Financial overregulation wasted the last eight years

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The eight-year experiment imposing prudential bank regulation on non-bank financial companies has apparently ended — for now.

None of the four non-bank companies originally designated as systemically important financial institutions (SIFIs) between July 2013 and December 2014 are still SIFIs. The designations of GECC, AIG and Prudential were all eventually rescinded, and MetLife successfully challenged its designation in federal court.

{mosads}The SIFI designation idea was ill-founded, and the process, in the view of at least one federal judge, was flawed. The Financial Stability Oversight Council (FSOC) essentially wasted eight years examining the financial entrails of four large companies in the hope of finding an anecdote for global financial crises.

The designation of four non-bank financial companies could never have achieved that goal, and the time could have been spent creating and deploying more effective global regulatory mechanisms and integrated regulatory responses.

In 2010, when a shell-shocked Congress decided to extend pervasive prudential regulation to SIFIs, it was a radical departure from precedent. Rarely had such pervasive regulation ever been imposed on companies that did not enjoy federal deposit insurance or some other form of an express or implicit government guarantee.

Yet, there was little if any analysis of this shift in direction, its unintended consequences or the economic costs. Moreover, an unusual vehicle was chosen to execute the idea. The President’s Working Group on Financial Markets established by President Reagan in response to the ‘‘Black Monday’’ stock market crash of Oct. 19, 1987 was effectively rebranded as FSOC.

The assumption that bank-like prudential regulation of non-bank financial companies would somehow lessen or prevent future financial meltdowns was just that — an assumption. Prudential regulation has certainly never prevented widespread bank failures when the economy turned sour.

No study of the benefits or economic costs of prudential regulation of non-banks was ever conducted, and no one considered how regular meetings of nine financial regulators would make them more effective collectively than they were individually.  

The designation process seemed scripted from the beginning, with some SIFIs actually being designated before the Federal Reserve ever proposed rules describing how they would be regulated.

How could FSOC reasonably have concluded on the record that prudential regulation of non-banks would make the system safer when it did not know what that regulation would look like and what it would cost? This lack of intellectual curiosity seemed to be of great concern to the judge who invalidated the MetLife designation.

The real damage over these last eight years has been the loss of an opportunity to build a better mousetrap. The long, drawn-out process of designating individual companies as SIFIs distracted policymakers from focusing on improvements that could actually have made a difference.

For example, if the Dodd-Frank Act really put the “too-big-to-fail” era behind us, we should expect the U.S. government to seize, restructure and dispose of global financial companies under Title II of Dodd-Frank in the next crisis. But that never has been done, and just how it would happen is not at all clear.

U.S. regulators have executed cooperation agreements with Canada, the U.K., the Cayman Islands and the EU, but they are little more than frail expressions of a willingness to cooperate with each other in the future to enhance communication and the planning of orderly resolutions consistent with the laws of each country.

That last phrase is indeed telling. No one should reasonably expect that other countries will simply defer to the Federal Deposit Insurance Corporation. Those countries will protect their economic interests just as the U.S. would: by trying to take control of the assets that they can reach for the benefit of their creditors.

{mossecondads}Now that the FSOC misadventure is back to square one, the resources of the nine FSOC agencies and those of other countries around the world should be directed at deploying human and artificial intelligence to create economic early warning systems that will actually help governments prepare for and address disasters — be they financial or technological — before they happen.

Agreements should be forged with other nations that above all else, guarantee economic stability. There have always been too-big-to-fail institutions, and there always will. Creating policies preoccupied with negating that fact is not realistic and wastes valuable resources.

Scientists know when a tsunami is approaching, and social media companies know what users are thinking, but we still seem to be largely in the dark when it comes to seeing the signs of impending financial disasters. If the FSOC can approximate those results in the financial world, it still can claim to be a success.

Thomas Vartanian is the founder and executive director of and professor of law at the Financial Regulation & Technology Institute at the Antonin Scalia Law School at George Mason University. 

Tags Bank regulation Dodd–Frank Wall Street Reform and Consumer Protection Act economy Finance Financial regulation Financial Stability Oversight Council Money Non-bank financial institution Prudential regulation Systemic risk Systemically important financial institution Too Big to Fail

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