[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
THE ARBITRARY AND INCONSISTENT
NON-BANK SIFI DESIGNATION PROCESS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
__________
MARCH 28, 2017
__________
Printed for the use of the Committee on Financial Services
Serial No. 115-10
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PETER T. KING, New York MAXINE WATERS, California, Ranking
EDWARD R. ROYCE, California Member
FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina NYDIA M. VELAZQUEZ, New York
STEVAN PEARCE, New Mexico BRAD SHERMAN, California
BILL POSEY, Florida GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri MICHAEL E. CAPUANO, Massachusetts
BILL HUIZENGA, Michigan WM. LACY CLAY, Missouri
SEAN P. DUFFY, Wisconsin STEPHEN F. LYNCH, Massachusetts
STEVE STIVERS, Ohio DAVID SCOTT, Georgia
RANDY HULTGREN, Illinois AL GREEN, Texas
DENNIS A. ROSS, Florida EMANUEL CLEAVER, Missouri
ROBERT PITTENGER, North Carolina GWEN MOORE, Wisconsin
ANN WAGNER, Missouri KEITH ELLISON, Minnesota
ANDY BARR, Kentucky ED PERLMUTTER, Colorado
KEITH J. ROTHFUS, Pennsylvania JAMES A. HIMES, Connecticut
LUKE MESSER, Indiana BILL FOSTER, Illinois
SCOTT TIPTON, Colorado DANIEL T. KILDEE, Michigan
ROGER WILLIAMS, Texas JOHN K. DELANEY, Maryland
BRUCE POLIQUIN, Maine KYRSTEN SINEMA, Arizona
MIA LOVE, Utah JOYCE BEATTY, Ohio
FRENCH HILL, Arkansas DENNY HECK, Washington
TOM EMMER, Minnesota JUAN VARGAS, California
LEE M. ZELDIN, New York JOSH GOTTHEIMER, New Jersey
DAVID A. TROTT, Michigan VICENTE GONZALEZ, Texas
BARRY LOUDERMILK, Georgia CHARLIE CRIST, Florida
ALEXANDER X. MOONEY, West Virginia RUBEN KIHUEN, Nevada
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
Kirsten Sutton Mork, Staff Director
Subcommittee on Oversight and Investigations
ANN WAGNER, Missouri, Chairwoman
SCOTT TIPTON, Colorado, Vice AL GREEN, Texas, Ranking Member
Chairman KEITH ELLISON, Minnesota
PETER T. KING, New York EMANUEL CLEAVER, Missouri
PATRICK T. McHENRY, North Carolina JOYCE BEATTY, Ohio
DENNIS A. ROSS, Florida MICHAEL E. CAPUANO, Massachusetts
LUKE MESSER, Indiana GWEN MOORE, Wisconsin
LEE M. ZELDIN, New York JOSH GOTTHEIMER, New Jersey
DAVID A. TROTT, Michigan VICENTE GONZALEZ, Texas
BARRY LOUDERMILK, Georgia CHARLIE CRIST, Florida
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana
C O N T E N T S
----------
Page
Hearing held on:
March 28, 2017............................................... 1
Appendix:
March 28, 2017............................................... 31
WITNESSES
Tuesday, March 28, 2017
Holtz-Eakin, Douglas, President, American Action Forum........... 4
Kupiec, Paul H., Resident Scholar, American Enterprise Institute. 5
Pollock, Alex J., Distinguished Senior Fellow, R Street Institute 9
Zaring, David, Associate Professor, Legal Studies and Business
Ethics, The Wharton School, University of Pennsylvania......... 7
APPENDIX
Prepared statements:
Holtz-Eakin, Douglas......................................... 32
Kupiec, Paul H............................................... 39
Pollock, Alex J.............................................. 45
Zaring, David................................................ 51
Additional Material Submitted for the Record
Wagner, Hon. Ann:
Written statement of the American Council of Life Insurers... 64
Written statement of the Property Casualty Insurers
Association of America..................................... 69
Wall Street Journal Commentary by Adam J. White entitled,
``Does `Too Big to Fail' Mean Too Big for the Rule of
Law?''..................................................... 75
THE ARBITRARY AND INCONSISTENT
NON-BANK SIFI DESIGNATION PROCESS
----------
Tuesday, March 28, 2017
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Ann Wagner
[chairwoman of the subcommittee] presiding.
Members present: Representatives Wagner, Tipton, Ross,
Messer, Zeldin, Trott, Loudermilk, Kustoff, Tenney,
Hollingsworth; Green, Cleaver, Beatty, Gottheimer, and
Gonzalez.
Ex officio present: Representatives Hensarling and Waters.
Chairwoman Wagner. The Subcommittee on Oversight and
Investigations will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time.
Today's hearing is entitled, ``The Arbitrary and
Inconsistent Non-Bank SIFI Designation Process.''
The Chair now recognizes herself for 4 minutes for an
opening statement.
The financial crisis nearly 10 years ago was born as a
result of poor government housing policy that encouraged
excessive risk-taking at taxpayer expense, as well as an
inability of financial regulators to properly identify systemic
risk and promulgate appropriate regulations.
As a response to the crisis, the Dodd-Frank Act doubled
down on the failed approach and created a new super-regulator
with enormous power, the Financial Stability Oversight Council
(FSOC), which was tasked with identifying systemic risk.
Additionally, Dodd-Frank enshrined too-big-to-fail. It
enshrined its policy in creating a new group of entities called
systemically important financial institutions (SIFIs), which
are subject to enhanced prudential standards by the Federal
Reserve after an FSOC designation. If the financial crisis
taught us anything, it was that relying on government
regulators in Washington to identify and root out systemic risk
will always end in failure.
Instead, government regulators should come up with
responsible regulations that enforce market discipline and
ensure that institutions are not excessively leveraging
themselves at the risk of taxpayers. The CHOICE Act, which this
committee is currently drafting, provides such a framework, not
for deregulation, but for smarter regulation that will open up
our economy, while ending taxpayer-funded bailouts and imposing
tougher penalties on those who commit fraud.
For a long time, the actions and deliberations of FSOC were
a mystery. Most meetings, nearly two-thirds conducted by FSOC,
take place in executive sessions that are closed to the public,
even though FSOC's governance documents encourage it to hold
public meetings whenever possible. Additionally, FSOC meetings
are closed to Members of Congress, as well as to regulators who
are not FSOC members.
And finally, there is very little documentation kept
regarding meetings in executive session that the FSOC does
convene, making it very difficult to determine the rationale
behind FSOC decisions, which oftentimes have significant
effects on the U.S. economy.
For instance, reports show that the annual consumer cost of
designating a non-bank financial institution as a SIFI could
range from $5 billion to $8 billion. Yet, FSOC additionally
fails to conduct any cost-benefit analysis when designating a
firm as a SIFI.
For this reason, the Oversight and Investigations
Subcommittee began a review last Congress of the FSOC's
designations of non-bank SIFIs by obtaining non-public internal
FSOC documents and soliciting testimony from FSOC officials.
After analyzing these documents, we released a staff report
last month which found the FSOC's non-bank designation process
to be arbitrary and inconsistent. First of all, the FSOC does
not follow its own rules and guidance in many ways. The staff
report also found that FSOC's analysis of companies has varied
among firms eventually designated and firms that FSOC chose not
to designate in considering different factors and weighing some
factors differently among different companies.
Ultimately, the staff report verifies what we have already
known: that Washington simply is unable to accurately identify
and define systemic risk. Instead, government bureaucrats have
acted very subjectively with very little transparency or
accountability in exerting their power to the detriment of U.S.
enterprises, their customers, and the economy in general.
I now recognize the gentleman from Texas, the distinguished
ranking member of the subcommittee, Mr. Green, for 5 minutes.
Mr. Green. Thank you, Madam Chairwoman. And congratulations
again on becoming the Chair of the subcommittee.
Madam Chairwoman, in my opinion, a better title for this
hearing would be, ``Another repeal bill.'' We have seen the
financial crisis that almost brought this country to its knees,
the Great Recession. I think it does merit some reflection so
that we can better understand the crisis that caused Dodd-Frank
to come into being.
In 2008, financial institutions fell by the wayside. In
2008, Countrywide was bought out. Bear Stearns was bought out.
IndyMac failed. Merrill Lynch was bought out. Lehman Brothers
went bankrupt. AIG had an $85 billion rescue. Washington Mutual
failed. And then on September 29th of 2008, we had the greatest
1-day decline in the stock market in history.
Under the Bush request for a $700 billion bailout, at the
time we were voting in the House of Representatives we could
see the votes as they were being tallied. And as the votes were
being tallied, we could also see the stock market in the
cloakroom. And as the votes were being tallied and the bill was
going down, the stock market was going down as well. The stock
market fell 777 points that day. Again, the greatest 1-day fall
in the market ever. That 1-day decline caused billions of
dollars to be lost.
I remember how my constituents responded the day before we
voted. My constituents wanted us to vote against the $700
billion bailout, as it was called. There were hundreds of calls
from people who were opposed to the bailout. Constituents were
concerned about taxpayer dollars being used.
After the bailout, the next day the calls were in the
hundreds, and they wanted to know why we failed to support the
$700 billion bailout. Constituents have the luxury of being
here today and there tomorrow. We in Congress have a
responsibility to evaluate the evidence and come to reasonable
and prudent conclusions. We did pass that $700 billion rescue
bill. And that bill caused us to turn this economy around,
along with some other things.
But I remember the auto industry, that the ``Big Three''
were here, and they needed help. Many of my friends across the
aisle said, ``Let them fail.'' Let them fail. It was a
responsibility of Democrats to stand and protect the auto
industry, and we did.
Democrats have been the party of, ``Yes, we can.'' Our
friends across the aisle have been the party of, ``No, we
can't.'' The latest indication is what happened with health
care. The party of repeal voted more than 60 times in one way
or another to repeal the Affordable Care Act, had the perfect
plan. For 7 years, they have had a perfect plan to replace the
Affordable Care Act. But when it was time to produce, when it
was time to build as opposed to repeal, they could not produce.
They could not replace. They are very good at repealing, but
very poor at replacing.
So today, on the heels of the failure to repeal and
replace--they could have repealed it to find a replacement--we
have yet another opportunity for them to repeal. They want to
repeal the Consumer Financial Protection Bureau (CFPB), the
bureau that is designed to protect consumers, they would repeal
it. They now want to repeal the economic disaster prevention
agency. It is called FSOC, but it is there to prevent another
AIG. And it did so with G.E.
This bill will do more repealing than replacing. I am
against it, and I am going to stand up for Dodd-Frank.
I yield back.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the Vice Chair of the
subcommittee, the gentlemen from Colorado, Mr. Tipton, for 1
minute for an opening statement.
Mr. Tipton. Thank you, Chairwoman Wagner.
It is incredibly concerning to learn that the counsel and
its staff, while evaluating institutions for potential SIFI
designation, failed to heed their own guidance, inconsistently
applied criteria to firms, and fundamentally misunderstood what
could cause financial distress in non-bank institutions.
Further, it is disturbing to read that the designation
process was often conducted on an ad hoc basis with no clear
guidance for FSOC or its staff and little hard evidence to
justify designation decisions. These critiques do not come from
the committee alone. Last year, the D.C. circuit court
overturned a SIFI designation based in part on the failure of
FSOC to conduct a cost-benefit analysis.
A recent GAO report came to similar conclusions, finding
that the FSOC did not develop a process for identifying
specific criteria to apply to analytical framework in
evaluating companies. Yet again, we find regulators are quick
to regulate, but slow to analyze. I look forward to learning
more in this hearing about ways to reform the designation
process to encourage a data-driven approach.
Thank you, and I yield back.
Chairwoman Wagner. The gentleman yields back.
We now welcome our witnesses. First, Dr. Doug Holtz-Eakin
is currently the President of the American Action Forum. He has
previously served as Chief Economist of the President's Council
of Economic Advisers as well as Director of the Nonpartisan
Congressional Budget Office, and as a Commissioner on the
Financial Crisis Inquiry Commission.
With that, Dr. Holtz-Eakin, you are now recognized for 5
minutes.
STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, AMERICAN ACTION
FORUM
Mr. Holtz-Eakin. Thank you, Chairwoman Wagner, Ranking
Member Green, and members of the subcommittee. It is a
privilege to be here today to discuss the non-bank SIFI
designation process.
I want to make three simple points, and then I look forward
to your questions.
First, as the staff report makes clear, there are deep
weaknesses in the FSOC's designation process. But I would
emphasize that even if there was a good process, there is a
mistaken emphasis on designating financial institutions as
opposed to the activities and instruments that they that they
operate.
The second is that the designation process has costs, it
has consequential cost for the firms, for their customers and
for the economy as a whole, and it is a mistake to ignore these
costs in making the designations.
And the third main point is that, thus far, only insurance
companies have been designated as non-bank SIFIs, and I would
urge the committee to consider removing the FSOC's authority to
do so as it appears to be redundant at best. Let me expand on
each of those.
First, with regard to the process, as the committee knows,
there are three stages in the designation process. Stage one
consists of essentially a series of quantitative flags that the
FSOC staff checks to see if a firm qualifies. And then it moves
to stage two, without the firm knowing it, to undertake an
analysis that is based on size, leverage, interconnectedness,
liquidity and maturity mismatch, substitutability, and the
existing regulatory apparatus surrounding that firm.
As the report makes clear, it is not at all obvious what
weights are attached to each of these factors. It is pretty
clear that they are applied differently to different firms and
that there is anything but a systematic process by which firms
are designated.
And then in stage three, it is an in-depth analysis of a
firm and, as I emphasized at the outset, the focus on firms is
a mistake in the FSOC to begin with and, thus, it repeats this
mistake in the final stage of its analysis.
The second main point is that there are costs associated
with this, and I would emphasize there some economic costs. In
the same industry, you will have non-bank SIFIs designated for
a higher standard of regulation and the costs that come with
it. That produces an un-level playing field for competition and
financial services. It is also true that across the globe, U.S.
firms will be at a disadvantage in competing for global
markets. These are all important costs to consider.
The Oliver Wyman study that was mentioned by the chairwoman
indicates that a single non-bank SIFI designation could cost
consumers somewhere between $5 billion and $8 billion. And that
is a cost that the courts have indicated that the FSOC should
take into consideration, and it has simply failed to do so.
And the last point is, what should be the path forward?
First and foremost, I think it is important for the FSOC to
move away from a focus on designating firms as systemically
important and instead, undertake an activities-based analysis.
It has indicated its interest and willingness to do so, but it
now has an inconsistent approach across industries. That
doesn't make a lot of sense.
And with regard to the non-bank SIFIs that have been
designated thus far, as I mentioned, they are all insurance
companies. And if you look at the way the designation process
is played out, essentially what they have done is taken these
insurers and imposed on them a second round of essentially
prudential safety and soundness type regulation. Each of these
insurers has a consolidated regulator at the State level.
The report indicates that these regulars were not consulted
adequately. Going forward, it looks as if the FSOC is
essentially imposing simply a second layer of the same kind of
regulation. It is not obvious that makes a lot of sense. And we
may want to think about removing the FSOC's capacity to
designate, at a minimum, insurance companies and perhaps
rethinking the designation process as a whole.
So I look forward for the chance to answer your questions,
and I thank you for the privilege of being here today.
[The prepared statement of Dr. Holtz-Eakin can be found on
page 32 of the appendix.]
Chairwoman Wagner. I thank the witness.
Our next witness is Dr. Paul Kupiec. Dr. Kupiec is a
resident scholar at the American Enterprise Institute. Prior to
that, Mr. Kupiec was Director of the Center for Financial
Research at the FDIC, as well as Chairman of the Research Task
Force of the Basel Committee on Banking Supervision.
Dr. Kupiec, you are now recognized for 5 minutes.
STATEMENT OF PAUL H. KUPIEC, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE
Mr. Kupiec. Chairwoman Wagner, Ranking Member Green, and
distinguished members of this subcommittee, thank you for
convening today's hearing.
In my oral remarks, I will summarize my written testimony,
and I will use a simple analogy from everyday life. On my
commute home, I drive west on K Street. If I see a flash of
light as I approach the 22nd Street underpass, I instinctively
check my speedometer, remember the 25-mile-an-hour speed limit,
and try to guess whether it was my car that triggered the speed
camera.
Now imagine that you are a CEO of a large, successful, non-
bank financial firm. One day you receive an e-mail from the
FSOC saying that your institution is selected for a stage-three
FSOC review. Stage-three review, you ask, who even knew the
FSOC put us through a stage-two review? Your institution is
profitable, well-capitalized, and growing. Your State
regulators, and you have regulators in every State where you do
business, have given you a clean bill of health. Your staff has
no idea why the FSOC picked you.
Keeping now with my speeding ticket analogy, ask yourself,
is there a speed limit for the institution? How fast is the
firm actually going? How fast does the FSOC think the firm is
going? Where can the institution find out answers to these
questions? The situation becomes more surreal when you discover
that there are no definite answers to any of these questions.
The FSOC has the power to set individual speed limits for
each and every non-bank financial institution under its
jurisdiction. Moreover, the FSOC does not have to disclose your
institution speed limit to your institution, even if you pay
your white-shoe law firm to make a formal request. They don't
have to tell you.
More troubling, the FSOC is the only agency authorized to
measure the speed of non-bank financial institutions. And now
you, as a target of a stage-three review, the FSOC scientists
are already measuring your institution's speed using an unknown
process and without any impartial witnesses present. If this
nightmare of jurisprudence reminds you of a ``Twilight Zone''
episode, it is called, ``The Dodd-Frank Act.''
I could mention specific troublesome details of the FSOC
stage-two and stage-three designation decisions, and I do so in
my written testimony. But the bottom line is, the
subcommittee's report shows the FSOC has no common methodology
or uniform standards or assumptions that are used in individual
firm SIFI designations. Each FSOC designation decision is an
outcome of an ad hoc process. The lack of standardization means
that identical firm characteristics can be and have been
evaluated differently in different FSOC designation cases.
An example will bring clarity to this problem. Say that the
FSOC staff separately examines two firms with nearly identical
characteristics. Let's call these two firms equally tall. They
are firm one and firm two. In examining firm one, the FSOC
staff decides that firm one is a safe firm because of its
height; it can reach the high fruit on trees and it will never
starve. The FSOC concludes that firm one is not a SIFI.
In a separate case and time, the FSOC examines firm two and
decides that tall firm two is risky because it is at risk of
being struck by lightning. FSOC decides the tall firm two is a
SIFI. If this designation process sounds unjust, it is. But
can't firm two appeal the FSOC's decision? Yes, it can, but
remember, only some FSOC SIFI designation decisions are made
public. There is no public record of FSOC decisions unless a
firm is actually designated.
So, tall firm two has no idea of the processes and
arguments the FSOC used to evaluate tall firm one, nor does it
even know that the FSOC evaluated tall firm one. Tall firm two
lacks the case law it needs to defend itself against an FSOC
designation. While I have purposely omitted technical jargon, I
have not exaggerated the deep-flawed nature of the Dodd-Frank
FSOC designation process.
I myself doubt there is a need for an FSOC SIFI designation
process. But even if you would disagree with me on this point,
I still doubt you would defend the current FSOC process as a
legitimate way to go about making SIFI designations.
The subcommittee has done invaluable work acquiring and
analyzing confidential FSOC records that have made transparent
the flaws in the FSOC designation process. The process is
arbitrary and broken. It should be repealed or, at a minimum,
fundamentally reformed.
Thank you very much, and I look forward to your questions.
[The prepared statement of Dr. Kupiec can be found on page
39 of the appendix.]
Chairwoman Wagner. I thank the witness for his testimony
and analogies that I can very much relate to. My apologies for
your waiting in the rain to get in, Mr. Kupiec, but we are so
glad that you are here.
Our next witness is Professor David Zaring. Professor
Zaring is an associate professor of legal studies and business
ethics at the Wharton School. Previously, Professor Zaring was
with the Washington Lee University School of Law, the New York
University School of Law, and he clerked on the U.S. Court of
Appeals for the D.C. circuit.
Professor Zaring, you are now recognized for 5 minutes.
STATEMENT OF DAVID ZARING, ASSOCIATE PROFESSOR, LEGAL STUDIES
AND BUSINESS ETHICS, THE WHARTON SCHOOL, UNIVERSITY OF
PENNSYLVANIA
Mr. Zaring. Chairwoman Wagner, Ranking Member Green, thank
you for inviting me.
At Wharton, I study financial regulation, and I have
written an article on the administrative procedure of the
Financial Stability Oversight Council with Daniel Schwartz, who
is a professor at the University of Minnesota. That article is
forthcoming in the University of Chicago Law Review.
And in my testimony on the procedures followed by the FSOC
today, I want to focus on three points and make a few
additional observations. First, the report prepared by the
Republican staff of the Committee on Financial Services
subjects the Council to a degree of after-the-fact review that
is inconsistent with the flexibility Congress gave the Council
in the Dodd-Frank Wall Street Reform Act.
In that statute, Congress charged the Council with
designating non-bank financial companies as systemically
significant on the basis of, among other things, a ten-factor
test; it did not specify how those factors should be weighed,
and it emphasized that the Council should apply ``any other
risk-related factors that the Council deems appropriate'' to
its designated decisions in addition to those identified in the
statute.
The Republican staff report identifies portions of the
written memoranda of the Council, where it emphasizes some
safety and soundness factors more heavily than it did other
factors. It also identifies cases where the Council considered
the riskiness of a financial institution as a general matter as
indicative of the risk institution would pose when the economy
was stressed.
There is nothing arbitrary about emphasizing some factors
more than others in such circumstances, nor is it arbitrary to
presume that a non-bank, risky in normal conditions, would also
be risky when times are difficult.
Second, the report, while a real contribution into how the
Council makes decisions, attempts to isolate particular aspects
of the Council's analysis and makes arguments about
inconsistency based on those aspects. But this sort of picking
and choosing is really not consistent with the way that FSOC
designations work.
The designation decision is meant to be a holistic one,
utilizing a number of different factors in a way that enables
the Council to consider a full picture of any particular non-
bank's position and of the effect that stress in that non-bank
would have on the broader financial markets and greater economy
as a whole.
FSOC has its constraints. It can only act given a super
majority of its members, it can only designate financial
companies as that term is defined in Dodd-Frank, and it must
revisit all of its designations annually. These constraints are
real and they cabin the ability of the Council to go rogue.
But the factors that Congress told it to consider when it
is making any particular determination decision of those
institutions that fall within its jurisdiction are, by a
necessity and sensibly, broad and open to interpretation.
Third, the Council itself has been given the responsibility
for taking a broad view of the safety of the financial system
and it is the only part of the Federal Government with the
power and the capability to do that. It has chosen to make
designations in a manner that makes it possible to revisit
those designations. Only the three largest insurance companies
in America have been designated as systemically significant, as
well as one large financing company.
But it is important that the Council retains its
flexibility to adjust its assessments of risk in the future.
Second-guessing small portions of large decisions is
inconsistent with the necessary flexibility that Congress gave
the Council.
Finally, the costs of designation are real, but they are
easy to overstate. While G.E. Capital transformed itself in an
effort to move away from designation, it is clear that there
were business judgment reasons to restructure the company
anyway. And it is important to remember that FSOC rescinded the
designation of that company. As the CEO of AIG has observed,
designation ``just simply isn't a binding constraint on our
capital returns and our objectives, so we don't spend too much
time worrying about it.''
For that insurance company, designation has not been a
burden, but rather a regulatory requirement that has not
imperiled its business or its ability to make plans in the
future. FSOC has only designated four companies. It has removed
one of those designations. There are two designations that are
currently active and one of them is an extremely large
insurance company, and the other is AIG, the company that
collapsed so spectacularly during the financial crisis.
There is no indication right now that more designations are
contemplated. That does not look like arbitrary exercise of
government power. Instead, to me, it looks quite cautious
indeed. And it certainly doesn't look entirely subjective.
With that, I thank the subcommittee, and I look forward to
your questions.
[The prepared statement of Professor Zaring can be found on
page 51 of the appendix.]
Chairwoman Wagner. Thank you, Professor Zaring.
Our final witness today is Mr. Alex Pollock. Mr. Pollock is
a distinguished senior fellow at the R Street Institute.
Previously, Mr. Pollock was with the American Enterprise
Institute, and was president and CEO of the Federal Home Loan
Bank of Chicago.
Mr. Pollock, you are now recognized for 5 minutes.
STATEMENT OF ALEX J. POLLOCK, DISTINGUISHED SENIOR FELLOW, R
STREET INSTITUTE
Mr. Pollock. Thank you, Madam Chairwoman, Ranking Member
Green, Vice Chairman Tipton, members of the subcommittee, and
full Financial Services Committee Chairman Hensarling.
To begin with, let me compliment the committee staff for
their detailed specific paper on FSOC's non-bank designation
process. This embodies what I think is a very good analytical
idea, namely to compare the FSOC evaluation memoranda against
each other, to measure their consistency. The comparison shows
they have been characterized by multiple inconsistencies and
anomalies, as we all agree.
The paper says these examples cast doubt on the fairness of
FSOC's designation process. They do, but, in my opinion, a more
important point than fairness is that these observations cast
doubt on the objectivity of the FSOC's work.
As we know, Federal District Judge Rosemary Collyer ruled
that FSOC's MetLife action was ``arbitrary and capricious,''
strong words, and that FSOC ``hardly adhered to any standard
when it came to assessing MetLife's threat to U.S. financial
stability.'' This sound and sensible judicial decision was
appealed by the previous Administration.
I believe the current Treasury Department should
immediately request the Department of Justice to withdraw the
appeal and the Department of Justice should do so as soon as it
can.
Just today, the Treasury Department received a letter from
10 members of the Senate Banking Committee, including the
chairman, which says, in part, the FSOC's process for
designating non-bank SIFIs ``lacks transparency and
accountability, insufficiently tracks data, and does not have a
consistent methodology.'' So we seem to have the two Chambers
tracking together here.
Going back to the FSOC designation, the independent member
of FSOC, Roy Woodall, who is a true expert in insurance, voted
against the SIFI designation of MetLife, objecting that ``the
analysis relies on implausible, contrived scenarios.'' Well,
implausible, contrived scenarios are what we don't want.
Ed DeMarco, a distinguished financial regulator, joined Mr.
Woodall's earlier dissent on Prudential and also pointed out
that key FSOC arguments lacked evidence. We certainly do want
evidence.
Was there a substantive discussion among the members of
FSOC about these issues? I am told that there was not. But the
whole point of FSOC is supposed to be a committee for
deliberation and development of insights together in
discussion.
I directly asked one former senior FSOC insider from the
previous Administration if the meetings of the FSOC members had
ever produced a new insight into financial issues. After
thinking a minute, he gave me a candid answer: no. The
underlying problem, it seems to me, is the structure of the
FSOC itself.
So the procedural issue leads us to a bigger structural
issue. The shortcomings of designation point us to the
question: what about the FSOC itself? We know they are
primarily a group of individuals, each from a regulatory
agency, each with turf to protect from intrusions by the others
and a regulatory record to defend. At the meetings, they bring
along helpers and allies. At the FSOC meeting that approved the
MetLife SIFI designation, there were, according to its minutes,
46 people sitting around the room. I don't think they had a
serious give-and-take, substantive discussion with 46 people.
The composition of the FSOC makes it a necessarily
political body. That is why FSOC's evaluations tend to make
inconsistent analyses. It is because the decisions made are
inherently judgmental with inherently subjective elements.
We might call those ``holistic,'' Professor Zaring.
What that means is FSOC actually acts as a little
legislature, and I think that is a bad idea.
Madam Chairwoman, you mentioned Fannie Mae and Freddie Mac,
which are obviously systemically important and, without
question, systemically extremely risky. But Fannie Mae and
Freddie Mac are never studied as possible SIFIs by the FSOC
staff in spite of the fact that they obviously are SIFIs. Why
not? Because the Secretary of the Treasury controls who gets
studied and would not allow the staff to look at Fannie and
Freddie, even though they are pure cases of the government
shielding creditors and counterparties from losses, not only as
a hypothetical, but as a vast fact. Protecting creditors in
this fashion is something that the Dodd-Frank Act instructs
FSOC to eliminate.
So FSOC needs some immediate actions on its procedural
issues, as we have discussed. But it also needs structural
reform for the longer term.
Thank you very much for the chance to share these views.
[The prepared statement of Mr. Pollock can be found on page
45 of the appendix.]
Chairwoman Wagner. I thank all four of our witnesses.
And without objection, the witnesses' full written
statements will be made a part of the record. Each member of
the subcommittee will now have 5 minutes within which to ask
questions.
The Chair now recognizes herself for 5 minutes.
Dodd-Frank, in directing the FSOC to identify systemic
risk, tasked a number of prudential financial regulators, such
as the Federal Reserve, the FDIC, and the OCC, as members of
FSOC.
Mr. Pollock, since you arrived first, I would like to first
start off in asking how these financial regulators have fared
in the past in identifying risks to the financial stability of
the United States?
Mr. Pollock. Thank you, Madam Chairwoman. Of course, they
haven't done very well. I was just reading two wonderful
quotations from the then-Chairman and the current Chairman of
the Federal Reserve from the end of 2007 and January 2008,
forecasting that there would not be a recession at that point.
Of course, as we know, the recession had already started. We
have numerous examples of regulators failing to see the
disaster that was coming, as other people and other forecasters
failed to see it.
Because the financial future, in particular, is inherently
uncertain, we certainly can't put faith in any bureaucratic
bodies to protect us from that. Personally, I would prefer to
put faith in higher capital.
Chairwoman Wagner. Thank you.
Dr. Holtz-Eakin, I would like to follow up on this as well
in asking if there is a simple way to measure systemic risk?
Mr. Holtz-Eakin. There is not; in fact, there is no
agreement on exactly how to measure it and what it looks like.
If you can't measure something, you can't manage it. And it is
far from obvious what the FSOC is trying to do in those
circumstances. I think that is a fundamental flaw in the entire
idea behind the FSOC.
Chairwoman Wagner. If you can't measure it, you can't
manage it. How then can Congress evaluate whether the FSOC is
properly performing its job?
Mr. Holtz-Eakin. The only way to evaluate the FSOC would be
to get some transparency about its procedures so that it at
least does whatever it is doing the same way every time and to
everybody. And all the evidence we have thus far is that it is
not doing that.
Chairwoman Wagner. Another issue, I believe, that impedes
Congress from evaluating whether FSOC is performing its job is
simply the lack of information and transparency from the
Council. From our previous work on this committee, we have
known the FSOC to be one of the least transparent Federal
entities, providing very little oversight for Congress and the
public into the deliberations of Council meetings.
These are quick, and we will switch it up.
Dr. Kupiec, I will start with you. It wasn't until the
release of this committee's staff report that we started to
actually see the rationale, and in many instances, lack of
rationale, for the decisions made by the FSOC. Dr. Kupiec,
should the FSOC be made more transparent?
Mr. Kupiec. I think the subcommittee report makes it very
clear that transparency is long overdue. I think from the
designations, from the public documents we saw associated with
the various designations, there were strong suspicions that the
FSOC decides on a designation and kind of makes up a story
afterwards to justify it. It is, sort of, an attempt at writing
financial fiction.
What I think we have seen with the subcommittee's report
where it actually goes through and analyzes the stage-two
documentation that was not publicly available or known to
anyone is in fact this whole characterization, that it is an
after-the-fact story made up to justify a decision or a non-
decision to designate I think comes out very clearly in the
subcommittee report.
Chairwoman Wagner. Let's go down the line, starting with
Dr. Holtz-Eakin, all four of you, yes or no, should the FSOC
publicize its internal process?
Mr. Holtz-Eakin. Yes.
Mr. Kupiec. Yes.
Mr. Zaring. No.
Mr. Pollock. Yes.
Chairwoman Wagner. Should FSOC allow observers at its
meetings, such as participants from member agencies or
Congress?
Mr. Holtz-Eakin. Yes.
Mr. Kupiec. Absolutely.
Mr. Zaring. No.
Mr. Pollock. Strongly yes.
Chairwoman Wagner. Should FSOC keep detailed minutes and
transcribe their meetings, like the Fed's Federal Open Market
Committee does?
Mr. Holtz-Eakin. Yes.
Mr. Kupiec. Yes.
Mr. Zaring. No.
Mr. Pollock. Yes, it would be a good idea.
Chairwoman Wagner. I thank you all.
While our committee is considering broader reforms and
changes to the structure and powers of FSOC, what are some
other actions that Treasury Secretary Mnuchin could make right
now at FSOC, to bring more transparency and accountability to
its action?
Dr. Holtz-Eakin?
Mr. Holtz-Eakin. I think that FSOC showed some improvement
with its 2015 guidance, and Secretary Mnuchin could pursue
greater transparency and greater consistency in its actions.
Chairwoman Wagner. Dr. Kupiec?
Mr. Kupiec. I think since systemic risk is such an elusive
construct and really can't be identified, in my opinion, that
the FSOC ought to move towards specific thresholds and evaluate
firms along guidelines that are observable and can be defended
or not.
Chairwoman Wagner. Thank you. My time has expired.
The Chair now recognizes Mr. Cleaver for 5 minutes.
Mr. Cleaver. Thank you, Madam Chairwoman, and Ranking
Member Green.
Mr. Kupiec, I do analogies in my real life quite a bit. And
so I was struck by your analogy of the traffic light catching
somebody for speeding and getting a ticket for speeding. And
then you compared that with the non-bank financial firm
suddenly getting a notice of a stage-three evaluation. Did I
restate your analogy correctly?
Are you aware that the Council published supplemental
procedures with 17 changes and a larger, increased transparency
in the designation process? Are you aware that they did that?
Mr. Kupiec. Yes, I am aware that following testimony in the
Financial Services Committee, which is very critical of the
FSOC's process, they did publish some changes and try to
improve transparency, yes.
Mr. Cleaver. But no matter why they did it, they did it,
right?
Mr. Kupiec. But they didn't do it out of their own good
will. That would matter.
Mr. Cleaver. Okay, you don't know why they did it. You have
no idea. You have absolutely no idea why they did it. All we
know is that they did it in 2015. And you said transparency is
long overdue, 2015. Now, how do you know that you know why they
did it?
Mr. Kupiec. I testified in the hearings that led up to
the--maybe I am mistaken, but that would be my judgment, that--
Mr. Cleaver. Okay, and that is fine. That is judgment, and
I like judgment, except if it has ``they'' on the end of it.
But the point I am trying to make is that you are calling for
transparency, and we have had transparency. And that is just a
little confusing. Have you looked at the website?
Mr. Kupiec. Excuse me?
Mr. Cleaver. Have you looked at the FSOC website?
Mr. Kupiec. Yes, sir. I have read the designation
decisions.
Mr. Cleaver. Yes, and you also know--
Mr. Kupiec. And the court court cases, the MetLife court
case.
Mr. Cleaver. And you know they detailed the criteria they
use in stage one--
Mr. Kupiec. Yes, in fact I was involved in the stage-one
designation process when I was at the FDIC as the head of the
economics group there.
Mr. Cleaver. But you know that is on the website, don't
you?
Mr. Kupiec. Yes.
Mr. Cleaver. Okay. I don't understand the ``pants on
fire,'' which was your testimony. Then you are now admitting
that they have a transparent--Professor Zaring, can you confirm
that FSOC announced that they will notify a company within 30
days of activating a review in stage two?
Mr. Zaring. That is right. They have this elaborate three-
stage process, and if they take a company into the third stage
of that process, the company has every opportunity and so far,
as far as I know, has taken every opportunity to interact with
the Council in either fighting or responding to an inquiry by
the Council that suggests that the stage-three review is
beginning. That includes meeting with Council members, turning
over documents to the Council.
The Council vote is public, of course, after which comment
and a hearing can be or--the tentative decision is public, of
course, after which the designated institution can provide
comments. There is an opportunity for a public hearing. I think
there is a great deal of process attached to this designation
decision.
Mr. Cleaver. And then stage two, Professor Zaring, do the
companies have the opportunity to present information to the
Council?
Mr. Zaring. They do after a stage three. In stage two, the
Council tries to figure out which companies to ramp up to this
adversarial determination.
Mr. Cleaver. I am trying to figure out this lack of
transparency, just that people are going into bunkers to do
business. I don't understand this.
Mr. Zaring. I agree. To me, the Council is providing the
very few institutions that it has designated with a strong
amount of process.
Mr. Cleaver. Thank you very kindly. I yield back.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the gentleman from Colorado, Mr.
Tipton, the Vice Chair of the subcommittee, for 5 minutes.
Mr. Tipton. Thank you, Chairwoman Wagner.
Dr. Kupiec, when the FSOC is conducting an assessment on an
institution's potential for creating systemic risk, does the
Council consider the existing supervisory process regulating
that entity?
Mr. Kupiec. They are supposed to consider the supervision
and regulation in place, but I would say the designation
decisions that have been made thus far do not take account of
those in any way.
Mr. Tipton. Thank you. How were the current non-bank SIFI
firms supervised then prior to their designation?
Mr. Kupiec. AIG was actually supervised by a primary
Federal regulator, the Office of Thrift Supervision, actually,
and State insurance commissioners in all the States that AIG
does business. And the other insurance companies, all their
insurance subsidiaries are supervised by the State insurance
regulators. And some of the designated SIFIs, at one time, had
bank subsidiaries which were supervised by both State
regulators and a Federal regulator. It varies case by case.
Mr. Tipton. Now, have these regulators raised issues about
financial health or safety of the current SIFI non-bank
institutions prior, during, or after their designation?
Mr. Kupiec. The short answer is no, I am not aware of that.
AIG, of course, did get in trouble in the financial crisis, but
I am not aware that it was under any kind of warning signs from
the Office of Thrift Supervision. I think they basically
weren't really looking at AIG. They were the ones responsible
for the Financial Products Group in London, which was actually
the part of the firm that wasn't supervised by a State
insurance regulator. And that is the part that caused the
troubles.
Mr. Tipton. So just to be clear, the whole series of
regulators are lined out, going through, they have raised no
concern about the health, the safety of the institutions that
were in place going forward. But now with the FSOC going in, we
are seeing them choosing to designate?
Mr. Kupiec. Yes, and the designations for the insurance
companies, the way the FSOC makes it, is very unusual in that
it treats the products of insurance companies as if they were
bank deposit-like liabilities that could be withdrawn, that
people would line up and withdraw the residual value of their
life insurance policies or whatever. And they are not bank
deposit-like products, and there is really no evidence that
there have been any institution-wide runs on all the various
subsidiaries at any time in the past.
So the story is a very fictional story that the FSOC uses
to make the designation.
Mr. Tipton. Now, did the FSOC do any sort of cost-benefit
analysis as part of the SIFI designation process?
Mr. Kupiec. None that I am aware of and none that they
specifically state in public documents. And their opinion is
that they don't have to, is their opinion in the legal case,
that they are not required to make any cost-benefit analysis.
Mr. Tipton. In your opinion, does this undermine the
credibility of the FSOC's conclusions, the fundamental aspects
of the assessment process are flawed, and the impact of its
SIFI designation was not extensively studied prior to the
beginning of the designations?
Mr. Kupiec. I don't think the FSOC or anybody has the
capacity to scientifically that identify one firm is a SIFI and
another firm isn't a SIFI. I do not think the science of
statistics or economics or finance is sufficiently advanced
that you can definitively separate out firms into those that
are a source of systemic risk and those that aren't until
perhaps after they blow up.
But ahead of time, I don't have any confidence that
regulators have that ability, or any academic or any person
anywhere at this point in the science of risk measurement.
Mr. Tipton. Thank you.
Mr. Pollock, I gather you agree with Mr. Woodall's
conclusions in regards to designation of MetLife and
Prudential. Why is that really important? Is it important to be
able to have somebody who actually has experience in an
industry playing a role in these designations?
Mr. Pollock. Congressman, I think to have somebody who
actually is an expert in the industry is extremely important.
And Mr. Woodall's dissents, in my opinion, were very articulate
and substantive.
Mr. Tipton. Once a firm is designated as a SIFI, they are
overseen by the Federal Reserve Board. How much experience does
the Federal Reserve have in insurance regulation?
Mr. Pollock. Very little, and it certainly by no means
could be considered an expert.
Mr. Tipton. Thank you.
And, Madam Chairwoman, my time has expired.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the gentleman from Texas, Mr.
Gonzalez, for 5 minutes.
Mr. Gonzales. I will be yielding the balance of my time to
Representative Al Green.
Mr. Green. Thank you for yielding, and thank you for being
such an outstanding member of the committee. We greatly
appreciate your service.
Let's start with Mr. Holtz-Eakin. Sir, you talked about the
cost of designating a bill as a SIFI. And I think that is
worthy of consideration. But what about the cost of not
designating an entity as a SIFI? AIG was not designated as a
SIFI and AIG cost the country a good deal of stress, an $85
billion rescue effort, and it was paid back by the way. Don't
you think that the cost of not doing it is important, as well?
Mr. Holtz-Eakin. If we could, as a matter of science--
Mr. Green. Let's examine that, if we could. Because we
can't do it perfectly, we should not do it at all, seems to be
your thought processes. But it seems to me that FSOC is
working. FSOC, by the way, is the economic disaster prevention
agency. It is in business to look over the economy and to spot
these AIGs.
By the way, Mr. Kupiec, how was AIG regulated?
Mr. Kupiec. AIG was an international insurance company--
Mr. Green. Okay, it was an insurance company. You seem to
have some concern about insurance companies being regulated.
AIG is the ultimate example of why we have to regulate some of
the insurance companies, some of them, not all of them, some of
them. Let me move on.
Mr. Kupiec. AIG was regulated.
Mr. Green. Excuse me, let me move on. I am going to my next
witness, if I may, please.
Mr. Zaring, is this economic disaster prevention
commission, if you will, is it working?
Mr. Zaring. So far, since the passage of Dodd-Frank, we
haven't had a financial crisis, despite the fact that around
the world there has been plenty of financial turmoil. There is
every reason to believe that financial institutions, especially
non-banks, are more solvent and have better protections in
place for a crisis. And I think a lot of that has to do with
the fact that they know that FSOC is watching.
So FSOC is being very cautious about its designations, but
because it has the power to reach out and get risky behavior by
financial institutions, it has had a salutary effect on those
institutions as a whole.
Mr. Green. And can you give an example of not only
designation, but also de-designation? Because FSOC has the
ability to designate and it has the ability to allow a company
to take the necessary steps to eliminate risk and de-designate.
Can you respond, please?
Mr. Zaring. That is right. In the case of G.E. Capital, the
firm was designated, and it was engaged in lots of
marketplaces, which meant that a lot of its financing was very
runnable. Financing and insurance companies also do practices
like securities lending, and get into markets where the
financial assets and stake in those markets are runnable as
well.
So G.E. Capital transformed itself from an institution that
relied on these runnable assets for financing into a much more
stable institution that did not. And the Council responded by
revoking the designation. It has an annual responsibility to
review every designation for revocation, and there is every
indication that FSOC takes that responsibility very seriously.
Mr. Green. As a matter fact, looking at G.E. Capital, they
were into consumer credit. They had a consumer credit arm. They
had a commercial lending business. They had a real estate
assets business. They had online deposits. They had an asset
management arm. They had hotel financing. They had restaurant
financing. They had transportation financing. They had health
care financing. They were all over the place.
Mr. Zaring. Right, and I might add that it didn't seem to
me that G.E. Capital was well-supervised by any regulator,
given all these various and potentially risky businesses it was
in. FSOC provided a backstop that I think was an important
source of stability in the way that it supervised G.E. Capital
and persuaded it to change its business in, I think, ways that
were good for the American economy.
Mr. Green. Does that cause you to hearken back to AIG and
how it was regulated and supervised?
Mr. Zaring. Big companies like AIG can get involved in new
and creative markets with levels of risk that they don't really
understand. FSOC is a barrier against that kind of thing.
Mr. Green. Thank you. I yield back.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the gentleman from Tennessee, Mr.
Kustoff, for 5 minutes.
Mr. Kustoff. Thank you, Madam Chairwoman.
Dr. Holtz-Eakin, thank you for being here this morning, and
thank you for your past public service.
As we have seen with the implementation of Dodd-Frank and
the creation of FSOC, it has been authorized to notice and
implement final rules to determine whether a non-bank company
will pose a threat to the financial stability of our country.
Undeniably, this authority has allowed for FSOC to impose
guidance on what it considers its own definition for what
actually constitutes a threat to financial stability, a
definition, in my opinion, which is inconsistent in their
rulemaking and, more specifically, their designation of
systematically important financial institutions.
These independent agencies are created by Congress and
staffed with presidential employees. As such, we expect these
individuals to create rules and regulations objectively and
independently. Do you believe that the FSOC is capable of
acting as an independent regulatory agency?
Mr. Holtz-Eakin. It could be a better regulator in the
sense of having processes that were more systematic, that were
uniform, that were transparent, and where you could have
objective criteria that they sought to meet. I do not think
that the science exists to fulfill its basic mission which is
to identify systemic risk and reduce it.
As you know, I served on the Financial Crisis Inquiry
Commission. I think all the time in the narrative of that
crisis and in the events as they unfolded, had there been an
FSOC, would it have known how to stop it? And the answer is no,
it would not have.
It is the activities that went on, the interconnectedness
of those activities, not just among firms, but across the globe
that is the most striking feature of the crisis. That took
place in many different regulatory environments. None of them
were smart enough to foresee the forces that combined to
produce the financial crisis. And FSOC would not have been
smart enough either.
Mr. Kustoff. As a follow-up, if I could, last year Chairman
Hensarling introduced the Financial CHOICE Act which would
eliminate the FSOC's ability to designate SIFIs. What
additional reforms would you recommend to this committee that
would remedy the FSOC's unchecked authority to make these
designations?
Mr. Holtz-Eakin. I think there are several levels of
reforms. First, is one that we have mentioned several times
about the process by which it operates: making it more
transparent; more uniform; with a clear exit ramp from SIFI
status; and making sure that the burden doesn't fall on firms
that are too small.
The second would be limiting its scope to designate non-
bank SIFIs. I, for example, think that in many cases, all we
are getting out of the regulation of these insurance companies
is a second layer of what the consolidated State regulars are
doing anyway. And they are ignoring that, so I don't see why we
should do that.
And then the third thing, level of reform, I think, would
be to really pull back on its ability to do this at all. It has
been given a mission that it can't fulfill. It has enormous
authorities and can impose large costs on the economy. That
strikes me as a very bad regulatory arrangement and ought to be
scaled back entirely.
Mr. Kustoff. Thank you very much. I yield back.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the gentleman from New Jersey, Mr.
Gottheimer, for 5 minutes.
Mr. Gottheimer. Thank you. I yield my time to Mr. Cleaver,
Madam Chairwoman. Thank you.
Mr. Cleaver. Thank you very much.
I want to kind of keep going in the direction I was going.
When the financial crisis hit--when Treasury Secretary Hank
Paulson, Sheila Bair from the FDIC, Ben Bernanke from the Fed,
and Chris Cox from the SEC were here--I was in here that day,
it was late in the day. I was sitting right over there next to
that empty seat on the end when they came in--half of the
Members were gone already--to tell us what was happening to the
economy. I was in here.
I get the impression that there are those of you on the
panel who would suggest we should have just walked out and
said, I hope things turn out on Monday. We were warned that if
we didn't start acting, that the U.S. economy, by the time the
Asian markets opened after the weekend, that the world economy
could very well fall into shambles.
Mr. Holtz-Eakin, are you guys saying we should have said,
well, whatever happens is fine, we want the free market to just
kind of do what it does and see you later; and walk out and
catch our planes? Because I was in here, and I guess sometimes
I get disturbed when people say, ``You guys should have done
this, and you should have done that.'' I was here, and I know
the tension that was going on. I saw what was happening
firsthand.
And so I am just curious, if you had been sitting in here,
what would you have said to Hank Paulson, who said that
President Bush asked him to come over? Would you have said,
well, go back and tell him, let's let the free market just kind
of roll?
Mr. Holtz-Eakin. I have been on record as saying it would
have been irresponsible for the Congress to do nothing and we
saw that in the aftermath of the first failed TARP vote
significant economic damage. I am not--
Mr. Cleaver. I watched that as well. I watched it in real
time going down on the TV in the cloakroom.
Mr. Holtz-Eakin. That is different from saying I think the
response was the most effective response possible, which I
don't think the TARP turned out to be. I do think it is
important to recognize that the Federal Reserve was the single-
most effective response to the financial crisis. It essentially
followed the oldest central bank's playbook and was remarkably
creative in lending against any reasonable collateral and
flooding markets with liquidity.
That has always been the recipe in a financial crisis. They
did it again, and the speed with which financial markets
recovered is a tribute, I think, primarily to that response.
Mr. Cleaver. Since that legislation was passed, how many
non-banks have been designated as SIFIs?
Mr. Holtz-Eakin. There have been a total of four.
Mr. Cleaver. Like one, two, three, four?
Mr. Holtz-Eakin. Yes.
Mr. Cleaver. Yes. This is just amazing.
Mr. Zaring, can you explain why--we are talking about this
traffic light, getting a ticket for speeding. What is--
Mr. Zaring. I agree with you, there is no sense that the
Council is going rogue here, with only 4 designations in 6
years of existence. And then, of course, it rescinded one of
those designations.
And the reason I don't think a traffic light camera is an
apposite is precisely for the reason that Dr. Holtz-Eakin
suggested. This Financial Stability Oversight Council occupies
a precautionary role in American regulation, because we do not
know where the next financial crisis will emerge from.
But we do know that the downside risk, as you have just
stated, Congressman Cleaver, is extremely high and extremely
serious. It makes sense to create an institution that can take
precautionary approaches to the possibility of that extreme
downside risk coming in some way that we don't precisely know
will occur.
And that is what FSOC does. The fact that financial crises
are not reducible to some sort of arcane or particular
mechanical measure, it seems to me, is a good reason to have a
regulator to take the broad view that FSOC has.
Mr. Cleaver. Thank you.
Mr. Kupiec, if you re-thought your analogy, would you
rather have a flashing yellow light?
Mr. Kupiec. No, sir, I think my analogy is completely apt,
and I would say that the FSOC has done nothing on regulation.
They have designated four firms. The Federal Reserve Board has
not promulgated any regulation specially for insurance
companies. And I fail to see how anybody would argue that just
merely designating four firms has made the world safer against
a financial crisis.
As far as I can tell, they have done nothing. The costs
caused G.E. Capital to jettison what had been a very profitable
line of business over many years. I don't see why destroying a
profitable, well-run firm and making it split apart is a
success. I would disagree with all those things that were said.
Chairwoman Wagner. The gentleman's time has expired.
The Chair now recognizes the gentlelady from New York, Ms.
Tenney, for 5 minutes.
Ms. Tenney. Thank you, Chairwoman Wagner.
And I thank the panel for being here today on this very
important issue.
You have heard from my colleagues about the inconsistent,
arbitrary designation of SIFIs. And for the record, I just want
to say that a systemically important financial institutions
because it just sounds so vague and bureaucratic. And I think
that instead of saying SIFI and FSOC, I think we need to let
the public know just exactly the nature of the vagueness, but
the costs associated and increased burdens that are involved.
I would like to touch on a couple of off-ramp strategies
specifically for the non-banks, systemically important
financial institutions, I have to get it all out there.
Dr. Holtz-Eakin, in your testimony you pointed out that
FSOC/Financial Oversight Stability Council, another vague
title, only designated insurance companies as non-bank SIFIs
and you believe they provide no additional financial stability.
FSOC has made it their mission to identify threats to
America's financial stability. But when they are blindly
designating companies based solely upon inconsistent and
arbitrary standards, that is a clear indication of poor
structure and management in the non-bank SIFI destination
process. Again, more vagueness.
I think you make a fair argument by calling for the removal
of FSOC's authority to regulate those non-bank financial
institutions because these companies are already being heavily
regulated at the State level. And I can speak for that as a
former State assembly member who actually voted ``no'' on the
consolidation of the banking and insurance agencies into one
financial services agency in the State of New York, which has
just caused more regulation and just evidence of the incredible
oversight and regulation that we already have in New York
State.
But let me add that FSOC has been criticized for failing to
provide clear standards, again, we are back at vagueness, for
de-designation and for failing to provide affected companies
with a clear path or exit ramp of actions the company could
take to take to change its business to get the designation
removed.
So let me address my first question to Dr. Kupiec. If there
is no clear standard for designation, how can there be a clear
standard for de-designation? Or to put the question another
way, does the fact that FSOC cannot clearly state what will
lead to de-designation mean that the entire designation process
is arbitrary?
Mr. Kupiec. I think that is an accurate statement. To the
best of my knowledge, the FSOC does not give the designated
firms clear guidance on what they would have to do to not be a
SIFI. The designation documents themselves paint a very
arbitrary and fictional story about how the FSOC gets into
trouble.
There is no way that you can, based on those stories and
narratives, decide how you would change your business to escape
that narrative. So I think it is very, very true that there is
no off-ramp, no specific off-ramp. G.E. negotiated one somehow
over time, took a very drastic step by getting out of the
financial services industry entirely. The FSOC couldn't
regulate it anymore. It fell below the 85 percent threshold.
So it wasn't like the FSOC did something, G.E. did it. They
got out of the financial services business period. And the FSOC
fell below the 85 percent threshold. And the FSOC couldn't
designate it anymore. So I wouldn't say that was a great day in
the FSOC history where they de-designated a firm. The firm did
it themselves and it was very costly and painful.
Ms. Tenney. Thank you.
Let me follow that up. So would you then say that the--do
you trust that FSOC has been fair in evaluating the de-
designation process?
Mr. Kupiec. No.
Ms. Tenney. Evaluating companies in the de-designation
process.
Mr. Kupiec. I think the subcommittee report does a very big
service to the public by making public the decision process for
the stage two non-designation decisions which you couldn't know
without the committee getting ahold of those documents, and
even with the very heavily redacted discussion of it we can
tell that the FSOC makes up a story and an ad hoc analysis for
each firm on any given day. And then they are never consistent
and there is no set standard that they follow.
Ms. Tenney. Thank you.
Dr. Hultz-Eakin, do you agree that we would have to have a
complete overhaul of the SIFI process or designating process?
Mr. Holtz-Eakin. I very much do.
Ms. Tenney. Okay.
Mr. Holtz-Eakin. From the sort of arbitrariness of the
analysis from firm to firm, from the ignoring of the experts in
the insurance business during the designation of insurance
companies, and from, I want to emphasize, the point that Dr.
Pollock made at the outset, which is, how can you not at least
look at Fannie Mae and Freddie Mac, which are the living,
breathing definition of dangerous financial institutions and
have proven it through time?
Chairwoman Wagner. The gentlelady's time has expired.
Ms. Tenney. Thank you very much. I appreciate it.
Chairwoman Wagner. The Chair now recognizes the ranking
member of the full Financial Services Committee, the gentlelady
from California, Ms. Waters, for 5 minutes.
Ms. Waters. Thank you very much, Madam Chairwoman.
And I thank the panelists for being here today.
One of the main arguments that opponents of the FSOC make
is that it simply has too much power, and Congress, through
Dodd-Frank, has given the agency unlimited authority to
determine which non-bank institutions are systemically
important. However, directly included in Dodd-Frank are 10
specific factors that the FSOC must consider prior to
designating a firm as systemically important.
Can you discuss--and this is for Professor Zaring--these
factors and how they serve as a check on FSOC's ability to
declare any institution a SIFI?
Mr. Zaring. That is right. The factors that Congress gave
it give it some flexibility, but also some instruction as to
how it is supposed to make particular designation decisions.
And, of course, FSOC can only designate companies that qualify
as financial companies. It can only designate them upon a
super-majority vote. And it can only designate them after going
through this three-stage process at which the companies have
time to respond.
FSOC has to find that a firm could pose a threat to the
financial stability of the United States, either in the event
of material financial distress or due to the nature, scope,
size, scale, concentration, interconnectedness, or mix of its
activities. Those factors and the other ones that it has
considered are guidance to FSOC as to what it should consider.
And I don't think it means that FSOC is arbitrarily applying
that guidance if they emphasize some factors over other factors
when it comes to figuring out whether a particular institution
poses a great deal of downside risk.
Ms. Waters. So this discussion about being arbitrary with
unlimited authority just does not ring true, based on the fact
that there are these 10 specific factors that you just helped
to explain.
Now, doesn't the fact that the FSOC has only designated
four non-banks as SIFIs since 2010 confirm that the FSOC is not
arbitrarily imposing SIFI designations on all non-bank
financial firms, but instead acting responsibly to protect
taxpayers and our financial system from another devastating
financial crisis, Mr. Zaring?
Mr. Zaring. I agree, Congresswoman. I very much agree with
that. FSOC has not designated any more than four institutions.
It has only designated four institutions. And those
designations, once again, made a great deal of sense. They were
the three largest insurance companies in the United States,
including AIG, which was the insurance company that collapsed
during the financial crisis necessitating a massive and painful
bailout. And if that is not systemically risky, then I am not
sure what is.
And then the final company that was designated was G.E. And
as we have discussed earlier, G.E. was poorly regulated by any
other regulator, was engaged in many different markets, had a
real risk of runnable financing that creates systemic risk; at
the very least, we know that. And so it was accordingly
designated and changed its business accordingly.
So I think that FSOC is being cautious in its designation
power use. It is being clear about the kinds of things it is
worried about. It only hasn't tried to create some sort of a
standard which informs some non-bank financial institutions
that they will never be designated, thereby encouraging them to
take on systemic risk after they get a free pass.
Ms. Waters. This may not be a fair question, but why is it
opponents of FSOC have forgotten the lessons of AIG? Can you
speculate on that?
Mr. Zaring. To me, it is a real concern. AIG had a AAA
credit rating. And it is not that their regulators were the
only people to miss its riskiness, so were its investors, its
managers, and the broader capital markets as a whole. So the
idea that we can rely on the free market, to the extent that
one exists in financial services to begin with, to uncover
risks like AIG, I think is naive.
What AIG did, in addition to its runnable securities-
lending business, was get involved in a new industry or a new
business, writing credit default swaps where it didn't
understand the risks posed in that business. That is the kind
of thing that a regulator is supposed to be able to step in and
caution a firm that it should pay attention to. And I think
that forgetting the lessons of AIG is unwise to the extreme.
Ms. Waters. Thank you very much.
And I yield back the balance of my time.
Chairwoman Wagner. The gentlelady yields back.
The Chair now recognizes the gentleman from Michigan, Mr.
Trott, for 5 minutes.
Mr. Trott. Thank you, Chairwoman Wagner.
And I thank the panel for being here.
Professor Zaring, so what happened in the MetLife case? You
have been singing the praises of FSOC all morning and what
happened there? Is it just some rogue judge who doesn't
understand, or what happened there?
Mr. Zaring. I disagree with the judge's decision in that
case. And I think in that case, the judge made a decision to
require FSOC to conduct a cost-benefit analysis that is plainly
not required by the language of the statute and that doesn't
really make sense for FSOC as a whole. And here is why. I will
be brief, I know you have more questions.
But the costs of designation, and that is something that is
pretty easy to calculate, but the benefit of designation is the
goal is to avoid a financial crisis or a calamity. It is really
difficult to quantify that, though it is a real benefit. So
FSOC does apply a cost-benefit analysis, but it doesn't apply a
quantified one in the way that the judge seemed to prefer, and
I disagree with that imposition.
Mr. Trott. You have testified this morning that you are
really not in favor of any kind of transparency, that you don't
feel they need to disclose their decision-making criteria, and
you are fine with FSOC exercising broad discretion and
authority basically shrouded in secrecy. So let me ask you this
question, have you ever run a business?
Mr. Zaring. I have not.
Mr. Trott. Have you ever been accountable to shareholders?
You were in the Justice Department, and you have been in
academia, but you have never run a large corporation, correct?
Mr. Zaring. That is for sure.
Mr. Trott. How would these corporations expect to proceed?
And the hypocrisy of this whole thing is illustrated from the
deposition testimony of Patrick Pinschmidt, who is the
executive director. And they are asking about the different
criteria that he looks at in terms of designating a SIFI. And
in his answer, he says, ``Again, I am sort of doing this on the
fly, here. The paragraph above acknowledges that obviously, if
something bad were to happen to this particular company, that
would probably be factors that would impact all other companies
in the same industry.''
Boy, that is just clear as mud, isn't it? That is his
answer on his criteria when he looks at an industry.
Mr. Zaring. All I will say is corporations and government
agencies don't have to disclose their internal deliberations.
The key question is, what is the decision you make, and is
there a basis for the decision that is made? FSOC provides that
to any designated institution.
It is definitely the case that the members of FSOC, because
of their expertise and because of the factors that have been
given it from Congress, can come to their own conclusions about
what counts as too risky and appropriate for designation and
not risky enough.
Mr. Trott. And those conclusions, you don't believe, can be
arbitrary, right? They are always well-reasoned and there is no
chance of any kind of arbitrary outcome that provides for a
disparate impact on companies within the same industry.
Mr. Zaring. I think the best way to measure the
arbitrariness of any designation decision is to look at the
basis for the decision that FSOC supplies and in the four cases
where it has made a designation, that basis hasn't looked at
all arbitrary to me.
Mr. Trott. Can you understand some of our concern here? And
let me know if you disagree with any of the following premises.
We are dealing with bureaucrats who yearn to be relevant
because that is how they keep a job. We are dealing with
unelected bureaucrats. We are dealing with bureaucrats who
really have no budget. We are dealing with the Department of
Justice that has no litigation budget when they decide to
fight. And it is also hard to fight the government.
So can you sort of understand? And maybe you don't accept
any of those statements, but if you accept any of them, can you
sort of understand why this designation process gives us pause?
Mr. Zaring. I worry about bureaucrats not making sensible
decisions, but that is why I think that they have to be in a
position to explain those decisions. And I think that FSOC has
done that in this case.
Mr. Trott. Speaking of explaining their decisions, in our
report we said that since they don't follow their own rules and
guidance in most multiple ways, Dr. Kupiec, the concern is that
they treat the companies in the same industry differently. Do
you think that is a risk of the way they are currently
preceding?
Mr. Kupiec. I think the evidence that the subcommittee
found in terms of second-stage designations exactly goes to
that point, where they found that collateral, in some cases,
was treated as a positive, as a risk mitigant. And in other
cases, collateral was the worst thing that could ever happen,
it was going to cause the end of the world.
So, yes, they looked at the same phenomenon for two
different firms and came to exactly opposite conclusions. I
think this is my story of the two tall firms.
Mr. Trott. When I was in business, all I wanted to know
was, tell me what the rules are and treat everyone the same and
let us go get about our business and see if we can make money.
And those two factors don't seem to be in play.
Mr. Pollock, one quick question, my time is running out.
Professor Zaring is not concerned about the cost of compliance.
Can you just speak briefly to the effect that has on the stock
price and reputational risk and cost of compliance and the
overall effect on the economy?
Mr. Pollock. I think, Congressman, you are right about all
of those. Clearly, the cost of compliance is substantial and
affects value. We are looking here at these arbitrary decisions
and I would just like to repeat, the biggest arbitrary decision
of the FSOC was not to look at the biggest, most obvious SIFIs
in the country, which are Fannie Mae and Freddie Mac. They get
a free pass. It is unbelievable. It is, in my opinion, a purely
political decision of the previous Administration.
Chairwoman Wagner. The gentleman's time has expired.
Mr. Trott. Thank you.
Chairwoman Wagner. The Chair now recognizes the gentleman
from Indiana, Mr. Hollingsworth, for 5 minutes.
Mr. Hollingsworth. Good morning. Thanks so much for all of
you being here.
Mr. Pollock, you continue to bring up something that
disturbs me as well. When I think about systemic risk, I think
about those things that are risks to the entire system itself.
And what I keep coming back to is the world's largest debtor,
the world's largest balance sheet are all held by institutions
of this government. And I want to make sure that we are not
creating adverse incentives and creating more systemic risk by
government policy itself.
Can you talk a little about maybe instead of, as my
colleagues continue to say, that it is lack of regulation that
created the financial crisis, instead maybe it is this
distortion that is caused by government getting involved in
markets. And now here we are talking about even more distortion
and even unclear, unaccountable distortion.
Mr. Pollock. Congressman, I think that is absolutely right.
There is no doubt that a very important part of the crisis was
what the government did itself in the way of promoting credit,
expanding credit, driving up housing prices and, in general,
inflating the bubble. Many parts of the government were
involved in that, but, of course, in particular, Fannie Mae and
Freddie Mac, pushing on credit and pushing up house prices.
I say in my testimony that there are two overwhelming
factors in systemic risk. One is highly leveraged real estate
and the other is the moral hazard created by government credit
policy and government implicit or explicit guarantees. Fannie
Mae and Freddie Mac are that to the max, but somehow they are
not SIFIs.
Mr. Hollingsworth. Right. Do you think that we have taken
adequate steps thus far to remove some of those misaligned
incentives or other challenges that are created in the market
through the efforts that have been undertaken in the last 7 or
8 years?
Mr. Pollock. No, Congressman, I don't. As a matter of fact,
one of the biggest problems with FSOC's being even able to
think about systemic risk is it has to think about systemic
risk created by the government.
Mr. Hollingsworth. Right.
Mr. Pollock. If you want a body to think about the massive
systemic risk created by the government itself, you need a
different body than FSOC.
Mr. Hollingsworth. An independent body?
Mr. Pollock. Yes.
Mr. Hollingsworth. Something that would be able to look at
all the participants, not just the private participants and the
issues created there?
Mr. Pollock. Yes, I think so.
Mr. Hollingsworth. Yes.
And then the second thing I wanted to talk about a little
bit is some of the costs around this gray-area regulation. And
maybe this goes to Dr. Holtz-Eakin.
I used to deal with a lot of contractors. And I knew one
thing for sure, when I handed out a scope of work that was
incomplete or unclear in any way, I knew I was going to get a
wider bid because they would protect themselves. They wanted to
stay further away from the line. The more exact the rules of
the game were, the further they could go in getting to that
line.
And so it is not just the immediate costs of compliance,
but it is the cost of not knowing and wanting to stay further
back and wanting to curtail business activities that might or
might not be viewed by FSOC as problematic.
Can you talk a little bit about, in your view, how not only
the idea of FSOC being there, but the lack of clarity around it
is creating this gray area that companies are being forced to
operate in and how that might incur more costs than we even
know?
Mr. Holtz-Eakin. I think that is a real issue. One of the
things we do at the American Action Forum is we actually add up
the self-reported compliance costs that agencies put to
regulations. And so over the past 8 years, it was $800 billion.
That is what they estimate it to cost businesses to comply.
Mr. Hollingsworth. Yes.
Mr. Holtz-Eakin. And as you point out, that is the easy
part. You actually know what you have to do there, fill out
paperwork and things. It is the business decisions that are
affected that are the genuine economic costs, whether they are
capital expansions you don't undertake because you don't want
to grow and get too big and become a target, you don't hire,
whatever it may be, those are genuine losses. And once the
designations are made, you now have different firms being
treated differently in the same industry and you don't have a
single set of rules and you don't have a fair competition.
Mr. Hollingsworth. Yes. One of the big things that I have
consistently pushed is, by more and more regulation, especially
more and more regulation from a variety of regulators, we
continue to herd companies in the financial services sector
into one corner. We continue to push companies that do and have
the same portfolios and same exposures because that is what we
want them to have.
But we should be darn sure if we are doing that, that they
are the exposures we want them to have because systematic risk
is really about dominoes toppling over. And the more these
firms look like each other because regulators have forced them
to look like each other, the more easily issues migrate from
one firm to another.
So I would just like maybe you, Dr. Holtz-Eakin, and Mr.
Pollock, to comment on that.
Mr. Holtz-Eakin. It is a huge irony because the basic
lesson of finance is to diversify.
Mr. Hollingsworth. Correct.
Mr. Holtz-Eakin. And that is a very undiversified view of
the universe.
Mr. Hollingsworth. Yes.
Mr. Pollock?
Mr. Pollock. I think that is a great example of systemic
risk created by government regulation, Congressman. An
excellent example.
Mr. Hollingsworth. Right. And so my concern, again, is, as
we herd these into a corner, we are going to find that the risk
really comes from something we didn't expect, and then we have
perfectly lined up all the dominoes ensuring that one is
transmitted to the other, whether that is through mark to
market accounting because they all hold the same portfolio
securities, et cetera.
So thank you for your time this morning.
I yield back to the Chair.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the distinguished ranking member
of the subcommittee, Mr. Green, for 5 minutes.
Mr. Green. Thank you, Madam Chairwoman.
Let's start with Mr. Zaring. Mr. Zaring, let's talk about
this cost of compliance and juxtapose it to the cost of not
finding another AIG. Could you give us some intelligence on
this, please?
Mr. Zaring. The costs of compliance with financial
regulation to make financial institutions safe and sound are
real, but the benefits are much more real, in my view. And what
FSOC is doing with its limited designation so far is, in my
view, looking around at firms where, if there was a collapse,
their collapse would likely break down the rest of the
financial sector in potentially unpredictable ways, and making
sure that those institutions are adequately regulated.
It is hard to know just how much of a benefit an avoided
financial crisis is, but I think we can all presume that
benefit is extremely high, very large, and very difficult to
quantify.
Mr. Green. If FSOC, which is the economic disaster
prevention agency, had had the opportunity to examine AIG with
the cost-benefit analysis, would it be such that it would have
been beneficial to find out what AIG was doing and see it as
systemically important?
Mr. Zaring. One of the advantages of FSOC is that it brings
together every financial regulator in the government, including
the newly created Federal Insurance Office and an insurance
representative.
The ability of all of those regulators to take a look, not
just at some aspect of AIG, its thrift business or some other
financial activities in a particular place, but all aspects of
the business, make it more likely that the regulators would
have realized that AIG was writing credit default swaps in a
relatively unhedged manner.
And we don't know what would have happened. But we do know
that AIG was a business failure and was never scrutinized
holistically by regulators in the way that FSOC promises to do.
Mr. Green. You make a good point, and I would like for you
to elaborate on it for just a moment, because there is a
contention that there are other prudential regulators that
would find these flaws in the system.
But it didn't happen with AIG and it didn't happen with
Bear Stearns. It didn't happen with Countrywide. It didn't
happen with a whole host of financial industry entities. Would
you elaborate, please?
Mr. Zaring. That is right. And one of the things that a
designation is supposed to do is increase capital, which is one
way of making sure that these institutions are prepared for a
shock, even a shock that comes from somewhere surprising.
But for the AIG story, the idea that the Office of Thrift
Supervision in overseeing its, I think, New York's chartered
savings and loan, which was a very small part of what AIG did,
was supposed to catch what was going on in London is, I think,
naive.
But on the other hand, if you get a team of rivals and a
group of regulators together in a room, to the extent that they
are rivals, you make catching that kind of new and creative
financial businesses all the more likely.
Mr. Green. Let's talk about proprietary information. Does
that have something to do with releasing information with
reference to an evaluation?
Mr. Zaring. I don't think that the institutions that the
Council has considered and carefully considered would want all
of the information that they provide the Council in discussing
and indeed sometimes contesting their designations to be
released to the public and to their competitors and to the
financial marketplace, more generally.
Some of the things that FSOC does that some of the
witnesses here seem to believe are sort of secret are the kinds
of secrets that businesses want the government to keep. And I
think it is responsible for FSOC to keep those secrets for the
businesses they are reviewing.
Mr. Green. Speaking of keeping secrets, there is a desire
on behalf of some to have Congresspersons in the room when
these deliberations are taking place. Is that going to be
beneficial to secrecy, and how do you think that will impact
the process?
Mr. Zaring. No, I don't think agencies or businesses
benefit from having their deliberations, internal deliberations
before a decision is rendered, being open for nitpicking or
after the fact. It is, at worst, Monday-morning quarterbacking.
What you should do is evaluate the decision and expect that
decision to be carefully articulated.
Mr. Green. I yield back.
Chairwoman Wagner. The gentleman yields back.
The Chair now recognizes the gentleman from Florida, Mr.
Ross, for 5 minutes.
Mr. Ross. I thank the chairwoman.
Interesting, of the four non-bank financial institutions,
three, of course, were insurance companies and we have
discussed today through your testimony that although there may
not be that great at transparency and there might not be the
best, well, rules in place in order to assess the
vulnerability, there are experts. FSOC has experts.
And yet, in the assessment of the SIFI designations, there
are two experts, one a voting member in the insurance industry
or arena, and two a nonvoting member, both of whom were ignored
by the designations with regard to whether these insurance
companies should be considered a SIFI.
Now, Dr. Holtz-Eakin, was there any discussion in this
FSOC's determination as to whether these insurance companies
were not properly regulated by their State insurance
regulators?
Mr. Holtz-Eakin. No, they didn't take that adequately into
consideration.
Mr. Ross. And do we not have the best form of regulation,
by way of our State regulators, of any other system in the
world?
Mr. Holtz-Eakin. The insurance system has proven to be very
well-regulated and it is also true that these same institutions
are regulated in other countries where they do business. There
is an enormous amount of regulatory oversight already prior to
designation.
Mr. Ross. And I guess my point is, is this not, this action
by the FSOC of designating these three insurance companies, is
it not an indictment of the State-regulated base form of
insurance regulation that we have in this country?
Mr. Holtz-Eakin. It is a mystery to me what the Federal
Reserve believes it will know that a consolidated regulator in
New Jersey, for example, doesn't already know about the
operations in these insurance companies.
Mr. Ross. And wouldn't you say that if we are going to go
this route and allow for FSOC to ignore its experts and indict
a State-based system of insurance regulation that we are
essentially setting up possibly a two-tiered system, one of
which that once you are designated, you are going to have
increased regulation, and would that not impact the free market
of insurance sale?
Mr. Holtz-Eakin. I have mentioned this several times. I am
very worried about the fact that we are going to end up with an
uneven playing field in financial services markets if we
continue down this path.
Mr. Ross. And who is going to get hurt the most?
Mr. Holtz-Eakin. The consumer.
Mr. Ross. The consumers are. And so, has there ever been a
run on an insurance company in the history of the United
States?
Mr. Holtz-Eakin. No. One of the mysteries of this
designation has been ignoring the history of successful
regulation of insurance companies and also the use of scenarios
which are completely unrealistic for that insurance business.
Mr. Ross. Dr. Kupiec, risk-based capital is used to assess
the systemically important nature of an insurance company.
Would you agree that there is no reason to deviate from the
State-based system that we have today, where we have never seen
a run on an insurance company, where a whole different method
of assessment and analysis of your risk is used as opposed to
financial institutions?
Mr. Kupiec. I don't think insurance merits a SIFI
designation. I think AIG was a special case.
Mr. Ross. It was a special case. There wasn't even a
regulator then at the time.
Mr. Kupiec. And I think--
Mr. Ross. So let me ask you this, Dr. Kupiec, because you
hit on it with General Electric. Now, we have discussed also
the designation. And it is like going to the doctor, you are
sick, but we are not going to tell you why you are sick or how
you got sick or how you can get better, but we will let you
know when you are dead. It's the same way with SIFI
designation.
We tell you you are now designated, but we don't tell you
how to get off. Where is the exit ramp? And it appears to me
that the only exit ramp that we have been able to see in this
regard has been the total sell-off like they did with G.E.
Capital. Is that a fundamentally good method of having an off-
ramp, not only for the business, but also the consumer?
Mr. Kupiec. No, I think if you think about my analogy, you
are a well-run, growing company, this becomes a penalty for
well-run, growing companies, that you might become the object
of an FSOC stage-three review. You have no idea why. You get
good marks from all your--
Mr. Ross. You get no answers. You don't know why you are
there, but you know that you are being investigated and you
have an obligation to your shareholders as well as your
consumers. And so what you do? You divest yourself from that
particular operation. That is the off-ramp.
Mr. Kupiec. One firm did that. Whether the insurance
companies, which are--G.E. Capital was part of G.E., which has
non-financial parts to it. Whether an insurance company can
actually divest its way out of this is maybe a bridge too far.
Mr. Ross. At least one went to court and was successful.
And I think one insurance company went to court and was
successful, MetLife. And I think that what we have to do is we
have to be able to allow for not only the review, but also the
ability to be de-designated, the ability to have the off-ramp.
And I see my time is up, so I yield back.
Chairwoman Wagner. The gentleman yields back.
I would like to thank our witnesses again for their
testimony today.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned.
[Whereupon, at 11:40 a.m., the hearing was adjourned.]
A P P E N D I X
March 28, 2017
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