Mike & Co. —
Here at the end of a quiet recess, the dust is still settling following the D.C. Federal District Court ruling against the FSOC on Wednesday in the MetLife case, with regulators and businesses speculating about the case’s ultimate disposition, scope, and the implications for TBTF designations going forward.
From a systemic risk perspective, does the MetLife ruling suggest that the prophylactic approach to TBTF of Dodd-Frank might not be workable? Or it is a narrow and provisional decision that will enable the FSOC to refine its designation process and take account of differences among the biggest non-bank financials?
More on MetLife and TBTF below. Next week, updates on the fiduciary rule, Puerto Rico, and relevant legislative activity as Congress returns — or on your suggestion regarding issues to cover.
Good weekends all,
For now, we await the April 6 deadline that District Court Judge Rosemary Collyer imposed on FSOC and MetLife to determine what parts, if any, of her full 23-page opinion will be released to the public. (Presumably, the full text contains references to confidential financial or businesses information which MetLife would prefer stay secret and thus may be redacted.)
Some conclusions can be drawn from the two-page summary decision provided by the Court, however. We know that Collyer ruled in MetLife’s favor, specifically funding that FSOC’s designation of MetLife was arbitrary and capricious and violated the Dodd-Frank Act, FSOC’s own regulations, and the APA because:
- FSOC failed to assess MetLife’s vulnerability to material financial distress
- It depended upon unsubstantiated, indefinite assumptions and speculation that failed to satisfy the statutory standards for designation and FSOC’s own interpretive guidance
- It failed to perform a cost/benefit analysis to consider the economic effects of designation on MetLife
The ruling hints what could be a sea change in the manner that regulators designate financial institutions as “systemically important.” Going forward, regulators may need to conduct “practice regulation” — based on an analysis of the firm’s business lines and the riskiness of its business practices.
The Appeals Process
A ruling that at least partially strikes down the FSOC SIFI designation process presents an early and almost existential threat to the Council, created for the express purpose of making such determinations. It’s clear that the Council will appeal this decision to the D.C. Court of Appeals. The timeline for such an appeal is not known. Most likely, the case will be eventually heard by a panel of three judges from among the eight (normally nine) on the Circuit.
Already, GE has filed a request with the FSOC that its designation as a nonbank SIFI be rescinded, citing the major downsizing of its US-based activities from $542 billion consolidated assets in 2012 to $265 billion today. As a result, it says, it is “smaller, simpler and less interconnected with the US financial system,” and “does not pose any conceivable threat to US financial stability.”
Attacks on Dodd-Frank; But it’s Working
There’s no word yet from Prudential or AIG, the other two insurance non-banks designated SIFIs and on whether or how they intend to challenge their classification. The institutions had a 30-day window to challenge FSOC’s ruling in court but decided instead to reorganize – if they choose to take FSOC to court now they will need to take a different route than MetLife did.
If MetLife had not filed this lawsuit, GE Capital would not have been cut nearly in half and the share price of not only MetLife but Prudential and AIG would not have risen sharply on yesterday’s news if Dodd-Frank’s impact on putatively Too Big to Fail firms were as illusory as its critics sometimes charge.
Both markets and businesses take DFA very seriously – the proof in this case lies in yesterday’s events, but evidence has stacked up in favor of the Act’s provisions for years now. While FSOC may have one of the lowest standards for declaring a business “systemically important,” the process need to be defended on the grounds that the size of an institution is at least equally important compared to its inherent risk.
There exists a dissonance between the popular view of the effectiveness of DFA and the evidence of its affects.
Some commenters are viewing the events of the week as a major step backward for regulators, but there is another way to view both Wednesday’s ruling and GE’s actions on Thursday. In the first instance, there is some credence to the idea that MetLife’s activities are safer than those of investment banks and other “traditional” SIFIs, and that Collyer’s decision will only result in a rethink of the process that FSOC uses to designate nonbank SIFIs. Secondly, GE’s request that its SIFI designation be rescinded is proof of the effectiveness of regulation – the reasoning behind GE’s request is that it has shed its most risky assets and simplified its portfolio. The first is an evolutionary step toward better and clearer regulations while the second is proof positive that DFA has continued to make steady progress toward a safer and more stable financial industry.
None of this is to say that FSOC should not consider the relative size of a firm when making its SIFI ruling, but perhaps an analysis that is less monolithic and more nuanced is the way forward. In this caseWednesday’s decision is an opportunity for the Council to seize. As for commenters calling this the end of an era – Collyer’s ruling was almost certainly provisional, narrow in scope and size, and has more to do with MetLife itself than the concept of regulating large firms. If the result of the ruling is that FSOC makes more detailed and thorough analyses during its nonbank SIFI designation proceedings, then chalk it up to a win for the economy, not a loss for the administration.
At first glance, it appears that DFA and TBTF initiatives took a hit this past week. However, upon closer examination, a few key ideas emerge.
1) The ruling is preliminary. As noted above, there is almost definitely going to be an appeal to the district court’s decision. Moreover, we have yet to hear from other major insurance firms on the issue. It is too soon to attribute anything overly meaningful to it.
2) It doesn’t contradict the facts. Dodd-Frank is doing precisely what is supposed to do in ending TFTB, just at a gradual pace. One of the most telling indicators of this: bond spreads and those tell us that the largest banks are shrinking. An Oliver Wyman study of financial firms in 2009 and the years following. Its findings are significant — in 2009, globally significant banks (GSIBs) had a bond spread advantage of 137 bps, that fell to 57 bps in 2011, and became statistically insignificant in 2013. It suggests that policy changes to reduce the TBTF premium have been enormously successful.
The borrowing cost advantage enjoyed by large firms, the so called TBTF premium or subsidy has decreased dramatically, but commenters and politicians are still heard to claim that Dodd-Frank codifies TBTF by designating members of the TBTF club — or that it hasn’t done enough to quash them.
One last note — there has been a popular misapprehension fostered by Republicans that DFA enshrines TBTF in a negative way, but the reality is the opposite. Why else would the stock prices MetLife, AIG, and Prudential all leap at the prospect of de-listing, as they did Wednesday? This viewpoint also discounts DFA’s well-documented quantifiable and effective impact.