In the aftermath of the financial crisis of 2007-2009, the U.S. Congress created the Financial Stability Oversight Council (FSOC – pronounced “F-Sock”)—a panel of the heads of the U.S. regulatory agencies—“to identify risks to the financial stability of the United States”; “to promote market discipline” by eliminating expectations of government bailouts; and “to respond to emerging threats” to financial stability.

Despite these complex and critical objectives, the law limited FSOC’s authority to the designation of: (1) specific nonbanks as systemically important financial intermediaries (SIFIs), and; (2) critical payments, clearance and settlement firms as financial market utilities (FMUs). Nonbank SIFIs are then supervised by the Federal Reserve, which imposes stricter scrutiny on them (as it does for large banks), while FMUs are jointly overseen by the Fed and the relevant market regulators.

At the peak of its activity in 2013-14, the FSOC designated four nonbanks as SIFIs: AIG, GE Capital, MetLife, and Prudential Insurance. Following the Council’s October 16 rescission of the Prudential designation, there are no longer any nonbank SIFIs. Not only that, but by making a future designation highly unlikely, Treasury and FSOC have undermined the deterrence effect of the FSOC’s SIFI authority. In short, by taking the sock out of FSOC, recent actions seriously weaken the post-crisis apparatus for securing U.S. (and global) financial stability. In the remainder of this post we review the Treasury’s revised approach to SIFI designation in the context of the Prudential rescission….

FSOC and Systemic Risk: Treasury's Report

In response to the financial crisis of 2007-2009, Congress created the Financial Stability Oversight Council (FSOC), a committee of the chiefs of the U.S. regulatory agencies, chaired by the Treasury Secretary, to monitor and secure the stability of the financial system. Critical to this task is the FSOC’s authority to designate nonbanks as “systemically important financial institutions” (SIFIs).

On November 17, the U.S. Treasury issued a report assessing the FSOC’s designation process. Treasury calls on the FSOC to adopt a strategy that prioritizes the regulation of activities or functions—affecting whole sectors of the financial industry—over regulation based on entity or legal form (such as the designation authority). For the most part, we find this sensible, as this focus reduces the scope for regulatory arbitrage that an entities-only approach may foster (see here).

However, we doubt that activities-based regulation alone will be sufficient to limit systemic risk. Our overall conclusion is that the Treasury’s approach sets the bar for FSOC designation too high, diminishing its deterrence effect on undesignated nonbanks. In the end, a sensible focus on both entities and activities is needed to fulfill one of FSOC’s key objectives—to restore market discipline. Adopting the Treasury’s proposed framework will not meet the goal, set out in the President’s Core Principles for Regulating the U.S. Financial system (see Executive Order 13772), of preventing taxpayer-funded bailouts....

Fire, fury and the national debt limit

During the 2016 campaign, then-candidate Donald Trump discussed his broad experience with debt. He would bring the skills and sensibilities of a real estate mogul to government debt management, and the result would be a better deal for the American public. He even broached the idea of renegotiating the obligations of the U.S. Treasury.

Well, the day of reckoning has arrived. The Treasury has announced that by the end of September, it will face a shortfall. Without the authority to issue additional debt, the government will not be able to pay all of its bills—including the interest on the outstanding debt. In response, President Trump has threatened the Congress: either fund the wall along the Mexican border, or he will shut down the government.

If the U.S. government fails to meet its obligations for any significant period, we will all be big losers. A government that cares about the people—both now and in the future—would never willingly inflict such a wound.

The Treasury's Missed Opportunity

Last week, the U.S. Treasury published the first of four reports designed to implement the seven core principles for regulating the U.S. financial system announced in President Trump’s Executive Order 13772 (February 3, 2017).

Seven years after the passage of Dodd-Frank, it’s entirely appropriate to take stock of the changes it wrought, whether they have been effective, and whether in certain cases they went too far or in others not far enough. President Trump’s stated principles provide an attractive basis for making the financial system both more cost-effective and safer. And much of the Treasury report focuses on welcome proposals to reduce the unwarranted compliance burden imposed by a range of regulations and supervisory actions on small and medium-sized depositories that—if adequately capitalized—pose no threat to the financial system. We hope these will be viewed universally as “motherhood and apple pie.”

Unfortunately, at least when considering the largest banks, our conclusion is that adopting the Treasury’s recommendations would sacrifice resilience to achieve cost reductions, yet with little prospect for boosting economic growth. Put simply, implementation of the Treasury plan would reduce regulation of the most systemic intermediaries, and in so doing, unacceptably reduce the resilience of the U.S. financial system....

Donald Trump, Treasury Debt and the Dollar

The time has come to start weighing in on presidential candidate Donald Trump’s statements on economic policy. Today, we examine his comments about U.S. government debt. After saying that he is the “king of debt” and that he “loves debt,” Mr. Trump recently went on suggest that if interest rates were to rise, he would seek to “make a deal” on U.S. Treasury debt. In his words, “I could see long-term renegotiations where we borrow long term at very low rates.” He also called this action: “refinance debt with longer term.”

Mr. Trump appears to assume that his sensibilities as real estate mogul and dealmaker can be directly applied to government debt management policy. They cannot. Treasury securities bear absolutely no resemblance to the debt issued by Trump Entertainment Resorts, which went bankrupt in 1991, 2004, 2009, and 2014...

Commentary

Money, Banking, and Financial Markets