Financial firms face new clampdown

Federal regulators voted Monday to propose new restrictions on nonbank financial companies whose demise could threaten the economy.

Led by Treasury Secretary Jack Lew, the 10-member Financial Stability Oversight Council  (FSOC) voted during a closed meeting to move forward with plans to designate “an initial set” of undisclosed firms, Treasury spokeswoman Suzanne Elio said.

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“Today, the Council took another important step forward by exercising one of its principal authorities to protect taxpayers, reduce risk in the financial system, and promote financial stability,” Lew, the panel’s chairman, said in a written statement.

Under the proposed designation, firms labeled as “systemically important” would be subject to increased new regulations imposed by the Federal Reserve, which traditionally supervises banks.

However, critics of the move say it would only serve to imperil the economy further.

House Financial Services Committee Chairman Jeb Hensarling quickly derided the vote, saying the designation was tantamount to labeling the nonbank firms as “too big to fail” and would set taxpayers up for another bailout.

“It causes erosion of market discipline. It also becomes a self-fulfilling prophecy by giving these firms market advantages over their competitors, helping to make them even bigger and riskier than they otherwise would be,” the Texas Republican said. “Unfortunately, Dodd-Frank codifies bailouts of ‘too big to fail’ firms into law.”

The FSOC declined to identify the firms, because the designations have not been finalized. However, in separate statements issued late Monday, American International Group (AIG) and Prudential confirmed that the council had proposed their designation. GE Capital had also been under consideration, though it was not immediately clear whether that firm had been included.

The long-anticipated action is among the boldest moves to date by the FSOC, which was created by the Dodd-Frank Wall Street reform bill in the aftermath of the 2008 economic crisis.

It is a step toward clamping down on the “shadow banking” world, which was virtually unregulated before the crisis, said Dennis Kelleher, president of Better Markets, a nonprofit group that promotes the public interest in the financial markets.

“Banks and nonbanks have to be regulated, or else we’re going to have another crash,” he said.

Framers of Dodd-Frank, concluding that distressed nonbank financial companies contributed to the crisis, empowered the FSOC to place certain firms under the Fed’s supervision.

The Council’s authority to designate nonbanks is seen by regulators as a key tool to unlock tougher standards in the financial services world, according to a source familiar with the process.

Nonbanks would likely be subject to new stress tests to monitor their stability, be required to keep larger capital reserves and draw up “living wills,” providing for how they would be dismantled in the event of failure.

The designations would also reflect an important shift sought by Dodd-Frank — regulations based on risk, rather than by the kind of charter an institution has, the source said.

Designations require a two-third’s vote and a sign-off from Lew, as chairman. Other voting members of the interagency panel include Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chairwoman Mary Jo White and other top regulators.

The Council has weighed the first round of potential designations since its inception almost three years ago.  

“It is a mystery that the American people have to wait so long to be protected from the high-risk activities of Wall Street, Kelleher said.

During a Senate Banking Committee hearing last month, Lew said the panel was conducting a “very orderly review” of those firms being considered, and that they would all be judged against the same standard: whether “material distress in those institutions is a threat” to U.S. financial stability.

Prudential Financial spokesman Bob DeFillippo said the company had been in “constant communications” with the Council and said any additional regulations must take into account the differences between an insurance company and a bank.

In his Senate testimony, Lew acknowledged concerns over whether regulators’  “tools are perfectly fitting for nonbanks.”

“I think that’s an issue that they will look at it and we will look at if designations are made,” he said on May 21.

Companies informed of a proposed designation have 30 days to request a hearing to contest the action, if they so choose. The Council then would have 30 days to conduct the hearing and an additional 60 days to make a final determination.

The firms could also choose to file a lawsuit challenging the designation.

“We are prepared for whatever decision is reached by FSOC,” GE Capital spokesman Russell Wilkerson said early Monday.