[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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