/Documents/Supplemental-
Procedures-Related-to-Nonbank-Financial-Company-Determinations-
February-2015.pdf.
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ICI welcomes these changes, which were overdue, as an initial
positive step towards providing greater fairness and clarity in the
designation process. Nonetheless, more needs to be done to improve the
FSOC's designation process. As it stands, the FSOC retain the absolute
discretion to eliminate or change the new ``supplemental procedures''
at any time and without prior notice. Instead, the recent changes
should be codified in law. This would provide a highly desirable
predictability and certainty about FSOC's designation process.
In addition, we believe Congress must act to reform the FSOC's
designation process \7\ in ways that will advance the Dodd-Frank Act's
dual goals of reducing systemic risk while reserving SIFI designation
as a tool to be used only in truly exceptional cases:
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\7\ As noted, bipartisan legislation introduced in the 113th
Congress by Reps. Dennis Ross (R-FL) and John Delaney (D-MD), and four
cosponsors, H.R. 5180, the FSOC Improvement Act, would codify these and
other good Government reforms to the SlFI designation process.
Additional provisions in the hill include important annual and 5-year
reviews of prior SIFI designations in order to provide important
information to firms and to the public about as to how previously
designated SIFIs can take measures to ameliorate risks.
First, the FSOC should allow a targeted firm's primary
financial regulator an opportunity, prior to designation, to
address any systemic risks identified by the FSOC. A company's
primary regulator generally will have greater expertise and
regulatory flexibility than the FSOC to address identified
risks. By way of example, the SEC already has the necessary
authority--and is taking steps--to strengthen oversight of
asset managers and funds, including by expanding oversight of
risk management in key areas and enhancing its collection of
mutual fund data. \8\
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\8\ ``Remarks at the New York Times DealBook Opportunities for
Tomorrow Conference'', Mary Jo White, Chair, SEC (Dec. 11, 2014),
available at http://www.sec.gov/News/Speech/Detail/Speech/
1370543677722#.VJMKZ14AKB.
Second, an entity being reviewed for SIFI designation
should have an opportunity to make changes to its structure or
business practices to address identified systemic risks prior
to designation. Allowing a firm the opportunity to change its
business model or practices often may be the most effective way
---------------------------------------------------------------------------
to address the identified risks.
These reforms would further the objectives of promoting market
discipline and reducing systemic risk, all while reserving designation
for the exceptional circumstances for which it was intended. It also
would avoid undue imposition of the remedies outlined in the Dodd-Frank
Act on nonbank institutions for which they are clearly inappropriate.
As specified in the Act, those remedies include the following: a risk
based capital requirement potentially as high as 8 percent; \9\
``enhanced prudential supervision'' by the Federal Reserve; \10\ and
susceptibility to paying into a resolution fund in the event of the
failure of a bank SIFI. \11\ We discuss the consequences of these
statutory remedies for funds and their managers in Section VI below.
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\9\ 12 U.S.C. 5371. An unresolved inconsistency between two
provisions in the Dodd-Frank Act calls into serious question just how
much flexibility the Federal Reserve would have to limit the
application of capital requirements to any U.S. mutual fund designated
as a SlFI or G-SIFI. Although one provision of the Dodd-Frank Act gives
the Federal Reserve discretion in applying capital standards to nonbank
SIFIs (Section 165(b)(1)(A)(i) of the Dodd-Frank Act (providing the
Federal Reserve authority to determine that capital standards are
inappropriate for a particular SIFI and to substitute ``other similarly
stringent risk controls.'')), another provision--known as the ``Collins
Amendment''--may not (see Section 171 of the Dodd-Frank Act, which
requires the imposition of minimum-leverage capital and risk-based
capital standards on any SIFI).
\10\ 12 U.S.C. 5365.
\11\ 12 U.S.C. 539(o)(1)(D)(ii)(l).
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Ill. The Absence of Particularity in SIFI Determinations Impedes
Interested Parties From Understanding and Benefiting From the
FSOC's Analyses
Providing a company and its primary financial regulator an
opportunity to mitigate identified systemic risks prior to designation
would have the added benefit of requiring the FSOC to explain the bases
for its designation decisions with some particularity. As discussed
below, this is not something the FSOC has done in any of its nonbank
SIFI designations thus far. Requiring an appropriate degree of
specificity would enable the firm under consideration, the firm's
principal regulator, other market participants, Congress and the public
at large to understand the specific reasons for the FSOC's actions,
thus enhancing both the transparency and accountability of the Council
and its actions.
The Dodd-Frank Act permits the FSOC to designate a nonbank
financial institution as ``systemically important'' in one of two
situations. The FSOC may designate a firm if either (1) the company's
material financial distress (the First Determination Standard) or (2)
the nature, scope, size, scale, concentration, interconnectedness, or
mix of the company's activities (the Second Determination Standard),
could pose a threat to the financial stability of the United States.
\12\ To date, the FSOC has predicated all of its nonbank SIFI
determinations on the basis of the First Determination Standard and has
not addressed whether the activities of the company could pose a threat
to the financial stability of the United States. In its 2014 report on
improving the FSOC designation process, the GAO noted the FSOC's
exclusive reliance on the First Determination Standard, and expressed
concern that the approach was flawed and would lead the FSOC to ignore
certain risks. \13\
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\12\ 12 U.S.C. 5323(a)(1).
\13\ See GAO, ``Further Actions Could Improve the Nonbank
Designation Process'' (Nov. 2014), available at http://www.gao.gov/
assets/670/667096.pdf.
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In effect, the approach taken by the FSOC has led to designations
that appear to be based on a firm's size, rather than on the basis of
the more complete and detailed analysis of a firm's activities and the
risks they present, as the Dodd-Frank Act envisioned. \14\ The FSOC's
State insurance commissioner representative stated, in response to the
MetLife, Inc. (MetLife) designation, that ``the [FSOC] has failed to
address the criticism that it did not conduct a robust analysis of
characteristics of MetLife beyond its size,'' and that without more
specific details on the bases for determination, ``any large company
could meet the statutory standard applied by the [FSOC].'' \15\ In
fact, Congress expressly required in the Dodd-Frank Act that the FSOC
consider at least 10 statutory factors, only 2 of which directly relate
to an institution's size. \16\ By avoiding any discussion of the
particular aspects or activities of an institution that are thought to
pose systemic risks, the FSOC not only forecloses the prospect of any
meaningful, reasoned justification for its decisions, but also
frustrates congressional intent.
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\14\ The Financial Stability Board (FSB) has proposed to take a
similarly flawed approach, focusing in its second consultation on the
size of firms to the exclusion of other factors. See FSB, ``Second
Consultative Document: Assessment Methodologies for Identifying Nonbank
Non-Insurer Global Systemically Important Financial Institutions''
(Mar. 4, 2015), available at http://www.financialstabilityboard.org/wp-
content/uploads/2nd-Con-Doc-on-NBNI-G-SIFI-methodologies.pdf.
\15\ Adam Hamm, ``View of the State Insurance Commissioner
Representative'' (Dec. 2014), available at http://www.treasury.gov/
initiatives/fsoc/designations/Documents/
Dissenting%20and%20Minority%20Views.pdf.
\16\ See 12 U.S.C. 5323(a)(2). The two considerations are 12
U.S.C. 5323(a)(2)(I) and (J), which require the FSOC to consider
``the amount and nature of the financial assets of the company'' and
``the amount and types of the liabilities of the company, including the
degree of reliance on short-term funding,'' respectively.
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In addition, and equally troubling, the FSOC's exclusive reliance
on the First Determination Standard does nothing to inform a designated
nonbank firm, other market participants, Congress or the general public
about the primary drivers (if any, other than size) of the Council's
designation decision. It therefore offers the firm no insight into how
it might ``de-risk'' and thereby no longer merit SIFI designation or
require application of the exceptional remedies specified in the Dodd-
Frank Act. This is an odd result indeed if the object of the exercise
is to eliminate or minimize what are thought to be outsized risks to
the financial system at large.
The GAO's 2014 study makes a similar point. The GAO found that even
nonpublic documentation of Stage 3 evaluations--the final stage of the
FSOC's multistaged analytic process--did not include sufficient detail
on the bases for the FSOC's determinations. \17\ In dissenting from
MetLife's SIFI designation, S. Roy Woodall, the presidentially
appointed independent member of the FSOC with insurance expertise,
noted that basing determinations solely on the First Designation
Standard ``does little else to promote real financial system reform''
because it does not provide ``constructive guidance for the primary
financial regulatory authorities, the [Federal Reserve] Board of
Governors, international supervisors, other insurance market
participants and, of course, MetLife itself, to address any [systemic]
threats posed by the company.'' \18\
---------------------------------------------------------------------------
\17\ See GAO, ``Further Actions Could Improve the Nonbank
Designation Process'', at 35 (Nov. 2014), available at http://
www.gao.gov/assets/670/667096.pdf (stating that the FSOC's nonpublic
documentation ``could have benefited from inclusion of additional
detail about some aspects of its designation decisions'').
\18\ S. Roy Woodall, ``Views of the Council's Independent Member
Having Insurance Expertise'' (Dec. 2014), available at http://
www.treasury.gov/initiatives/fsoc/designations/Documents/
Dissenting%20and%20Minority%20Views.pdf.
---------------------------------------------------------------------------
The FSOC should be explicit about the systemic risks it identifies
arising from a firm's structure or activities. It should provide enough
detail to enable both a company and its primary regulator to respond
substantively with proposals to mitigate the risk. This is beneficial
on all sides--systemic risk would be curbed, the public and market
might gain insight on what activities or structures the FSOC considers
to be systemically risky and why, and the firm could avoid unnecessary
and potentially inappropriate regulation and supervision.
IV. The FSOC's Approach to Designation Is Predicated on Conjecture, as
Opposed to Empirical Data
If the FSOC were required to provide greater specificity about the
bases for its designation decisions, as the Dodd-Frank Act anticipates,
it would be more likely to engage in the kind of robust, empirically
based, data-driven, ``bottom up'' analysis that one would reasonably
expect in connection with such a significant regulatory determination.
Such an approach would take fully into account all of the factors that
Congress enumerated in Section 113 of the Dodd-Frank Act, including the
degree to which a firm already is regulated and the prospects of using
that preexisting regulatory structure to address perceived risks. It
would help ensure that designations are not made on the basis of
prejudgment or conjecture or on ``implausible, contrived scenarios'';
it also would make the FSOC far less susceptible to criticism, from
within its own ranks, for ``failures to appreciate fundamental
aspects'' of a potential designee's business, products, and services.
\19\ Remarkably, in dissenting to Prudential Financial, Inc.'s
(Prudential) designation as a SIFI, Mr. Woodall observed the following:
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\19\ Id.
Key aspects of [the FSOC's] analysis are not supported by the
record or actual experience; and, therefore, are not
persuasive. The underlying 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 . . . . [T]he grounds for the Final Determination are
simply not reasonable or defensible, and provide no basis for
me to concur. \20\
---------------------------------------------------------------------------
\20\ S. Roy Woodall, ``Views of the Council's Independent Member
Having Insurance Expertise'' (Sept. 19, 2013), available at
www.treasury.gov/initiatives/fsoc/councilmeetings/Documents/
September%2019%202013%20Notational%20Vote.pdf.
The State insurance representative on the FSOC, John Huff, agreed;
he found the FSOC's analysis of Prudential to be ``flawed,
insufficient, and unsupportable.'' \21\
---------------------------------------------------------------------------
\21\ John Huff, ``View of Director John Huff, the State Insurance
Commissioner Representative'' (Sep. 2013), available at http://
www.treasury.gov/initiatives/fsoc/council-meetings/Documents/
September%2019%202013%20Notational%20Vote.pdf.
---------------------------------------------------------------------------
Moreover, this highly theoretical approach is not unique to the
FSOC. The Financial Stability Board (FSB) recently issued a second
consultation on evaluation criteria for nonbank, noninsurer global
SIFIs (NBNI G-SIFls). \22\ In this second consultation, the FSB frankly
states that ``the NBNI G-SIFI assessment methodologies aim to measure
the impact that an NBNI financial entity's failure can have on the
global financial system and the wider economy, rather than the
probability that a failure could occur.'' \23\ Apparently, if bank
regulators meeting in Switzerland can conjure up some ``systemic''
concern, then their conjecture can serve as a basis for global
policymaking--even if it has no historical, factual or even rational
predicate. When we have argued for a process informed by facts, we
often have been invited to prove a negative--that is, to demonstrate
that the hypothetical risks so articulated cannot arise.
---------------------------------------------------------------------------
\22\ FSB, supra note 14.
\23\ Id. at 10, emphasis in the original.
---------------------------------------------------------------------------
In sum, the way in which the FSOC has approached the question of
nonbank SIFI designation has every feel of a result-oriented exercise
as opposed to an objective analysis--where a single blunt metric (size)
dwarfs the other statutory factors and mere hypotheses are used to
compel a seemingly predetermined outcome--i.e., that designation is
required.
We believe Congress expected, and it should demand, something more
of the FSOC. SIFI designation should be predicated on a thorough,
objective analysis of a specific institution, its structure and
activities, its historical experience, the ways in which it is
regulated currently and ocher empirical information, including all the
factors set out in the Dodd-Frank Act--and the results of this analysis
should be made available to the public. Relatedly, if it determines to
consider asset managers and their funds for SIFI designation, the FSOC
should subject the metrics and thresholds used to evaluate such
entities to notice and comment. \24\ With such a focus on facts, the
FSOC also would do well to consider whether using one of the other
tools that the Dodd-Frank Act makes available to it would be more
appropriate than SIFI designation. Indeed, requiring a consideration of
the costs and benefits of designation would put the FSOC's decision
making on par with the Administrative Procedure Ace's requirements for
significant rulemakings and the Obama administration's executive orders
regarding rulemaking processes. \25\
---------------------------------------------------------------------------
\24\ The FSOC has warned that it may use other methods to assess
the asset management industry, but, as a bipartisan group of
Congressmen has pointed out, ``the FSOC: should . . . publicly disclose
the economic models, data, and analysis that support its approach
before taking any steps to identify particular asset management
entities for SIFI designation.'' Letter to The Honorable Jacob J. Lew,
Secretary, U.S. Department of the Treasury, Chairman of the FSOC, from
Reps. Dennis Ross (R-FL) and John Delaney (DMD) and 39 other members of
the House Financial Services Committee (May 9, 2014). Publicizing the
metrics will ensure the FSOC is not relying on inaccurate data and
false assumptions, such as those in the Office of Financial Research's
Asset Management Study.
\25\ Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 2011)
(requiring certain agencies to engage in cost-benefit analysis before
rulemaking); Exec. Order 13,579, 76 Fed. Reg. 41585 (July 14, 2011)
(encouraging independent regulatory agencies to engage in cost-benefit
analysis before rulemaking).
---------------------------------------------------------------------------
V. The FSOC's Review of Asset Management Appears Similarly Flawed
A 2013 report on asset management written by the Office of
Financial Research (OFR), the research arm of the FSOC, heightened our
concerns with the FSOC's SIFI review process and demonstrated the need
for increased public input. The report was the subject of withering
criticism--for reflecting a deeply inaccurate understanding of the
asset management industry, for rendering sweeping conclusions
unsupported by data or analysis and for lacking clarity, precision, and
consistency in its scope, focus, and use of data. \26\
---------------------------------------------------------------------------
\26\ See, e.g., ``Letter to the Honorable J. Lew, Secretary, U.S.
Department of the Treasury, Chairman of the FSOC, from Sen. Mark Kirk
(R-IL), Sen. Thomas Carper (D-DE), Sen. Patrick Toomey (R-PA), Sen.
Claire McCaskill (D-MO), Sen. Jerry Moran (R-KS)'', dated Jan. 23,
2014, (stating that the report ``mischaracterizes the asset management
industry and the risks asset managers pose, makes speculative
assertions with little or no empirical evidence, and in some places,
predicates claims on misused or faulty information''); ``Letter to The
Honorable Jacob J. Lew, Secretary, U.S. Department of the Treasury,
Chairman of the FSOC, from Sen. Mike Crapo (R-lD)'', dated Jan. 27,
2014 (stating that ``OFR's failures to take into account the
perspectives of and data from market participants will result in flawed
evaluation of the asset management industry by FSOC and, worse, a move
towards designation of asset management firms as SIFIs without an
accurate understanding of the rule they play in the financial
system''); Daniel M. Gallagher, Commissioner, SEC, ``Public Feedback on
OFR Study on Asset Management Issues'' (May 14, 2014), available at
http://www.sec.gov/comments/am-1/am1-52.pdf. (citing multiple critics
of the asset management report and calling the report ``a botched
analysis that grossly overstates--indeed, in many cases simply invents
without supporting data--the potential risks to the stability of our
financial markets posed by asset management firms'').
---------------------------------------------------------------------------
Regrettably, the FSOC appears to be persisting in this pattern of
reliance on conjecture and hypothesis in its consideration of liquidity
and redemption risks associated with investment vehicles that are
offered by asset managers. Its recent Notice Seeking Comment on Asset
Management Products and Activities (the Notice) \27\ simply assumes a
variety of potential threats to the financial system arising from asset
management, much as the OFR report did in 2013. For example, the Notice
hypothesizes that shared trading costs for stock and bond funds create
a unique and powerful incentive for fund investors to redeem en masse
in the face of a market decline, potentially leading to severe
additional downward pressure on markets. The Notice points to no
historical experience nor any empirical data to support this
hypothesis. In fact, there is none: the hypothesis is based on a series
of assumptions that simply do not reflect how stock and bond funds and
their managers operate nor how their investors behave, as the Institute
discusses in detail in its comment letter to the FSOC to be filed on
March 25, 2015. Even if this hypothesis were at all plausible, there is
nothing to suggest it would in fact pose a risk to financial stability.
---------------------------------------------------------------------------
\27\ 80 Fed. Reg. 7595 (Feb. 5, 2015), available at http://
www.gpo.gov/fdsys/pkg/FR-2015-02-11/pdf/2015-02813.pdf.
---------------------------------------------------------------------------
While we are concerned with the highly theoretical nature of some
of the questions presented in the Notice, ICI commends the FSOC for
seeking public comment on this occasion. We hope and expect that
Council members will thoroughly review and give due consideration to
all the public comments they receive, including the extensive research
and commentary submitted by ICI and its members. A transparent, fact-
based and fair FSOC process with respect to funds and their managers--
one that takes full account of the structure and characteristics of
these entities, the ways in which they operate, the 75-year history of
the industry, and the highly effective framework of regulation under
which it currently operates--will, we believe, allay any concerns that
funds or their managers pose risks to the financial system meriting
SIFI designation.
VI. The Consequences of Inappropriate Designations Would Be Severe
Ensuring that the FSOC meets high standards of transparency and
accountability as it exercises its authority under the Dodd-Frank Act
is vitally important: its designations carry with them exceptional
consequences. In the case of funds and their managers, we submit that
there is no basis for designation--and, if they were designated, the
consequences would be highly adverse to investors and the capital
markets.
As noted above, if a fund or its manager were to be designated a
SIFI, the Dodd-Frank Act could require it to meet bank-level capital
requirements. The fund or manager would have to cover the costs of its
``enhanced prudential supervision'' by the Federal Reserve. It would
bear a share of the costs of the FSOC and OFR annually. It would even
be subject to assessments to cover the cost of bailing out another SIFI
if one were to fail, thus exposing fund investors (likely retirement
savers) to having to foot the bill.
All of these costs would be unique to the designated fund or
manager, and thus uniquely borne by that fund complex. The fund
marketplace in the U.S. is highly competitive. There are many
substitutable funds and providers from which to choose, and our
investors and their financial advisers are properly focused on the
impact of fees and expenses on long-term investment results. It is not
apparent that a stock and bond fund or manager saddled with the
additional costs of being a SIFI can remain fully competitive under
these circumstances. Its shareholders may have very strong incentives
to invest elsewhere. SIFI designation for some funds or fund managers
thus stands to greatly distort the fund marketplace.
Of still more fundamental concern are the implications of
``enhanced prudential supervision'' of a stock or bond fund or its
manager by the Federal Reserve. The bank model of regulation seeks
first and foremost to preserve the safety and soundness of banks and
the banking system. It contrasts strongly with the model of regulation
enshrined in the Investment Company Act and Investment Advisers Act as
administered by the SEC. Under that model, the adviser to a fund owes
the fund's shareholders an exclusive duty of loyalty and care--and one
of the SEC's primary missions is to protect the fund investors'
interests.
An overlay of bank regulation thus would introduce a new and
troubling dynamic of conflicted regulation. For example, a SIFI-
designated stock and bond fund or its manager would be expected to
comply with the Federal Reserve's directions about how to manage its
investment portfolio, irrespective of the fund adviser's or independent
directors' fiduciary duties or the best interests of the fund's
shareholders. This is not a theoretical concern. In the aftermath of
the financial crisis, some bank regulators vocally criticized fund
managers for acting to protect their investors from financial losses by
not maintaining short-term investments with banking institutions that
were at risk of failure. \28\ The priority of the bank regulators, of
course, was not protecting the interests of the fund investors, but
propping up failing banks and thereby the banking system.
---------------------------------------------------------------------------
\28\ ``Remarks at the Federal Reserve Bank of New York Workshop on
Fire Sales as a Driver of Systemic Risk in Triparty Repo and Other
Secured Funding Markets'', Jeremy C. Stein, Member, Board of Governors
of the Federal Reserve System (Oct. 4, 2013), available at http://
www.federalreserve.gov/newsevents/speech/stein20131004a.htm; ``Remarks
at the Global Research Forum on International Macroeconomics and
Finance on Dollar Funding and Global Banks'', Jeremy C. Stein, Member,
Board of Governors of the Federal Reserve System (Dec. 17, 2012),
available at http://www.bis.org/review/r121218c.pdf.
---------------------------------------------------------------------------
Just this kind of approach to regulating asset managers is
something that Federal Reserve Governor Daniel K. Tarullo explicitly
called for in a recent speech--terming it ``prudential market
regulation,'' something needed to provide a ``systemwide perspective''
that would trump traditional investor protections and market regulation
and respond to ``systemwide demands.'' \29\ Presumably, any fund or
manager designated a SIFI henceforward would be put to the service of
two masters--the Federal Reserve in the interests of the ``system,''
and secondarily the fund's shareholders.
---------------------------------------------------------------------------
\29\ ``Remarks at the Office of Financial Research and Financial
Stability Oversight Council's 4th Annual Conference on Evaluating
Macroprudential Tools: Complementarities and Conflicts'', Daniel K.
Tarullo, Member of the Federal Reserve System (Jan. 30, 2015 ),
available at http://www.federalreserve.gov/newsevents/speech/
tarullo20150130a.pdf.
---------------------------------------------------------------------------
Moreover, a SIFI regime for funds or their managers likely will
result in highly prescriptive regulations and a common sec of
``approved'' investments within portfolio structures--just as the Basel
standards pushed banks toward a standard portfolio of ``lower-risk''
assets, and thus helped usher in the financial crisis of 2008. This is
the model that the Federal Reserve would bring to asset management.
With it would come decreasing diversification, increasing correlation,
great volatility, and more--not less--risk. Such requirements would
ultimately compromise and diminish the exceptional role that funds play
as a source of financing to the economy.
That the remedies in the Dodd-Frank Act seem altogether
inappropriate when applied to stock and bond funds and their managers
is perhaps not surprising: during consideration of the Dodd-Frank Act,
there was no thought that these remedies would be applied to a part of
the financial system that had remained comparatively so resilient even
in the midst of the crisis.
This underscores the need for Congress to craft, with respect to
asset management, a very different set of remedies that would flow from
any SIFI designation. If the FSOC does identify systemic risks in the
asset management sector, we believe enhanced oversight by the SEC, and
not by the Federal Reserve, is appropriate.
The figure [below] illustrates just how consequential allowing the
FSOC and the Federal Reserve to proceed down the current path is likely
to be. In connection with its ``Workstream on Other Shadow Banking
Entities'', \30\ led personally by Governor Tarullo, the FSB recently
released for public comment proposed thresholds for identifying the
pool of asset managers and individual funds that automatically would be
evaluated for potential designation as G-SIFIs. The FSB proposes
alternative thresholds for funds and for asset managers. The below
chart applies the broader FSB threshold for funds--any fund with assets
of more than $100 billion in assets. For asset managers the below chart
applies the FSB's $1 trillion under management threshold.
---------------------------------------------------------------------------
\30\ FSB, supra note 14.
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The vast majority of the funds and asset managers that
automatically would be evaluated under these criteria are U.S. firms.
Applying these thresholds to our industry--something that seems to be
highly likely if the FSB adopts them \31\--we estimate that more than
half of the $6.3 trillion in assets in defined contribution plans would
fall either directly or indirectly under the ``enhanced prudential
supervision'' and thus the ``prudential market regulation'' of the
Federal Reserve, assuming that the funds and managers meeting the
thresholds are designated. More broadly, we estimate that well over
half--nearly $10 trillion--of the $18 trillion in assets that U.S.
households have invested in mutual funds, ETFs, or other registered
investment companies would fall under such supervision by the Federal
Reserve.
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\31\ We note that all insurance companies that have been
designated as SIFIs were first designed by the FSB as global
systemically important insurers (G-SIIs).
We do not believe that any Member of Congress had any conceivable
notion of the prospect that this extraordinary expansion of Federal
Reserve authority could result from the Dodd-Frank Act. Surely,
however, important participants today in the FSOC and FSB are well
aware of it. And, ironically, there are voices in the bank regulatory
community urging that the real problem with the FSOC is not that it has
too little accountability, but that it has too much--and give due
consideration to all these extraordinary new regulatory powers with a
very high degree of independence from Congress and the executive
branch. \32\
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\32\ See, e.g., Donald Kohn, ``Institutions for Macroprudential
Regulation: The U.K. and the U.S.'' (Apr. 17, 2014), available at
http://www.brookings.edu/research/speeches/2014/04/17-institutions-
macroprudential-regulation-kohn (advocating for a change in the FSOC's
structure ``to enhance its independence'').
---------------------------------------------------------------------------
In conclusion, let me say that ICI and all its members have deep
concerns about the transparency, accountability, and fairness of the
FSOC process. We by no means object to the Council's examination of
asset management as it weighs possible outsized risks to the financial
system. What we do ask is simple, and nothing more than common sense
and good governance would seem to require:
The FSOC should consider all the tools available to it to
mitigate risks, not simply SIFI designation;
SIFI designations should have a clear and compelling
empirical basis and take into account all the factors Congress
enumerated in statute;
The FSOC should communicate with particularity the bases
for its designations;
Congress should ensure that there is an opportunity for
``de-risking'' by a primary regulator and by the institution
concerned in advance official SIFI designation; and
In the event that the FSOC does not heed the volume of data
to the contrary and designates a stock or bond fund or asset
manager as a SIFI, Congress should ensure that the remedies to
which the designated fund or manager is subject are appropriate
ones, for those currently contained in the Dodd-Frank Act
clearly are not.
We appreciate the opportunity to share these views with the
Committee. ICI looks forward to working with Congress on reforming the
FSOC's SIFI designation process to ensure that it works as Congress
intended.
______
PREPARED STATEMENT OF DOUGLAS HOLTZ-EAKIN
President, American Action Forum
March 25, 2015
Chairman Shelby, Ranking Member Brown, and Members of the
Committee, thank you for the opportunity to appear today and share my
views on the Financial Stability Oversight Council (FSOC or the
Council) nonbank designation process.* FSOC's mission is to identify,
monitor, and address threats to America's financial stability. Yet
without significant changes to the process by which nonbank financial
companies (NBFCs) are designated as systemically important and
regulated, FSOC risks losing the confidence of the public and
policymakers and burdening the economy without resultant benefits. In
my testimony, I wish to make three main points:
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*I thank Marisol Garibay, Sarah Hale, and Andy Winkler for their
assistance. The views expressed here are my own and not those of the
American Action Forum.
FSOC's process thus far has prioritized designation and
regulation of institutions over the identification of
activities that pose systemic threats, and done so in a
fundamentally flawed manner. I applaud the Committee for taking
---------------------------------------------------------------------------
a critical look at this process and all its implications;
Further clarity is needed on the metrics leading to
designation. And equally important, companies must be able to
address the activities identified as posing systemic risk,
avoid a designation, and, if unable to do the aforementioned,
have a path exiting designation;
Finally, recently adopted procedures to open up FSOC and
improve communication with firms under review should be
commended as a good first step.
Let me provide additional detail on each in turn.
Current Nonbank Designation Process
Title I, Subtitle A, of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act) established FSOC, outlined the
Council's powers, and introduced factors that must be considered when
designating NBFCs as systemically important financial institutions
(SIFIs). Because banking companies with over $50 billion in assets are
automatically considered SIFIs in the Dodd-Frank Act, key issues
involving designation revolve around nonbanks.
Specifically, Section 113 of the Dodd-Frank Act gives FSOC the
authority by two-thirds vote (including the chairperson) to bring a
NBFC under increased supervision and regulation by the Federal Reserve
Board (FRB) if the Council determines that ``material financial
distress at the U.S. nonbank financial company, or the nature, scope,
size, scale, concentration, interconnectedness, or mix of the
activities of the U.S. nonbank financial company, could pose a threat
to the financial stability of the United States.'' \1\ In making that
determination, the Dodd-Frank Act lists 10 criteria for FSOC to
consider along with ``any other risk-related factors that the Council
deems appropriate.'' \2\ As such, FSOC has broad authority statutorily
when evaluating companies for SIFI designation. In April 2012, FSOC
released a final rule and interpretive guidance on the process it uses
to designate SIFIs. \3\ The Council recently voted to supplement that
process during its February 2015 meeting following an internal review
and input from the public and stakeholders. \4\
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\1\ 12 U.S.C. 5323 (a)(1).
\2\ 12 U.S.C. 5323 (a)(2)(K).
\3\ ``Authority To Require Supervision and Regulation of Certain
Nonbank Financial Companies; Final Rule and Interpretive Guidance'', 77
Federal Register 70 (April 11, 2012) pp. 21637-21662; https://
federalregister.gov/a/2012-8627.
\4\ FSOC, ``Supplemental Procedures Relating to Nonbank Financial
Company Determinations'', (February 4, 2015); http://www.treasury.gov/
initiatives/fsoc/designations/Documents/
Supplemental_Procedures_Related_to_Nonbank_Financial_Company_Determinati
ons-February_2015.pdf.
---------------------------------------------------------------------------
The three-stage evaluation process FSOC developed is intended to
narrow the pool of companies potentially subject to designation by
applying specific thresholds based on 11 criteria included in Section
113 of the Dodd-Frank Act. The 11 criteria have been incorporated into
six overarching framework categories that FSOC considers: (1) size, (2)
interconnectedness, (3) leverage, (4) substitutability, (5) liquidity
risk and maturity mismatch, and (6) existing regulatory scrutiny. Table
1 highlights how thresholds in these categories are applied and how
scrutiny increases as a company advances through each stage. However,
in practice, it is not clear the weight given to certain factors over
others or what makes a designation more likely.
Table 2 includes a summary of all changes adopted in February, many
of which attempt to address the need for increased transparency and
communication. Items shaded in gray are substantially similar to
reforms previously highlighted in past work by the American Action
Forum.\5\ \6\ \7\ \8\
---------------------------------------------------------------------------
\5\ ``Authority To Require Supervision and Regulation of Certain
Nonbank Financial Companies; Final Rule and Interpretative Guidance'',
77 Federal Register 70 (April 11, 2012) p. 21661; https://
federalregister.gov/a/2012-8627.
\6\ Satya Thallam, ``Considering an Activity-Based Regulatory
Approach to FSOC'', (September 12, 2014) http://
americanactionforum.org/research/considering-an-activity-based-
regulatory-approach-to-fsoc.
\7\ Satya Thallam, ``Reform Principles for FSOC Designation
Process'', (November 11, 2014) http://americanactionforum.org/research/
reform-principles-for-fsoc-designation-process.
\8\ Satya Thallam, ``Reform Principles for FSOC Designation
Process (Cont'd),'' (January 15, 2015); http://americanactionforum.org/
solutions/reform-principles-for-fsoc-designation-process-contd.
Because Dodd-Frank gives FSOC such expansive authority to set the
specific determinants of a SIFI designation, FSOC's operational
procedures have largely been set internally and through the regulatory
rulemaking process. Table 3 outlines the actions FSOC and the Federal
Reserve Board have taken to date to define their procedures, receive
feedback from the public, and exercise their authority to designate
NBFCs and regulate them. Since its creation, four NBFCs (AIG, GE
Capital, Prudential Financial, and MetLife) have already been
affirmatively voted as SIFIs. FSOC voted unanimously to designate AIG
and GE Capital in June 2013 and reaffirmed their status last year. The
votes to designate Prudential Financial and MetLife, in September 2013
and December 2014, respectively, were not unanimous--both included
objections from the voting and nonvoting members of FSOC with insurance
experience.
Primary Criticisms and Recommended Changes
Established in Section 113 of the Dodd-Frank Act, FSOC has been
given the difficult task of identifying and monitoring threats to U.S.
financial stability in real-time. However, there is no single or simple
way to measure and mitigate systemic risk. In fact, the process FSOC
has developed to designate NBFCs as SIFIs can also disrupt markets and
impose unnecessary regulatory burdens and costs that outweigh its
benefits to the economy. So despite recent improvements, FSOC's process
needs more rigorous quantitative analysis, respect for other regulators
and their expertise, greater concern for market impacts, and a clear
path for the removal of a designation. Here is further detail on the
issues FSOC reforms should address:
1. FSOC's lack of transparency and failure to provide meaningful
information on the determinants leading to designation result in
unclear guidance on systemic threats. While FSOC is right to worry
about the effect of leaks and disclosures of proprietary information,
room still exists for the release of more information detailing issues
in the broadest, macro terms. According to a report issued by the
Government Accountability Office (GAO), ``FSOC's transparency policy
states its commitment to operating transparently, but its documentation
has not always included certain details.'' \9\ GAO recommended, ``To
enhance disclosure and strengthen transparency, the Secretary of the
Treasury, in consultation with FSOC members, . . . should include
additional details in its public basis documentation about why FSOC
determined that the company met one or both of the statutory
determination standards.'' \10\ Designation decisions available to the
public should reflect the shared goal of minimizing systemic threats;
if there is a specific activity or subsidiary of a designated firm that
poses an acute threat, the final decision should disclose it.
Furthermore, GAO is not alone in suggesting more open communication
with the public and companies under consideration, the Bipartisan
Policy Center and many others have echoed such concerns. \11\
---------------------------------------------------------------------------
\9\ GAO, ``Financial Stability Oversight Council: Further Actions
Could Improve the Nonbank Designation Process'', (November 20, 2014);
http://www.gao.gov/products/GAO-15-51.
\10\ Ibid.
\11\ Bipartisan Policy Center, Economic Policy Program--Financial
Regulatory Reform Initiative, ``Dodd-Frank's Missed Opportunity: A Road
Map for a More Effective Regulatory Architecture'', (April 2014);
http://bipartisanpolicy.org/library/report/dodd-frank's-missed-
opportunity-road-map-more-effective-regulatory-architecture.
---------------------------------------------------------------------------
2. If there is a particular activity or activities that threaten
the financial system, a company should be able to work with FSOC to
remediate the problem. As a company moves through FSOC's 3-stage
evaluation process, FSOC does not inform companies of what changes
could be made to either their structure or operations to avoid
designation. While FSOC has outlined the characteristics it considers
in its evaluation process, it is still not clear the weight they give
to certain factors over others or what makes a designation more likely.
In the supplemental procedures adopted in February, FSOC made some
effort toward increasing the amount of communication between firms
under consideration and FSOC staff. Yet ultimately, the Council does
not encourage companies to work with the Office of Financial Research
and FSOC staff to clearly define a potential systemic threat through
data and modeling, explore lower cost alternatives to designation, and
then move forward if a company cannot remediate the problem. In meeting
its aim of financial stability, FSOC should consider all the tools
available instead of quickly moving to designation.
3. FSOC should consider the effectiveness of existing primary
regulators and defer to their expertise when designating nonbanks.
While FSOC is comprised of relevant financial regulators, each one has
different expertise and experience. A firm's primary regulator should
be given an enhanced role in designation proceedings. Thus far this has
not been the case; insurance company designations proceeded with little
respect for State regulators and over the objections of FSOC's voting
and nonvoting members with insurance expertise. \12\
---------------------------------------------------------------------------
\12\ See FSOC's Meeting Minutes for September 19, 2013 and
December 18, 2014: http://www.treasury.gov/initiatives/fsoc/council-
meetings/Documents/September_19_2013_Notational_Vote.pdf and http://
www.treasury.gov/initiatives/fsoc/council-meetings/Documents/
December_18_2014_Meeting_Minutes.pdf.
---------------------------------------------------------------------------
4. FSOC's institution-by-institution approach engenders disparate
treatment and misses the key issue, identifying activities and
practices that generate systemic risks. After designating AIG,
Prudential Financial and MetLife, FSOC appeared it would move next to
asset managers. Yet that institution-by-institution approach misses the
key issue: what specific activities or practices generate systemic
risks? In this regard, activity-based regulation is more comprehensive
as it will identify all of the market participants engaged in an
activity that could pose a threat to stability. This is substantially
better than singling out one or a few large firms or funds for
designation, which creates disparities in regulation across firms and
sectors that could have a very real and unintended economic costs.
Positively, FSOC has shown it is open to an activity-based approach in
assessing the risks posed by asset managers. However, FSOC has acted
inconsistently thus far in its approach to insurance companies. \13\
---------------------------------------------------------------------------
\13\ For a more thorough discussion, see Satya Thallam,
``Considering an Activity-Based Regulatory Approach to FSOC'',
(September 12, 2014) http://americanactionforum.org/research/
considering-an-activity-based-regulatory-approach-to-fsoc.
---------------------------------------------------------------------------
5. Designation decisions must be supported by evidence, rooted in
rigorous economic analysis, and backed by statutory authority. In his
dissent from the FSOC's SIFI designation of Prudential Financial, Roy
Woodall, appointed by President Obama as FSOC's independent member with
insurance expertise, noted his concerns about the analytical rigor of
the designation process stating, ``The underlying analysis utilizes
scenarios that are antithetical to a fundamental and seasoned
understanding of the business of insurance.'' \14\ John Huff, the
nonvoting member of the Council representing State insurance
regulators, echoed Woodall's concerns, writing in his dissent, ``The
analysis contained in the basis for the final determination in large
part relies on nothing more than speculation.'' \15\ Experts have
further argued that the analytical processes behind designations are
generally far too opaque and likely insufficient. \16\ Additionally,
FSOC has stated it does not intend to ``conduct cost-benefit analyses
in making determinations with respect to individual nonbank financial
companies,'' reflecting how recent designations have failed to
accurately assess the implications of SIFI designations on the
insurance industry. \17\
---------------------------------------------------------------------------
\14\ Roy Woodall, ``Views of the Council's Independent Member
Having Insurance Expertise'', (Sept. 2013); http://www.treasury.gov/
initiatives/fsoc/council-meetings/Documents/
September_19_2013_Notational_Vote.pdf.
\15\ John Huff, ``View of Director John Huff, the State Insurance
Commissioner Representative'', (Sept. 2013); http://www.treasury.gov/
initiatives/fsoc/council-meetings/Documents/
September%2019%202013%20Notational%20Vote.pdf.
\16\ Peter Wallison, American Enterprise Institute, ``What the
FSOC's Prudential Decision Tells Us About SIFI Designation'', (March
2014); http://www.aei.org/outlook/economics/financial-services/banking/
what-the-fsocs-prudential-decision-tells-us-about-sifi-designation/.
\17\ ``Authority To Require Supervision and Regulation of Certain
Nonbank Financial Companies'', 77 Fed. Reg. 21640 (April 11, 2012)
(Amending 12 CFR 1310); https://federalregister.gov/a/2012-8627.
---------------------------------------------------------------------------
FSOC should attempt to fully assess the economic effect, both costs
and benefits, of designating only certain nonbanks as SIFIs. This means
producing a convincing model that a firm's failure, its financial
distress, or its activities could destabilize the financial system. In
such a way, FSOC can demonstrate what is at stake and how a designation
will help, and then justify the costs. Preventing the next financial
crisis may undoubtedly have enormous benefit, but FSOC has not clearly
outlined how each firm or industry segment it has scrutinized poses an
actual threat to stability. Since the economic cost of eliminating
systemic risk entirely is prohibitive, FSOC's goal must be to find the
``right'' amount of risk, a difficult feat since FSOC can neither
measure its progress nor know its target. Because of the difficulty of
regulating entities posing only a potential systemic threat,
designations should be firmly rooted in sound economic analyses that
explore all costs and benefits (as well as alternatives to designation)
and be substantially justified by applicable Dodd-Frank Act statutes.
6. Annual reevaluation should not be a check-the-box exercise, but
a genuine opportunity for a nonbank SIFI to address Council concerns
and exit designation. SIFI designation should not be indefinite. FSOC
must create a process that permits firms to address risks and avoid
designation. Once designated, FSOC revisits the designation annually
and must vote only to rescind, creating little more than a check-the-
box exercise. SIFIs should have a way to ``de-risk,'' address the
concerns or activities raised by FSOC that merited a designation, and
follow an exit ramp from SIFI status. Whether through sunset provisions
or other policy options, the changes announced in February do not go
far enough to tackle this issue.
7. FSOC and its staff must continue to actively engage the public,
experts, and stakeholders to comprehensively examine potential systemic
threats, firm types, and changes in the financial economy environment
as well as areas for FSOC procedural improvement. Last fall FSOC began
the process of reviewing and evaluating its SIFI designation process
for nonbanks, seeking input from stakeholders and assessing potential
changes. Ultimately, this process led to the adoption of a number of
positive steps toward increasing communication between FSOC staff and
firms under review and adding transparency to the process. If anything,
this should encourage FSOC to continue to collaborate with
stakeholders, seek input from the public, and continue to advance
efforts that open up its opaque process. As FSOC considers increasingly
different potential threats, firms, and industry changes, engagement
with outside experts will be integral and may substantially improve
public confidence in its efforts.
8. The Federal Reserve's role as chief regulator of designated
firms will likely endanger and diminish its independence, which should
concern lawmakers. The Federal Reserve Board is the chief regulator of
all firms designated as SIFIs, whether insurance companies, asset
managers, or something else. While the Federal Reserve is a world-class
monetary authority and quality bank regulator, it may struggle to
tailor regulations for other financial companies outside of its
expertise. This will also likely lead to greater scrutiny by the
Congress and endanger central bank independence. In addition to the
designation process, it may behoove policymakers to consider primary
regulators in an enhanced supervisory role instead of the Federal
Reserve Board.
At a minimum, FSOC must conduct its business in a way that is
analytically sounder and better grounded in the data and regulatory
history, with a clear path away from SIFI designation for nonbanks.
Thank you and I look forward to answering your questions.
______
PREPARED STATEMENT OF DENNIS M. KELLEHER
President and CEO, Better Markets, Inc.
March 25, 2015
Thank you Chairman Shelby, Ranking Member Brown, and Members of the
Committee for the opportunity to provide Better Markets' views about
the Financial Stability Oversight Council (the Stability Council).
Better Markets is a nonprofit, nonpartisan organization that
promotes the public interest in the domestic and global capital and
commodity markets. It advocates for transparency, oversight, and
accountability with the goal of a stronger, safer financial system that
is less prone to crisis and failure, thereby eliminating or minimizing
the need for more taxpayer funded bailouts. To do this, Better Markets
engages in the rulemaking process, public advocacy, independent
research, and litigation. For example, it has filed more than 150
comment letters in the U.S. rulemaking process related to implementing
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) and has had dozens of meetings with regulators. Our Web
site, www.bettermarkets.com, includes information on these and the many
other activities of Better Markets.
I am the President and CEO of Better Markets. Prior to starting
Better Markets in October 2010, I held three senior staff positions in
the Senate: Chief Counsel and Senior Leadership Advisor to the Chairman
of the Democratic Policy Committee; Legislative Director to the
Secretary of the Democratic Conference; and Deputy Staff Director and
General Counsel to what is now known as the HELP Committee. Previously,
I was a litigation partner at the law firm of Skadden, Arps, Slate,
Meagher, & Flom, where I specialized in securities and financial
markets in the U.S. and Europe. Prior to obtaining degrees at Brandeis
University and Harvard Law School, I enlisted in the U.S. Air Force
while in high school and served 4 years active duty as a crash-rescue
firefighter. I grew up in central Massachusetts.
``No More AIGs''
Yesterday, March 24, was the 6 year anniversary of the testimony
given by then Treasury Secretary Timothy Geithner and then Federal
Reserve Chairman Ben Bernanke before the House Financial Services
Committee on the American International Group (AIG) bonus controversy.
The surprise and shock of the U.S. having to bailout a private,
international insurance conglomerate like AIG with about $185 billion
was compounded by the disgust at AIG for nonetheless paying bonuses to
some of its employees who were involved in the reckless trading that
led to the collapse of the company and the need for it to be bailed out
in the first place.
Triple-A rated AIG's involvement in hundreds of billions of dollars
of complex, high risk derivatives gambling was a total surprise in
September 2008. No one (outside of the too-big-to-fail Wall Street
banks that were its counterparties) had any idea that AIG was in that
line of business or, more shockingly, had not reserved or set aside
anything close to sufficient amounts to cover any potential losses.
Given these facts, and its extensive interconnectedness with the entire
U.S. and global banking and finance systems, its inability to cover its
own derivatives gambling losses unexpectedly threatened the collapse of
the U.S. and world economies.
The result was an historic, unlimited bailout where, initially, the
U.S. Government effectively threw money into the massive hole AIG
created: first, $85 billion, then a week later another $85 billion,
ultimately reaching about $185 billion in cash bailouts. It is fitting
that we are here 6 years later discussing the Stability Council because
its very existence and purpose is to prevent a situation like AIG from
ever happening again.
``No more AIGs'' should be the Stability Council's motto. Never
again should a private company appear out of nowhere and threaten to
collapse the entire U.S. and global financial systems. Never again
should the U.S. Treasury or taxpayers have to cover the losses of a
private company that threaten the stability of our economy or the
living standards of our citizens.
And, most importantly, never again should the U.S. have to suffer
the consequences of future AIGs: the devastating economic wreckage
inflicted on Americans from coast to coast who lost their jobs, homes,
savings, retirements, educations, and so much more. As Better Markets
has documented, the 2008 crisis will cost the U.S. more than $12
trillion in lost economic output \1\ That too is why the Stability
Council was created, and is an important part of its mission.
---------------------------------------------------------------------------
\1\ Better Markets, ``The Cost of the Wall Street-Caused Financial
Collapse and Ongoing Economic Crisis Is More Than $12 Trillion'' (Sept.
15, 2012), available at http://bettermarkets.com/sites/default/files/
Cost%20of%20The%20Crisis_2.pdf.
---------------------------------------------------------------------------
No More Economic Calamities From Unexpected Collapses of Companies That
Threaten the Stability of the United States
While only a few short years ago, too many have forgotten--or
choose to ignore--that the 2008 crash was the worst financial crash
since the Great Crash of 1929 and caused the worst economy since the
Great Depression of the 1930s. Just a few highlights of that economic
wreckage:
Unemployment and under-employment skyrocketed, peaking in
late 2009, early 2010 to a rate of over 17 percent. The one-
month peak of what is referred to as the ``U6'' rate was almost
27 million Americans out of work or forced to work part time
rather than fill time as shown below:
Housing prices collapsed to 2001 levels and have remained
at persistently low levels far beyond the official end of the
recession:
Americans experienced foreclosure at record rates:
Tax revenues plummeted at the Federal, State, and local
level, and essential spending on social needs skyrocketed as
layoffs exploded, causing the deficit and debt to dramatically
increase:
This massive economic wreckage resulted from the financial crash of
2008 and the near collapse of the U.S. and global financial systems.
The Stability Council was created to be an early warning system to help
detect and prevent this type of financial, economic, and human calamity
from ever happening again.
With that as the essential context for understanding and thinking
about the Stability Council, the testimony that follows addresses three
main points:
1. Congress created the Stability Council in response to the
catastrophic failure of unregulated systemic threats like AIG,
and the Stability Council's success is vital to strengthening
the financial system and economy while reducing future systemic
threats.
2. The Stability Council's implementation of Section 113 of the
Dodd-Frank Act shows that it is using its power deliberatively
and judiciously. And, recent significant changes demonstrates
it is listening and responding appropriately to constructive
input from stakeholders.
3. Additional proposals to change the Stability Council would impair
or cripple its ability to protect American families, workers,
and taxpayers from another financial crash and economic
calamity.
1. Congress Created the Stability Council in Response to the
Catastrophic Failure of Unregulated Systemic Threats Like AIG
and the Stability Council's Success Is Vital To Strengthening
the Financial System and Economy While Reducing Future Systemic
Threats
The Stability Council was created to close the gigantic gap in the
regulatory system that arose from changes in the financial industry and
the regulatory rollbacks of the late 1990s. In particular, following
Congressional passage of the Gramm-Leach-Bliley Act and the Commodity
Futures Modernization Act, banks, investment firms, derivatives
dealers, and insurance companies became supersized into enormous,
complex, global, and interconnected financial companies. While the
industry changed dramatically, the regulatory system did not, and as a
result, on the eve of the 2008 financial crisis our financial
regulators focused, at most, on their specific segment of the financial
services industry without looking at broader threats and risks.
Importantly, none of the regulators were responsible for detecting,
addressing, or preventing unseen, unknown, and unexpected risks and
threats.
The best known example of this phenomenon was AIG. In 2008 AIG was
the world's largest insurance company. However, in addition to selling
traditional products like health and life insurance, a division of AIG
called AIG Financial Products (AIG FP) accumulated hundreds of billions
of dollars of liabilities by selling credit default swaps, a type of
derivative that ``insured'' the buyer of the swap against certain
credit risks. This caused AIG to become deeply interconnected through
the entire financial system. While AIG's traditional insurance business
was overseen by the States, AIG's other lines of business were supposed
to be overseen by the Office of Thrift Supervision, a regulator charged
with overseeing small savings and loans organizations. Due to
competition among regulators, among other reasons, AIG was able to shop
around for the weakest regulation possible, which the Office of Thrift
Supervision provided in exchange for collecting the fees AIG paid for
its regulation.
When the mortgage-backed and other securities AIG FP was
``insuring'' failed, AIG lacked the capital necessary to fulfill its
obligations. The result is well known: the Federal Government was
forced to bailout AIG with about $185 billion, take on AIG's
obligations, bailout its counterparties including many foreign banks,
and enable the payment of $218 million in bonuses to some of AIG FP's
executives who were involved in the company's reckless risk-taking in
the first place.
AIG's failure, and subsequent bailout, happened in large part
because no regulator was responsible for overseeing the systemic risk
posed by the firm or, for that matter, posed by any firm. AIG's
insurance business was regulated by State insurance commissioners; its
thrift was insufficiently regulated by the Office of Thrift
Supervision; and its credit default swaps business was largely
unregulated due to legal prohibitions on the regulation of such swaps,
among other reasons.
That is why, in the immediate aftermath of the crisis, it was very
widely agreed that fixing this incredibly consequential regulatory gap
required the creation of a single regulator responsible for overseeing
systemic risk across the financial system. In fact, following the
crisis, politicians and financial industry participants testified to
the public and Congress that one of the essential ways of preventing
such a crisis from happening again was to create such a systemic risk
regulator.
A sample of those statements include the following:
``We must create a systemic risk regulator to monitor the
stability of the markets and to restrain or end any activity at
any financial firm that threatens the broader market.''--Henry
Paulson, former Secretary of the Treasury \2\
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\2\ ``How To Watch the Banks'', New York Times OP-ED (Feb. 15,
2010).
``One of the reasons this crisis could take place is that while
many agencies and regulators were responsible for overseeing
individual financial firms and their subsidiaries, no one was
responsible for protecting the whole system from the kinds of
risks that tied these firms to one another.''--Robert S.
Nichols, President and Chief Operating Officer, Financial
Services Forum \3\
---------------------------------------------------------------------------
\3\ Testimony at House Financial Services Committee (July 17,
2009).
``I believe an interagency council with a strong authority in a
focused area, in this case monitoring and directing the
response to risks that threaten overall financial stability,
could, like the [National Security Council], serve the Nation
well in addressing complex and multifaceted risks.''--Paul
Schott Stevens, President and CEO, Investment Company Institute
\4\
---------------------------------------------------------------------------
\4\ Testimony at Senate Banking Committee hearing (July 23, 2009).
``A systemic risk regulator that has access to information
about any systemically important financial institution--whether
a bank, broker-dealer, insurance company, hedge fund or private
equity fund--could have the necessary perspective to ensure
firms are not exploiting the gaps between functional
regulators, or posing a risk to the larger system.''--Randolph
C. Snook, Executive Vice President, Securities Industry and
Financial Markets Association (SIFMA) \5\
---------------------------------------------------------------------------
\5\ Testimony at House Financial Services Committee (July 17,
2009).
``The ABA strongly supports the creation of a systemic
regulator. In retrospect, it is inexplicable that we have not
had a regulator that has the explicit mandate and the needed
authority to anticipate, identify, and correct, where
appropriate, systemic problems. To use a simple analogy, think
of the systemic regulator as sitting on top of Mount Olympus
looking out over all the land. From that highest point the
regulator is charged with surveying the land, looking for
fires. Instead, we have had a number of regulators, each of
which sits on top of a smaller mountain and only sees its part
of the land. Even worse, no one is effectively looking over
some areas. This needs to be addressed.''--Edward L. Yingling,
then President and Chief Executive Officer, American Bankers
Association \6\
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\6\ Testimony at House Financial Services Committee (Mar. 17,
2009).
Based in part on this testimony, Congress created the Stability
Council as part of the Dodd-Frank Act, and tasked the Stability Council
with the mission of identifying and responding to risks to the
financial stability of the United States. As such, the Stability
Council is the front line macroprudential regulator that serves as the
early warning system needed to identify such threats, and address the
challenges presented by the shadow-banking system to the financial
stability of the U.S.
Congress gave the Stability Council a number of important tools to
carry out this mission including the ability to:
Designate nonbank financial companies as systemically
important and subject those companies to supervision by the
Federal Reserve
Make policy and enforcement recommendations to primary
financial regulators
Collect information through the Office of Financial
Research
Publish annual reports about systemic risks to the
financial system
In addition, for the first time, the Stability Council enables all
of the financial regulators to communicate with each other regularly
and gain the benefit of each regulator's expertise. All of these tools
provide the Stability Council with the ability to take a holistic view
of the financial system, just as the ICI, ABA, SIFMA, and Financial
Services Forum, among many others, said was so necessary.
The ability to designate nonbank financial companies for prudential
supervision by the Federal Reserve is among the most important tools
Congress provided the Stability Council. The ability to designate a
company for enhanced supervision is the primary mechanism to prevent
any firm or activity--like the derivatives dealing at AIG FP--from
slipping through the regulatory cracks. For that reason, ensuring that
the Stability Council can continue to adequately and appropriately use
this authority is critically important to protecting America's
families, workers, savers, communities, taxpayers, financial system,
and economy as a whole.
2. The Stability Council's Implementation of Section 113 of the Dodd-
Frank Act Shows That It Is Using Its Power Deliberatively and
Judiciously. And, Recent Significant Changes Demonstrates It Is
Listening and Responding Appropriately to Constructive Input
From Stakeholders
Under Section 113 of the Dodd-Frank Act, the Stability Council has
the authority to designate a nonbank financial company for enhanced
prudential regulation by the Federal Reserve only if it finds that:
``material financial distress at the U.S. nonbank financial company, or
the nature, scope, size, scale, concentration, interconnectedness, or
mix of the activities of the U.S. nonbank financial company, could pose
a threat to the financial stability of the United States.''
Before making such a designation, the Stability Council is required
to consider 10 specific factors, plus any other risk-related factors
the Stability Council finds appropriate.
To provide a standard method for considering these designations, on
April 11, 2012, the Stability Council released a final rule and
interpretive guidance implementing a three-stage process for
designating nonbank companies for enhanced regulation, \7\ outlined
below:
---------------------------------------------------------------------------
\7\ Financial Stability Oversight Council, ``Authority To Require
Supervision and Regulation of Certain Nonbank Financial Companies'', 77
Fed. Reg. 21637 (Apr. 11, 2012).
In Stage 1, the Stability Council ``narrow[s] the universe
of nonbank financial companies to a smaller set'' by evaluating
the size, interconnectedness, leverage, and liquidity risk and
---------------------------------------------------------------------------
maturity mismatch of nonbanks.
If a firm has been identified in Stage 1, in Stage 2 the
Stability Council then ``conduct[s] a robust analysis of the
potential threat that each of those nonbank financial companies
could pose to U.S. financial stability,'' based on data from
existing public and regulatory sources.
Finally, if a firm makes it to Stage 3, then the Stability
Council conducts a more detailed review using information
obtained directly from the nonbank financial company. At this
point, the Stability Council, by a two-thirds vote (including
that of the Treasury Secretary who is also the Stability
Council Chairman), may make a Proposed Determination with
respect to any company. A firm subject to a Proposed
Determination may request a hearing to contest the
determination. After the hearing, the Stability Council may
vote, again by two-thirds, to make a Final Determination.
Throughout this stage, firms may provide written comments to or
meet with Stability Council staff and discuss their potential
designation.
Importantly, on February 4, 2015--not 3 years after finalizing its
rule and only last month--the Stability Council approved a series of
very significant changes to the designation process designed to improve
transparency and public accountability. \8\ (Those changes are attached
as Exhibit A hereto.) Those changes include:
---------------------------------------------------------------------------
\8\ Financial Stability Oversight Council, ``Supplemental
Procedures Relating to Nonbank Financial Company Determinations'' (Feb.
4, 2015), available at http://www.treasury.gov/initiatives/fsoc/
designations/Documents/Supplemental-Procedures-Related-to-Nonbank-
Financial-Company-Detenninations-February-2015.pdf.
First, the Stability Council will now engage with companies
during the designation process to a greater extent than
previously. For example, the Stability Council will notify a
company when it is under Stage 2 review, and any such company
may provide data for the Stability Council to review prior to
Stage 3. The Stability Council will alert companies when they
have not been recommended to Stage 3. Finally, the Stability
Council will begin communications with a company's primary
---------------------------------------------------------------------------
regulator or supervisor during Stage 2, rather than Stage 3.
Second, the Stability Council will now more fully engage
with designated companies during its annual review of a
company's designation to improve the de-designation process.
Going forward, if a designated company contests its designation
during that annual review, and if the Stability Council votes
not to rescind the designation, it will provide the company and
primary regulators with an explanation why. This change, and
others to the de-designation process, are a significant
improvement that will adequately allow a designated company to
document that it no longer meets the statutory criteria without
harming the Stability Council's ability to protect the
financial system, the economy, and the public.
Finally, the Stability Council will provide increased
transparency to the public. Previously, if a company announced
it was under consideration for designation, the Stability
Council would neither confirm nor deny that. Now, if the
company publicly confirms that is under consideration the
Stability Council will confirm that upon request to do so by a
third party. The Stability Council will also annually publish
the number of companies considered for designation along with
the number of companies considered but not designated. Finally,
the Stability Council has agreed to publish further details of
how its Stage 1 thresholds are calculated in the future.
These changes were very significant and telling for two reasons.
First, as a matter of process, the Stability Council's actions
demonstrate that it listens carefully to those who comment on its
activities and responds with meaningful action. Such actions are all
too rare and the Stability Council should be applauded for doing so.
Second, as a matter of policy, the changes make the Stability
Council's designation determinations better, which will ensure better
outcomes for the firms under review and the public. Increased
communications between the Stability Council and firms under
consideration for designation will enable a more robust, data based
decision-making process based on all material information.
Additionally, increased public disclosure and transparency will build
trust and confidence that the Stability Council is on watch and
fulfilling its important role.
In its very short life of less than 5 years, the Stability Council
has designated just four nonbank financial institutions for enhanced
supervision. In each instance, the Stability Council acted prudently,
designating the firm only after conducting a thorough analysis and
concluding that each one satisfied the applicable statutory standards.
Each fits the requirements for designation by having a systemwide reach
and being so interconnected with other financial companies that its
failure would cause damage to the financial system and real economy.
The clearest example of this is AIG. \9\ AIG was so large and
interconnected that, as the subprime bubble burst, its credit default
swap portfolio was so large that it became insolvent, unable to pay its
counterparties, and had to be bailed out by taxpayers. As the Stability
Council said in its public final basis for designating AIG,
``Individual exposures to AIG may be relatively small, but in the
aggregate, the exposures are large enough that material financial
distress at AIG, if it were to occur, could have a destabilizing effect
on the financial markets.''
---------------------------------------------------------------------------
\9\ Financial Stability Oversight Council, ``Basis of the
Financial Stability Oversight Council's Final Determination Regarding
American International Group, Inc.'' (July 8, 2013), available at
http://www.treasury.gov/initiatives/fsoc/designations/Documents/Basis-
of-Final-Determination-Regarding-General-Electric-Capital-Corporation,-
Inc.pdf.
---------------------------------------------------------------------------
Furthermore, AIG and its subsidiary are the reference entities
``for a combined $70 billion in notional single-name CDS, which is
significant and comparable to several of the largest money-center
banks, investment banks, bond insurers, and prime brokers,'' meaning
that its failure would have a large impact on other, non-AIG companies.
Like AIG, GE Capital was so deeply affected by the financial crisis
that it required a $139 billion bailout for fear that a collapse would
greatly affect other financial firms. In its designation, the Stability
Council explained that ``there is approximately $77 billion in gross
notional credit default swaps outstanding for which GECC is the
reference entity:'' even larger that the notional value for AIG. \10\
Furthermore, GE Capital's portfolio of assets, $539 billion as of
December 31, 2012, is ``comparable to those of the largest U.S. BHCs.''
As such, among other things, any rapid liquidation of GE Capital's
assets could lead to a fire sale of the securities of other large
corporations, including of the largest financial institutions.
---------------------------------------------------------------------------
\10\ Financial Stability Oversight Council, ``Basis of the
Financial Stability Oversight Council's Final Determination Regarding
General Electric Capital Corporation, Inc.'' (July 8, 2013), available
at http://www.treasury.gov/initiatives/fsoc/designations/Documents/
Basis-of-Final-Determination-Regarding-General-Electric-Capital-
Corporation,-Inc.pdf.
---------------------------------------------------------------------------
The Stability Council also determined that Prudential met the
statutory criteria after determining that the financial system is
significantly exposed to Prudential ``through the capital markets,
including as derivatives counterparties, creditors, debt and equity
investors, and securities lending and repurchase agreement
counterparties.'' \11\ It also found that the complexity and
interconnectedness of Prudential would make it difficult for the firm
to be resolved, posing a material threat to U.S. financial stability.
---------------------------------------------------------------------------
\11\ Financial Stability Oversight Council, ``Basis of the
Financial Stability Oversight Council's Final Determination Regarding
Prudential Financial, Inc.'' (Sept. 19, 2013), available at http://
www.treasury.gov/initiatives/fsoc/designations/Documents/
Prudential%20Financial%20Inc.pdf.
---------------------------------------------------------------------------
The Stability Council made a similar determination in the case of
MetLife. \12\ In this case, the Stability Council found that there
would be a severe negative impact on the financial system if a
situation occurred in which MetLife was forced to liquidate its
holdings. The Stability Council's public final basis for designating
the insurance company states that, ``[a] large-scale forced liquidation
of MetLife's large portfolio of relatively illiquid assets, including
corporate debt and asset-backed securities (ABS), could disrupt trading
or funding markets.'' This is because ``[a]s of September 30, 2014,
MetLife held $108 billion of U.S. corporate securities at fair value,
and $70 billion of asset-backed securities and mortgage-backed
securities at fair value.'' The resulting fire sale would depress
prices for the assets MetLife holds, similar to the fire sale which
resulted from the Prime Reserve Fund's failure in 2008.
---------------------------------------------------------------------------
\12\ Financial Stability Oversight Council, ``Basis of the
Financial Stability Oversight Council's Final Determination Regarding
MetLife, Inc.'' (Dec. 18, 2014), available at http://www.treasury.gov/
initiatives/fsoc/designations/Documents/MetLife%20Public%20Basis.pdf.
---------------------------------------------------------------------------
Whatever one wishes to say about the Stability Council's
designation process or the decisions it has reached, the Stability
Council can hardly be accused of acting hastily or over-broadly. Four
designations in less than 5 years is far fewer than what could have
been done given the number of nonbank financial companies that failed,
received bailouts, or posed systemic risk during the financial crisis
just a few short years ago. \13\ Furthermore, the three insurance
companies designated by the Stability Council are also all listed on
the Financial Stability Board's list of Global Systemically Important
Insurers, suggesting that the Stability Council's actions are not
without merit.
---------------------------------------------------------------------------
\13\ See U.S. Gov't Accountability Office, Rep. No. GA0-11-696,
``Federal Reserve System: Opportunities Exist To Strengthen Policies
and Processes for Managing Emergency Assistance'' (July 2011);
ProPublica, ``Bailout Recipients'', available at https://
projects.propublica.org/bailout/list/simple.
---------------------------------------------------------------------------
Clearly the Stability Council is acting deliberatively and
carefully when considering and making designation determinations.
3. Additional Proposals To Change the Stability Council Would Impair or
Cripple Its Ability To Protect American Families, Workers, and
Taxpayers From Another Financial Crash and Economic Calamity
Regarding the consideration of any changes to the Stability
Council, it must be remembered that it is not even 5 years old. During
that time it has had to translate legislative text regarding a
stability council into a working reality of the Stability Council. As
if that wasn't enough, it had to do so with 15 member agencies,
organizations, and departments, with, as is well known, all that
entails. And it had to do it from the still smoldering ashes of the
financial crash, in the midst of the ongoing economic crisis, and in
the face of relentless attacks and criticism.
Frankly, although not perfect, it is a remarkable achievement. In
addition, as it did all that, it has listened carefully to those who
think it might be able to improve its procedures, including criticism
from Better Markets. After careful consideration and deliberation, the
Stability Council, as set forth above, has recently adopted a number of
very significant changes and those changes should be allowed to be
implemented before any additional changes are legislatively imposed on
the Stability Council. Given its willingness to listen, change, and
improve, the Stability Council deserves no less.
Making matters worse, most of the legislative changes proposed
would prevent the Stability Council from carrying out its mission, and
would leave our financial system and economy vulnerable to another
crisis. Indeed, a number of proposals have recently been put forward
that would severely weaken the Stability Council and, in fact, make
future AIGs more likely. An overview of those proposals, including an
explanation of how they would prevent the Stability Council from
fulfilling its critical role follows.
Proposal: Require the Stability Council to make certain decisions
within arbitrary time considerations, and force the Stability Council
to begin the designation process again unless it meets those time
constraints.
Impact: It is in no one's interest for the Stability Council to act
in haste. The Stability Council's process for designating a nonbank
financial institution should be deliberative and not rushed. Requiring
a decision to be made within an arbitrary deadline could put the
Stability Council in an untenable situation, potentially forcing them
to designate in haste or forego an otherwise necessary and important
designation. These scenarios are simply unacceptable, given the
importance of Stability Council's mission and the consequences of
designation or a failure to designate when appropriate and necessary.
Proposal: Require that the designation of a nonbank financial
company be a last resort that is taken only after all other regulatory
steps are exhausted.
Impact: This proposal disregards the already very high bar and
robust process that the Stability Council must go through before
designation (as set forth above and in the law and regulations). It has
no reasonable rationale and it would add substantial burdens that would
only constrain the Stability Council with no countervailing benefit.
Importantly, designation authority was designed not only to respond
to the last crisis, but to be a forward-looking warning system to
prevent systemic risks that could cause the next crisis. For that
reason, the Stability Council needs the flexibility and discretion to
identify new and emerging risks and keep abreast with market
developments and financial innovations. Furthermore, these proposals
would add yet more unnecessary layers of work for the Stability Council
and primary regulatory agencies, creating risky delays that would
undermine the Stability Council's mission.
Proposal: Reform the designation process by subjecting it to
additional process constraints like cost-benefit analysis.
Impact: Imposing such economic analysis obligations on the
Stability Council is as unwise as it is unwarranted. It will only force
the Stability Council to engage in an inherently inaccurate yet
burdensome process, encumber and delay the Stability Council's work,
and ultimately make any designation a more inviting target for legal
challenge in court. When applied to financial regulation, cost-benefit
analysis is more aptly described as ``industry cost-only analysis,'' in
which industry focuses exclusively on the costs of regulation while
ignoring the benefits. \14\
---------------------------------------------------------------------------
\14\ Better Markets, ``Setting the Record Straight on Cost-Benefit
Analysis and Financial Reform at the SEC'' (July 30, 2012), available
at http://www.bettermarkets.com/sites/default/files/
Setting%20The%20Record%20Straight.pdf.
---------------------------------------------------------------------------
The case of designating a firm for enhanced regulation by the
Federal Reserve lends itself to just this one-sided analysis, as the
designated entity will always be able to cite a long list of specific
(if highly questionable) quantifiable costs that would appear to cast
designation as unjustifiable. Yet viewed holistically, the benefits of
designation are potentially enormous and, in many respects,
incalculable, representing the tangible and intangible gains that come
from averting another financial crisis, systemic collapse, and untold
trillions in bailouts. As traditionally framed, however, cost-benefit
analysis does not capture these benefits and does not yield a balanced
and accurate picture.
In addition, the process is time-consuming and resource intensive.
It will inevitably slow down the designation process and sap the
Stability Council's resources, which would be far better spent on its
core mission of detecting and analyzing potential risk and responding
appropriately.
Finally, a cost-benefit requirement will also make it easier for a
designated company to litigate the designation, just as industry groups
have relentlessly challenged Securities and Exchange Commission and
Commodity Futures Trading Commission regulations alleging insufficient
analysis of costs and benefits relating to mutual fund governance,
conflict minerals, and position limits. As these cases demonstrate,
should Congress choose to require the Stability Council to conduct
quantitative cost benefit analysis it would cause a litigation bonanza,
creating yet another opportunity for industry to argue that the costs
imposed upon them should be more highly prioritized than the benefit to
the public of preventing a future crash. This would severely weaken the
Stability Council's ability to protect the public and carry out its
congressionally directed mandates.
Proposal: Give the primary regulator heightened deference in the
designation process.
Impact: No one questions that a company's primary regulator may
have significant insights into the workings of that industry and that
the primary regulator can provide much needed assistance in
understanding the nuances of a company's balance sheet, activities,
risks and related issues. However, that regulator may not be in the
best position to decide whether the company poses a systemic risk,
since they lack the broader perspective that the Stability Council was
created to provide. It is also undeniable that individual regulators
may bring certain biases to bear, stemming from a sense of ``turf'' or
a desire to downplay the systemic risks that may have evolved under
their ``watch.'' There is also the well-known problem of regulatory
capture. Thus, the primary regulator may oppose actions that would
otherwise be necessary to protect the public from systemic risks. In
short, the statutory framework already requires the Stability Council
to consult the primary regulator for any entity being considered for
designation, and requiring any further deference would be unnecessary
and counterproductive.
Proposal: Delay the Stability Council's ability to designate a firm
for enhanced regulation until the Federal Reserve explains what
enhanced measures it will impose as a result of the designation.
Impact: Two of the core purposes of the Stability Council are to
identify and respond to risks to the financial stability of the United
States. By law, the Stability Council has the authority to do so by
designating companies as systemically important This authority differs
significantly from that of the Federal Reserve, which must determine
how best to regulate a designated company. Because the duties of these
two agencies are different, the Stability Council should not be
required to wait for the Federal Reserve before carrying out its legal
obligations. The systemic importance of a company, and the Stability
Council's decision to designate it as such, should not be dependent
upon or influenced by how the company might or might not be regulated
after designation.
Proposal: Change the method by which the Stability Council votes.
Impact: The key decisions made by the Stability Council already
require super majorities. These decisions are complex and require a
great deal of judgment over which reasonable minds might disagree.
While the Stability Council should--and does--strive for consensus,
there may come a time when some members oppose an action while a super
majority of seven believe the risk to financial stability warrants
action. It would be a serious mistake if the Stability Council were
unable to go forward under this scenario, preventing action and putting
our financial system to significant risk.
Proposal: Expand the number of members on the Stability Council,
either by increasing membership or by requiring regulatory agencies to
vote to determine how the agency head will vote during Stability
Council proceedings.
Impact: The Stability Council already consist of 15 members, 10
voting members and 5 nonvoting members. Expanding it further risks
creating a body that is so large it would be ineffective. This would
also risk politicizing the decision-making process, turning any
Stability Council vote into a partisan exercise and an opportunity for
scoring political points. This proposal would therefore lead to
unnecessary delays and weaker actions as a result.
Conclusion
Thank you again for the opportunity to appear before you today. I
look forward to answering your questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF GARY E. HUGHES
Executive Vice President and General Counsel, American Council of Life
Insurers
March 25, 2015
Chairman Shelby and Ranking Member Brown, my name is Gary Hughes,
and I am Executive Vice President and General Counsel of the American
Council of Life Insurers (ACLI). ACLI is the principal trade
association for U.S. life insurance companies with approximately 300
member companies operating in the United States and abroad. ACLI member
companies offer life insurance, annuities, reinsurance, long-term care
and disability income insurance, and represent more than 90 percent of
industry assets and premiums.
ACLI appreciates the opportunity to address the procedures
governing the designation of nonbank financial companies by the
Financial Stability Oversight Council (FSOC). ACLI has a particular
interest in the subject matter of this hearing; three of the four
nonbank financial companies that have been designated by FSOC for
supervision by the Federal Reserve Board are insurance companies, and
all of those companies, Prudential, MetLife, and AIG, are members of
ACLI. Many ACLI member companies also are actively engaged in asset
management, which is a business under active review by FSOC.
Last year, ACLI along with several other national trade
associations submitted a petition to FSOC recommending changes to the
procedures for designating nonbank financial companies as being subject
to supervision by the Federal Reserve Board. In response, FSOC made
some needed improvements to the process. Nonetheless, additional
reforms to the procedures and standards applied by FSOC in its
designations are necessary to promote transparency and ensure a fair
process.
My testimony addresses five key points: (1) the additional
procedural safeguards that should be adopted by FSOC in connection with
designations; (2) FSOC's flawed application of the ``material financial
distress'' standard for designations; (3) FSOC's failure to give
sufficient weight to the views of State insurance authorities in
connection with designations; (4) FSOC's failure to give consideration
to the consequences of designation; and (5) FSOC's failure to consider
an ``activities-based'' approach for insurance. My testimony concludes
with recommendations to address these matters.
1. The Designation and De-Designation Processes Lack Sufficient
Procedural Safeguards and the Public Explanations Accompanying
Designations Give the Public and Other Nonbank Financial
Companies Insufficient Insight Into Why Particular Companies
Have Been Designated
FSOC has established a three-stage process for determining whether
a nonbank financial company should be subject to supervision by the
Federal Reserve Board. In response to concerns raised by ACLI and other
national trade associations, FSOC has made some improvements to the
process. Nonetheless, additional reforms are needed.
A company should have access to the entire record.
A company that advances to the third and final stage of review has
no way of knowing what materials FSOC believes are relevant, whether
and in what form the materials it submits are provided to voting
members of FSOC, or what materials, in addition to those submitted by
the company, FSOC staff and voting members reviewed and relied upon. In
other words, a company is not provided with the evidentiary record upon
which the voting members will make a proposed or final determination. A
company should have access to the entire record that is the basis for
an FSOC determination.
FSOC should have separate staff assigned to enforcement and
adjudicative functions.
Council staff who identify and analyze a company's suitability for
designation and author the notice of proposed determination and final
determination should not also advise Council members in deciding
whether to adopt the notice of proposed determination and final
determination. Dividing Council staff between enforcement and
adjudicative functions would protect the independence of both
functions. Separation of powers principles and basic fairness require
no less. In addition, communications between Council members and
enforcement staff should be memorialized as part of the agency record
and provided to companies under consideration for designation.
Special weight should be given to the views of the Council member with
insurance expertise and to the primary financial regulatory
agency for a company.
FSOC must vote, by two-thirds of the voting members then serving
including the affirmative vote of the Chairperson, to issue a final
determination. The requirement for a super majority vote is intended to
ensure that designation is reserved for companies that pose the most
obvious risk to the financial stability of the United States. Yet, the
members of FSOC vote as individuals rather than as representatives of
their agencies. Thus, the vote is based upon their own assessment of
risks in the financial system rather than the assessment of their
respective agencies. Moreover, the voting process gives equal weight to
views of all members, regardless of a member's experience in regulating
the type of company being considered for designation. In the case of an
insurance company, special weight should be given to the views of the
Council member with insurance experience, and to the State insurance
regulator for the company.
The explanation of a designation should provide greater insight into
the basis for designation, and a designation should be based
upon evidence and data.
When FSOC votes to designate a company, it provides the company
with an explanation of the basis for the determination and releases a
public version of that document. These documents provide little insight
into the basis for a designation, typically offering only conclusory
statements unsupported by data or other concrete evidence and analysis.
For example, in the documents released by FSOC in connection with the
Prudential and MetLife determinations, FSOC concluded that material
financial distress at Prudential and MetLife would be transmitted to
other financial firms and harm the financial system. In drawing this
conclusion, FSOC relied on extensive speculation about the behavior of
policyholders and the reactions of competing insurers and assumed that
State regulatory responses would be inadequate, even though history and
empirical evidence were to the contrary. When the only explanation for
a designation disregards historical experience, empirical research, and
fundamental and proven principles of economic behavior and risk
analysis, the industry can at best only speculate about the kind of
evidence that would satisfy FSOC that designation is neither necessary
nor appropriate.
A company should have more than 30 days to seek judicial review of a
final decision in a Federal court, and during judicial review,
the company should not be subject to supervision by the Federal
Reserve Board.
Upon receipt of a final designation, a company may seek judicial
review before a Federal court. Even this safeguard, however, is subject
to limitations. A company has only 30 days in which to file a
complaint, and loses the right to do so beyond that date. Moreover,
filing the complaint carries no automatic stay of supervision by the
Federal Reserve Board. Thus, while a company is challenging the
legitimacy of a designation, it simultaneously must establish a
comprehensive infrastructure (e.g., systems, procedures, and controls)
to comply with Board supervision.
Companies should be able to petition for a review of a designation
based upon a change in operations or regulations, and a company
should be provided with an analysis of the factors that would
permit it to be de-designated.
FSOC is required to review the designation of a company on an
annual basis. A company also should have the opportunity to obtain a
review based upon a change in its operations, such as the divestiture
of certain business lines, or a change in regulation. Moreover, during
a review, FSOC should be required to provide a company with an analysis
of the factors that would lead FSOC to de-designate a company. This
would lead a company to know precisely what changes in its operations
or activities are needed to eliminate any potential for the company to
pose a threat to the financial stability of the United States.
FSOC's determinations should be independent of international regulatory
actions.
Finally, the lack of transparency in FSOC's designation process and
the thinly-reasoned explanations in its designation decisions support
the concern voiced by some that FSOC's designations have been
preordained by actions of an international regulatory entity, the
Financial Stability Board (FSB). The member of FSOC with insurance
expertise, Roy Woodall, expressed this concern in his dissent to the
Prudential designation. The U.S. Department of Treasury and the Federal
Reserve Board are both important participants in the FSB, which in
2013, issued an initial list of insurance companies that the
organization considered to be ``global systemically important
insurers.'' AIG, Prudential, and MetLife were all on the FSB's list.
Those companies' designations as SIFIs should have been based on the
statutory requirements of the Dodd-Frank Act, which differ meaningfully
from the standards FSB has said it applies. Yet, there is ground for
concern that leading participants in FSOC were committed to designating
as systemic under Dodd-Frank those companies that they had already
agreed to designate as systemic through the FSB process. FSOC should
not be outsourcing to foreign regulators important decisions about
which U.S. companies are to be subject to heightened regulation.
2. FSOC's Flawed Application of the Material Financial Distress
Standard for Designation Distorts the Purpose of Designations
by Failing To Account for the Vulnerability of Prospective
Designees and Departs From the Requirements of the Dodd-Frank
Act and Its Own Regulatory Guidance
The Dodd-Frank Act authorizes FSOC to designate a nonbank financial
company for supervision by the Federal Reserve Board if either (1)
material financial distress at the company, or (2) the nature, scope,
size, scale, concentration, interconnectedness, or mix of activities of
the company could threaten the financial stability of the United
States. Each of the designations made by FSOC has been based on the
first standard, the material financial distress standard. Moreover, in
each case, FSOC assumed the existence of material financial distress at
the company, and then concluded that such distress could be transmitted
to the broader financial system.
This interpretation of the material financial distress standard
departs from the authorizing statute and FSOC's own regulatory
guidance, and distorts the purpose of designation. The Dodd-Frank Act
expressly directs FSOC, when considering a company for designation, to
consider 11 factors, a number of which implicate the company's
vulnerability to material financial distress. And FSOC's own
interpretive guidance recognizes that a company's vulnerability to
financial distress is a critical part of the designation inquiry. \1\
The statute, FSOC's guidance, and well-established principles of
reasoned regulation make clear that FSOC should not evaluate a
company's systemic effects by assuming that the designated company is
failing, but instead should separately assess the company's
vulnerability to material financial distress. Making this a part of the
designation process also provides guidance and the right incentives for
companies that may be considered for designation in the future, because
it incentivizes them to change aspects of their business that FSOC
regards as vulnerabilities.
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\1\ See ``Authority to Require Supervision and Regulation of
Certain Nonbank Financial Companies'', 77 Fed. Reg. 21,637 (Apr. 11,
2012).
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Roy Woodall addressed FSOC's flawed application of the material
financial distress standard in his dissents in both the Prudential and
MetLife cases. In the Prudential case, he noted that:
the Notice's analysis under the [material financial distress
standard] is dependent upon its misplaced assumption of the
simultaneous failure of all of Prudential's insurance
subsidiaries and a massive and unprecedented, lightning, bank-
style run by a significant number of its cash value
policyholders and separate account holders, which apparently is
the only circumstance in which the Basis concludes that
Prudential could pose a threat to financial stability. I
believe that, absent a catastrophic mortality event (which
would affect the entire sector and also the whole economy),
such a corporate cataclysm could not and would not occur.
Similarly, in his dissent in the MetLife case, Mr. Woodall
highlighted the lack of evidence to support one of FSOC's principal
bases for assuming ``material financial distress'' at MetLife:
I do not, however, agree with the analysis under the Asset
Liquidation Transmission Channel of the Notice of Final
Determination, which is one of the principal bases for the
finding under the [material financial distress standard]. I do
not believe that the analysis' conclusions are supported by
substantial evidence in the record, or by logical inferences
from the record. The analysis relies on implausible, contrived
scenarios as well as failures to appreciate fundamental aspects
of insurance and annuity products, and, importantly, State
insurance regulation and the framework of the McCarran-Ferguson
Act.
One consequence of FSOC's interpretation of the material financial
distress standard is that FSOC focuses too narrowly on a company's
size. When it passed the designation provisions in the Dodd-Frank Act,
Congress never intended a unilateral focus on size. Rather, size is
just one of 11 factors that Congress directed FSOC to consider when it
designates a company.
Another consequence of FSOC's reliance on the material financial
distress standard is that it is difficult for a company, or the public,
to understand the basis for a designation. The documents accompanying
designations address how the company's failure might impact financial
stability, but do not address what hypothetically caused the company to
fail in the first place. Thus, a designated company has little, if any,
insight into what activities are, in FSOC's view, associated with
systemic risk.
Under a material financial distress standard that actually meets
the statutory requirements of the Dodd-Frank Act, FSOC would need to
employ the 11 statutory factors to first determine whether the company
is vulnerable to material financial distress based upon its company-
specific risk profile and, if it is, then determine whether the
company's failure could threaten the financial stability of the United
States. In other words, FSOC should not be able to designate a company
on an assumption that it is failing, but instead should only designate
a company when a company's specific risk profile--including its
leverage, liquidity, risk and maturity alignment, and existing
regulatory scrutiny--reasonably support the expectations that the
company is vulnerable to financial distress, and then that its distress
could threaten the financial stability of the United States. The
purpose of designations should be to regulate nonbanking firms that are
engaged in risky activities that realistically ``could'' cause the
failure of the firm, not to regulate firms that are not likely to fail.
3. FSOC Does Not Give Sufficient Weight to the Views of Primary
Financial Regulatory Agencies
In drafting the Dodd-Frank Act, Congress recognized that many
nonbank financial companies are subject to supervision and regulation
by other financial regulators. Insurance companies, for example, are
subject to comprehensive regulation and supervision by State insurance
authorities. Thus, Congress directed FSOC to consult with other primary
regulators when making a designation determination, and required FSOC
to consider ``the degree'' to which a company is already regulated by
another financial regulator. Congress also gave the Federal Reserve
Board authority to exempt certain classes or categories of nonbank
financial companies from supervision by the Board, and directed the
Board to take actions that avoid imposing ``duplicative'' regulatory
requirements on designated nonbank companies.
FSOC's designation of insurance companies shows little deference to
these requirements. In the case of MetLife, for example, FSOC
discounted State insurance regulation even after the Superintendent of
the New York State Department of Financial Services (NYDFS), Benjamin
Lawsky, told FSOC that: (1) MetLife does not engage in nontraditional
noninsurance activities that create any appreciable systemic risk; (2)
MetLife is already closely and carefully regulated by NYDFS and other
regulators; and (3) in the event that MetLife or one or more of its
insurance subsidiaries were to fail, NYDFS and other regulators would
be able to ensure an orderly resolution. \2\ Similarly, in his dissent
in the Prudential case, the Council member with insurance experience
noted that the scenarios used in the analysis of Prudential were
``antithetical'' to the insurance regulatory environment and the State
insurance company resolution and guaranty fund systems.
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\2\ Letter to Honorable Jacob J. Lew, Secretary of the Treasury,
from Benjamin M. Lawsky, Superintendent, New York State Department of
Financial Services, July 30, 2014.
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This lack of deference to an insurer's primary financial regulator
is particularly troubling given the fact that insurance, unlike every
other segment of the financial service industry, does not have any of
its primary regulators as voting members of FSOC. Moreover, none of the
primary regulators of the three insurers that have been designated were
``at the table'' when FSOC designation decisions were made.
4. FSOC Has Failed To Consider the Consequences of Designation
FSOC has an obligation to consider the consequences of its actions.
Administrative law requires that an agency consider the effects of its
actions, and the failure to do so can cause a court to void the action.
SEC Chair Mary Jo White acknowledged publicly in June that a principle
of good policymaking is to know `` . . . what is on the other side if I
make that decision . . .'' and to understand what a decision `` . . .
actually accomplish[es] in terms of the issue you're trying to solve
for.'' \3\ In its determinations to date, however, FSOC has failed to
consider the consequences of its designations.
---------------------------------------------------------------------------
\3\ ``SEC Chair: Asset Managers Not Overreacting to FSOC'',
Politico Pro. June 22, 2014. https://www.politicopro.com/
financialservices/whiteboard/?wbid=33914.
---------------------------------------------------------------------------
This failure is particularly relevant to designations involving
insurance companies. The insurance industry is highly competitive, and
the additional regulation imposed upon a designated company can place
that company at a significant competitive disadvantage relative to its
nondesignated competitors. Capital standards are the most obvious
example. Congress recently clarified that the Board has the ability to
base capital standards for designated insurance companies on insurance
risk, rather than banking risk. We appreciate very much this
Committee's role in effecting that important clarification. At this
point, we are waiting on a proposal from the Federal Reserve Board that
makes use of this revised statutory provision. Should the Federal
Reserve Board impose capital requirements on designated insurers that
are materially different from those imposed by the States, designated
insurers may find it difficult to compete against nondesignated
competitors.
Additionally, FSOC's failure to consider the consequences of
designations on insurance companies is at odds with FSOC's ``duty''
under the Dodd-Frank Act to monitor regulatory developments, including
``insurance issues,'' and to make recommendations that would enhance
the ``integrity, efficiency, competitiveness, and stability'' of U.S.
financial markets. \4\
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\4\ 112(a)(2)(D) of the Dodd-Frank Act.
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5. FSOC Has Failed To Consider an ``Activities-Based'' Approach to
Insurance
The Dodd-Frank Act gives FSOC two principal powers to address
systemic risk. One power is the authority to designate nonbank
financial companies for supervision by the Federal Reserve Board. The
other power is an ``activities-based'' authority to recommend more
stringent regulation of specific financial activities and practices
that could pose systemic risks. FSOC has not been consistent in its
exercise of these powers. In the case of the insurance industry, FSOC
has actively used its power to designate. In the case of the asset
management industry, FSOC has undertaken an analysis of the industry so
it can consider the application of more stringent regulation for
certain activities or practices of asset managers, and it has not
designated any asset management firm to date.
FSOC held a public conference on the asset management industry in
order to hear directly from the asset management industry and other
stakeholders, including academics and public interest groups, on the
industry and its activities. Furthermore, following its meeting on July
31, 2014, FSOC issued a ``readout'' stating that FSOC had directed its
staff ``to undertake a more focused analysis of industry-wide products
and activities to assess potential risks associated with the asset
management industry.''
In contrast, FSOC has not held any public forum at which
stakeholders could discuss the insurance industry and its activities.
Instead, FSOC has used its power to designate three insurance companies
for supervision by the Federal Reserve Board.
ACLI supports the more reasoned approach that FSOC has taken in
connection with the asset management industry and believes that FSOC
should be required to use its power to recommend regulation of the
specific activities of a potential designee before making a designation
decision with respect to that company.
FSOC's power to recommend more stringent regulation of specific
activities and practices has distinctive public policy advantages over
its power to designate individual companies for supervision by the
Federal Reserve Board. FSOC's power to recommend brings real focus to
the specific activities that may involve potential systemic risk and
avoids the competitive harm that an individual company may face
following designation. As noted above, in certain markets, such as
insurance, designated companies can be placed at a competitive
disadvantage to nondesignated companies because of different regulatory
requirements. Finally, the power to recommend avoids the ``too-big-to-
fail'' stigma that some have associated with designations.
FSOC's recommendations for more stringent regulation of certain
activities and practices must be made to ``primary financial regulatory
agencies.'' These agencies are defined in the Dodd-Frank Act to include
the SEC for securities firms, the CFTC for commodity firms, and State
insurance commissioners for insurance companies. A recommendation made
by FSOC is not binding on such agencies, but the Dodd-Frank Act
includes a ``name and shame'' provision that encourages the adoption of
a recommendation. That provision requires an agency to notify FSOC
within 90 days if it does not intend to follow the recommendation, and
FSOC is required to report to Congress on the status of each
recommendation.
Recommended Reforms
To address the concerns highlighted in this statement, ACLI
recommends the following reforms:
Institute additional procedural safeguards during the designation
process.
We recommend the following changes to the designation process: (1)
companies that receive a notice of proposed determination should be
given access to the entire record upon which FSOC makes the
determination to issue the notice; (2) the same FSOC staff should not
serve as fact finder, prosecutor and adjudicator; (3) in the case of an
insurance company, the views of the Council member with insurance
expertise and the primary financial regulatory agency for the company
should be given greater weight; (4) a company should be given more than
30 days to initiative judicial review of a final determination; and (5)
supervision of the company by the Federal Reserve Board should be
stayed during judicial review.
Establish additional procedures for de-designation.
In addition to the mandatory annual review of a determination, FSOC
should be required to conduct a review upon the request of a designated
company if there has been a change in the operations of the company or
a change in regulation affecting the company. In connection with such a
review, FSOC should also provide a company with an analysis of the
factors that would lead FSOC to de-designate the company. This would
permit a company to know precisely what changes in its risk profile are
needed to eliminate any potential for the company to pose a risk to the
financial stability of the United States. Finally, during the de-
designation review, the views of the Council member with insurance
expertise and the primary financial regulatory agency for the company
should be given special weight.
Require FSOC to pursue an ``activities-based'' approach before using
its power to designate a company for supervision by the Federal
Reserve Board.
FSOC should use its authority under the Dodd-Frank Act to recommend
specific activities and practices for more stringent regulation before
designating individual nonbank financial companies within an industry
for supervision by the Federal Reserve Board. More stringent regulation
of the activities or practices of an entire class or category of
financial firms can have a greater impact on financial stability than
the designation of an individual firm.
Require FSOC to consider ``vulnerability'' in its designation
decisions.
The statute, FSOC's own regulatory guidance, and common sense
dictate that a company should not be designated systemic without an
evaluation of whether the company, as currently structured and
operated, is indeed vulnerable to material financial distress. Steps
should be taken to ensure that FSOC makes this factor an element of its
decision-making process in the future.
Promulgate the regulations required by Section 170 of the Dodd-Frank
Act.
Section 170 of Dodd-Frank directs the Federal Reserve Board, in
consultation with FSOC, to issue regulations exempting certain classes
or categories of companies from supervision by the Federal Reserve
Board. \5\ However, to date no such regulations have been issued
pursuant to this authority. This requirement represents yet another
tool Congress created to delineate between those entities that pose
systemic risk and those that do not. How such regulations might affect
insurance companies, if at all, is unknown. But presumably the
regulations will shed additional light on what metrics, standards or
criteria operate to categorize a company as nonsystemic. The primary
goal here should be to clearly inform companies of how to conduct their
business and structure their operations in such a way as to be
nonsystemic. Only if that primary goal cannot be met should the focus
turn to regulating systemic enterprises.
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\5\ 170 of the Dodd-Frank Act.
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Conclusion
Mr. Chairman, we believe the best interests of the U.S. financial
system and the stated objectives of the Dodd-Frank Act can be realized
most effectively by an FSOC designation process that operates in a more
transparent and fair manner. The overarching purpose of the Dodd-Frank
Act is to minimize systemic risk in the U.S. financial markets.
Providing companies with the choice and the ability to work
constructively with FSOC to structure their activities in such a way as
to avoid being designated as systemic in the first instance advances
that purpose and reflects sound regulatory policy--as would affording
companies a viable opportunity for de-designation. The reforms we are
recommending are intended to achieve these objectives, and we pledge to
work with this Committee and others in Congress toward that end.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM JACOB J. LEW
Q.1. Secretary Lew, FSOC recently announced changes to its
designation procedures, including a new effort to notify
companies that they are being considered for designation
earlier in the process.
Can you explain what prompted FSOC to amend its procedures?
Will those amended procedures be used to reevaluate companies
that have already been designated under the prior FSOC regime?
A.1. The FSOC is committed to the continued evaluation of its
procedures and to engagement with stakeholders. Our adoption of
supplemental procedures to the nonbank financial company
designations process represents the latest example of the
FSOC's willingness to revisit how it conducts its work, based
on ideas raised by stakeholders, without compromising the
FSOC's fundamental ability to achieve its mission. Last fall,
FSOC conducted extensive outreach with a wide range of
stakeholders about potential changes to its process. The FSOC
Deputies Committee hosted a series of meetings in November with
more than 20 trade groups, companies, consumer advocates, and
public interest organizations. We also solicited input from
each of the three companies then subject to a designation. FSOC
discussed the findings from this outreach and potential changes
during a public meeting in January, and adopted the
supplemental procedures in February.
The supplemental procedures provide greater public
transparency regarding the FSOC's process. Many of these
procedures reflect practices that were already used in the
evaluation of companies that were previously designated by the
FSOC. With regards to the supplemental procedures applicable to
annual reevaluations of previously designated companies, the
changes will enhance the FSOC's already-robust process for
reviewing each previous designation.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM JACOB J. LEW
Q.1. FSOC's 2014 annual report notes that the Council is
charged with promoting market discipline by eliminating the
expectation of bailouts in the event of a failure of a large
financial company. In pursuing that mandate, the Council has
designated a number of nonbank financial companies as SIFIS,
which subjects them to additional supervision by the Federal
Reserve. While increased supervision may allow regulators to
better understand and manage the perceived systemic risk these
firms present, many market participants may view SIFI
designation as a signal that a firm is in fact too-big-to-fail
and would receive Government assistance in the event of its
imminent failure. With that in mind, one goal of the nonbank
designation process might be voluntary de-risking by SIFIs and
potential SIFIs.
Does FSOC provide any guidance to companies under review on
steps that they could take voluntarily in order to reduce their
systemic importance and avoid designation?
In its annual reevaluation of designated companies, does
FSOC provide those companies with actionable guidance on the
steps necessary to remove their SIFI designation? If not,
should it?
During the hearing, Chairman Shelby asked about giving
firms the opportunity to ``work their problems out.'' You
responded: ``I think that in its wisdom Congress created a
process for these matters to be decided and resolved and
adjudicated, and that process should stand.'' Please expand
upon that response to explain why the designation process
should not include an opportunity for firms to work with FSOC
to voluntarily reduce risk and avoid designation.
A.1. When evaluating a nonbank financial company for potential
designation, the FSOC engages extensively with the company to
understand and consider any ways in which the firm's material
financial distress could pose a threat to U.S. financial
stability. For past designations, FSOC has engaged with the
company during a period ranging from 10 to 17 months. As part
of its engagement, the FSOC provides the company with a
detailed explanation of the basis for any proposed designation,
which can include hundreds of pages of company-specific
analysis. Prior to any final designation by the FSOC, companies
have an opportunity for a hearing before the FSOC. Upon a final
designation, the FSOC provides the company with a detailed
written explanation of the basis for the designation that
specifically describes the potential risks identified by the
FSOC in its evaluation.
For each of the four nonbank financial companies that the
FSOC has designated since the enactment of the Dodd-Frank Act,
the FSOC determined, based on its consideration of the 10
statutory factors set forth in the Dodd-Frank Act, that the
company's material financial distress could pose a threat to
U.S. financial stability. Those statutory factors include,
among others, size, assets, leverage, interconnectedness, and
existing regulatory scrutiny. The extensive engagement with
companies and existing regulators during the designation
process, and the detailed written explanations provided by the
FSOC both before and after a final designation, allow companies
and their regulators to take steps to address the potential
risks identified by the FSOC.
In addition to the engagement and explanations provided to
firms in connection with a designation, the FSOC has a robust
process to reevaluate each previous designation at least
annually. We take these reviews seriously, and the FSOC will
rescind the designation of any company if the FSOC determines
that it no longer meets the statutory standard for designation.
Before the FSOC's annual reevaluation of a firm subject to a
designation, the company has the opportunity to meet with FSOC
staff to discuss the scope and process for the reevaluation and
to present information regarding any relevant changes,
including a company restructuring, regulatory developments,
market changes, or other factors. If a company contests its
designation during the FSOC's annual reevaluation, the FSOC's
supplemental procedures state that it intends to vote on
whether to rescind the designation and provide the company, its
primary financial regulatory agency, and the primary financial
regulatory agency of its significant subsidiaries with a notice
explaining the primary basis for any decision not to rescind
the designation. The notice will address the material factors
raised by the company in its submissions to the FSOC contesting
the designation during the annual reevaluation. In addition,
the FSOC provides each designated company an opportunity for an
oral hearing to contest its designation every 5 years.
Q.2. In considering the overall regulatory regime of the
financial system, what would signal that it is sufficiently
regulated, under-regulated, or over-regulated?
Since the passage of Dodd-Frank, de novo bank charters have
all but ceased, perhaps in part because of the high regulatory
hurdles facing small institutions. In response, this Committee
has spent a great deal of time considering how it can right-
size regulatory touch for smaller firms. Do you support
tailoring regulations for small firms and is there any
legislative action that you would recommend to relieve pressure
on small firms without unduly increasing their risk and
systemic risk?
A.2. Policymakers should be attentive to the benefits and
burdens of financial regulations that are put forward,
including as they relate to community banks. In crafting and
implementing Dodd-Frank, Congress and the Federal regulatory
agencies understood that community and regional banks did not
cause the financial crisis. Accordingly, they should not be
subject to the same requirements that are appropriate for large
institutions.
Treasury supports the regulators' efforts to tailor their
rules for community banks and is committed to implementing the
Dodd-Frank Act in a way that builds a more efficient,
transparent, and stable financial system that contributes to
our country's economic strength, instead of putting it at risk.
The Dodd-Frank Act generally authorizes tailored regulation to
reflect the size and complexity of banking organizations. The
Dodd-Frank Act recognizes that community banks did not cause
the financial crisis and was structured to limit their
regulatory burdens.
Treasury will continue to work with Congress and the
regulators to help make sure that laws are implemented in a way
that preserves the important roles of community and regional
banks and keeps capital flowing to the customers they serve.
Q.3. In July of 2013, the Treasury Borrowing Advisory Committee
reported that new regulations stemming from Basel III and Dodd-
Frank will likely result in constrained liquidity in the
market. Even well-intentioned rules like the Supplementary
Leverage Ratio (SLR) may constrain liquidity in markets as deep
and understood as those for U.S. Treasury securities.
What has been done specifically to address concerns
regarding market liquidity in anticipation or as a result of
new regulations?
Given the views and commentary of the TBAC and other market
participants, which rules are worth revisiting?
A.3. Our efforts to reform the financial sector have made the
system far safer and more resilient than it was in 2008. There
is much less leverage, and the big banks are better
capitalized. Moreover, we believe that financial reform will
create more effective and better functioning markets throughout
business cycles. We know that many factors are having
significant effects on financial markets, some of which pre-
date the crisis and reflect the evolution of market structure.
All of these factors are affecting market behavior, and
Treasury is constantly monitoring liquidity in financial
markets--as they continue to evolve--and the degree to which
the reforms we put in place are achieving the intended results.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
FROM PAUL SCHOTT STEVENS
Q.1. What can be done to improve the determination process
including with respect to improving transparency and
accountability? Please clarify which of your recommendations
warrant congressional action and which recommendations the FSOC
would be able to implement on its own pursuant to an existing
statutory authority.
A.1. ICI supports U.S. and global efforts to address abuses and
excessive risk in the financial system, but we are concerned
that the FSOC is seeking to exercise its designation authority
quite broadly and to the exclusion of other mandates. The
opacity of the designation process only exacerbates this
problem.
The FSOC's supplemental procedures to the SIFI designation
process, implemented in February, are welcome, but fall well
short. These changes should be codified in statute to provide
greater certainty and predictability to the process. In
addition, Congress must act to require the FSOC to give both
primary regulators and companies under consideration for
designation an opportunity to address identified systemic risks
prior to designation, as well as require an enhanced post-
designation review process. Such steps would support the FSOC's
mission both by reducing risks in the financial system and by
reserving SIFI designations and the exceptional remedies that
flow there from only to those circumstances in which they are
clearly necessary.
The Institute believes that Title III of the Financial
Regulatory Improvement Act of 2015 significantly addresses
these concerns. The Institute also supports H.R. 1550, the
Financial Stability Oversight Council Improvement Act, which
includes similar de-risking provisions, as well as codifies
into statute FSOC's supplemental procedures.
In none of its nonbank designations thus far has the FSOC
chosen to explain the basis for its decision with any
particularity. Instead, it appears to have relied on a single
metric (a firm's size) to the exclusion of the other factors
cited in the Dodd-Frank Act. It also has theorized about risks
instead of conducting the kind of thorough, objective,
empirical analysis that should underlie its decisions. The FSOC
should be explicit about the systemic risks it identifies
arising from a firm's structure or activities, and the results
of any analysis that might lead to designation should be made
public. This would be beneficial on all sides--it would help
market regulators and firms address such risks, and it would
promote public understanding of and confidence in what the FSOC
regards to be systemically risky and why.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
FROM DOUGLAS HOLTZ-EAKIN
Q.1. What can be done to improve the determination process
including with respect to improving transparency and
accountability? Please clarify which of your recommendations
warrant congressional action and which recommendations the FSOC
would be able to implement on its own pursuant to an existing
statutory authority.
A.1. There are at least 18 GAO recommendations with an open
status that mirror some of the concerns raised in my testimony
related to the transparency of FSOC's process. \1\
Additionally, past work at the American Action Forum has
highlighted many potential reform options to improve
transparency and accountability including but not limited to:
\2\
---------------------------------------------------------------------------
\1\ These recommendations are part of four previous GAO reports:
GAO-15-51, GAO-13-622, GAO-12-886, and GAO-12-151.
\2\ See Satya Thallam, ``Considering an Activity-Based Regulatory
Approach to FSOC'', (September 2014); http://americanactionforum.org/
research/considering-an-activity-based-regulatory-approach-to-fsoc;
Satya Thallam, ``Reform Principles for FSOC Designation Process'',
(November 2014); http://americanactionforum.org/research/reform-
principles-for-fsoc-designation-process; and Satya Thallam, ``Reform
Principles for FSOC Designation Process (Cont'd)'', (January 2015);
http://americanactionforum.org/solutions/reform-principles-for-fsoc-
designation-process-contd.
Regular meetings and communication with experts and
---------------------------------------------------------------------------
stakeholders
More detailed minutes
Public disclosure of a checklist of findings
regarding a firm along the criteria codified in Dodd-
Frank
Final designations decisions available to the
public that cite specific activities or subsidiaries of
designated firms posing acute threats to America's
financial stability
Comprehensive assessments of the economic costs and
benefits of designation
The Dodd-Frank Act granted FSOC broad authority statutorily
to set the specific determinants of a SIFI designation for
nonbanks and lay out its operational procedures. FSOC has
independently shown some willingness to address criticisms
related to the processes and procedures it has developed.
Specifically, the procedures adopted in February to open up
FSOC and improve communication with firms under review were a
good first step. FSOC's broad statutory authority should allow
it continue these improvements and make the changes recommended
in my testimony.
Of the eight primary criticisms I outlined, the
supplemental procedures adopted in February related to points
1, 6, and 7, though none fully addressed the issues raised. If
FSOC appears unlikely to move forward with further
improvements, it may behoove the Committee to consider
legislation that at a minimum requires FSOC to conduct its
business with greater analytical rigor, puts oversight
authority in the hands of existing regulators and not the
Federal Reserve Board of Governors, encourages the Council to
consider an activity-based approach ahead of institution-by-
institution designation, and more clearly outlines and
emphasizes the ability to de-risk and exit designation.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM DOUGLAS HOLTZ-EAKIN
Q.1. Your testimony recommends that the FSOC share its analysis
of what makes a company systemic so that the company might have
an opportunity to address those risks and reduce its systemic
footprint.
If our ultimate policy goal is to reduce systemic risk,
would it make sense for the de-designation process to be more
clear, more structured, and more robust?
A.1. Yes, absolutely. As outlined in my testimony, FSOC has not
given companies the necessary information or opportunity to
understand and address the metrics leading to a SIFI label. The
internal changes announced in February are additionally not
enough to ensure that designated nonbanks have a genuine
opportunity to address Council concerns and exit designation.
While FSOC's primary mission is to identify activities and
practices that generate systemic risks, in practice it has
prioritized designation and regulation of institutions. At a
minimum, further clarity and analytical rigor are needed to
make annual reevaluations of SIFI status more than just check-
the-box exercises, to provide a clear path for companies away
from designation, and to uphold FSOC's primary mission of
identifying and mitigating risks to America's financial
stability.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
FROM DENNIS M. KELLEHER
Q.1. What can be done to improve the determination process
including with respect to improving transparency and
accountability? Please clarify which of your recommendations
warrant congressional action and which recommendations the FSOC
would be able to implement on its own pursuant to an existing
statutory authority.
A.1. The Financial Stability Oversight Council was created less
than 5 years ago in the Dodd-Frank Wall Street Reform and
Consumer Protection Act. It was tasked with a number of very
important responsibilities, including identifying, analyzing,
and, if appropriate, designating systemically significant
nonbank financial institutions. As AIG, GE, Bear Stearns,
Lehman Brothers, and so many more nonbank financial risks
proved conclusively in the 2008 financial crash, systemically
significant nonbank financial institutions can pose grave risks
to the American people, the financial system and our economy.
Moreover, they can be costly to our taxpayers and Government
when, as they did in 2008, they line up with their hands out
for bailouts.
Thus, identifying, analyzing and, if appropriate,
designating systemically significant nonbank financial
institutions are a key part of protecting the American people
and our treasury. A great deal of important work has been done
in this area by the Stability Council, including very
significant recent changes to make the process work even
better.
First, it has to be recognized that the Stability Council
did a remarkable job in standing up the entire Council in very
little time and acting swiftly to implement the law as
directed. While doing that, it has also made great strides in
increasing the transparency and accountability of its
designation process. The process was previously too opaque,
depriving the public as well as potential designees of
important information. For example, the Council did not
disclose important data such as the number of firms under
consideration, which firms were under consideration, and the
number of firms FSOC declined to designate. In addition, the
Council did not provide sufficient information about the
process it follows for designation. However, to its credit, the
Stability Council heard those criticisms, including prominently
from Better Markets. It engaged in extensive outreach to all
stakeholders.
Second, the Stability Council acted on those concerns and
recently changed procedures to be more transparent and
accountable. Referred to as Supplemental Procedures, the
Stability Council released this past February a series of very
significant changes to their processes and procedures, which
are designed to improve transparency and accountability. Under
the new provisions, the Council provides information about the
number of firms it considers for designation and provides
additional information as to how it conducts designations.
Further, the Council also now interacts with firms under
consideration and primary regulators much earlier in the
process. These changes are indeed significant, showing that the
Council is listening carefully to those who comment on its
activities, and is responding with meaningful, timely,
inclusive action.
Thus, we do not believe that this is the appropriate time
to impose changes on the Stability Council, especially not
changes mandated by Congress that are written in law that would
deprive the Council of essential flexibility to adapt to
unseen, unanticipated, new and emerging systemic risks. We
believe that now is the time to let the Stability Council
implement its new Procedures and to monitor those changes and
the Council to determine if they were sufficient and
implemented as well as they could be.
We hold this view knowing that not all of the changes
recommended by Better Markets and others were adopted and all
criticism, merited or not, has not abated. That, however,
should not detract from the remarkable and unprecedented way
the Stability Council has done its work while also adapting to
new information and circumstances. Given that the Stability
Council has shown an ability and willingness to listen and
change on its own, we believe that it has earned the trust and
respect of critics to continue to work to refine its procedures
and policies to balance a number of competing interests while
fulfilling its incredibly important mission.
Additional Material Supplied for the Record
LETTER SUBMITTED BY THE NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
STATEMENT SUBMITTED BY PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN
FINANCIAL POLICY STUDIES AT THE AMERICAN ENTERPRISE INSTITUTE
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
STATEMENT SUBMITTED BY AARON KLEIN, DIRECTOR OF THE BIPARTISAN POLICY
CENTER'S FINANCIAL REGULATORY REFORM INITIATIVE
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
REPORT SUBMITTED BY THE BIPARTISAN POLICY CENTER
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
LETTER OF DISSENT SUBMITTED BY BENJAMIN M. LAWSKY, SUPERINTENDENT, NEW
YORK DEPARTMENT OF FINANCIAL SERVICES
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
ROY WOODALL AND JOHN HUFF DISSENTS ON PRUDENTIAL
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
ROY WOODALL AND ADAM HAMM DISSENTS ON METLIFE
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
STATEMENT OF THE NATIONAL ASSOCIATION OF MUTUAL INSURANCE COMPANIES
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
STATEMENT SUBMITTED BY STEPHEN D. STEINOUR, CHAIRMAN, PRESIDENT, AND
CEO, HUNTINGTON BANCSHARES, INC.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]