The Treasury Department recently released a new report endorsing numerous regulatory reforms for U.S. asset managers and insurance companies and is about to release another report next week assessing the Financial Stability Oversight Council, an unaccountable regulatory body created in 2010 by the Dodd-Frank Act.
During the past seven years, FSOC has threatened to use its sweeping powers to subject asset managers and insurers to cumbersome, inappropriate bank-style regulation by the Federal Reserve, whose leadership lobbied for and embraced these nonbank regulatory powers. Treasury’s recent report endorses some policies that will undo the damage of this regulatory framework, but it can do much more. Fortunately, the upcoming Treasury report on FSOC and the pending ascension of a new Fed chair provide perfect opportunities to abandon Dodd-Frank-inspired regulatory hubris and begin improving economic growth and financial access.
In the FSOC report, Treasury must respond to an April 2017 presidential memorandum calling upon Treasury Secretary Steven Mnuchin to critique FSOC’s processes for designating nonbanks (and some of their practices) as “systemically important.” Designation initiates duplicative Fed regulation even if the company is not a bank and banklike rules are not appropriate to the firm. Unlike a bank, a mutual fund makes no loans and has virtually no leverage. Likewise, an insurance company’s business model is entirely different than that of a bank.
Designations purport to protect the U.S. economy through ensuring the proper oversight of very large nonbank financial firms. Instead, past designation decisions have caused serious economic harm through the anti-competitive too-big-to-fail status that designations implicitly confer. Decreased competition and increased compliance burdens that designations bring about ultimately mean higher prices and reduced choice for basic nonbank financial products like annuities and life insurance. (Our companies currently serve financial firms that have been affected or could be affected by FSOC’s use of its designation powers.)
Accordingly, the president’s April memorandum asked Treasury to examine whether FSOC’s processes “adequately consider the costs” of designation and align with his January executive order, which calls for ending taxpayer-funded bailouts and expanding financial choices for consumers. Treasury’s response to the president must be “no and no.”
To advance the president’s objectives, Treasury’s upcoming FSOC report should endorse House legislation that ends FSOC’s designation powers. Until Congress repeals this authority, Treasury’s FSOC report must build upon its recent report to reject firm-specific designations and call for a requirement that FSOC justify all of its regulatory activities with rigorous, quantified assessments of potential economic consequences. For too long, FSOC has skirted regulatory best practices embraced by Democrat and Republican presidents alike since Carter and Reagan to transparently consider costs and benefits of proposed designations, which was certainly a motivation behind the president’s FSOC memorandum.
Successfully achieving these reforms, however, also necessitates a course correction at the Fed. Under its past two chairs, the Fed — traditionally a banking regulator — embraced its expanded powers and asserted that its new regulatory authority over nonbanks is critical to market stability. Indeed, in a recent speech to fellow central bankers, Chair Janet Yellen claimed not only that the Fed’s actions saved us from the 2008 crisis, but also that its post-crisis powers are essential to mitigating the risk of future market downfalls. In her mind, the 2008 crisis was driven by securitization, money market funds, the “madness of crowds” and other market developments. Left out of the story was the Fed’s low pre-crisis interest rates, which fueled the subprime mortgage market bubble. She also failed to mention Fed regulations that drove banks to hold toxic mortgage-backed securities.
Chair Yellen’s remarks underscore the common driver behind the Fed’s expansion into nonbank regulation and FSOC’s sweeping powers: regulatory hubris. FSOC was built upon the false premise that a huddled group of bureaucrats can identify bubbles and prevent financial crises. Likewise, the Fed’s expansion into nonbank regulation is justified by a misguided notion that the Fed’s “experts” are well-equipped to monitor and halt risks in all types of financial markets. Yet in pursuit of broad regulatory powers, FSOC and the Fed abandoned good government basics, such as thorough ex ante analyses of regulatory decisions, monetary policy stability and the rule of law. Hopefully, Treasury’s upcoming FSOC report and new leadership at the Fed will set forth a regulatory vision grounded in reality, and by doing so, foster the regulatory stability and market discipline essential for economic growth.