Lawmakers press financial regulators on systemic importance designation

For FSOC, designation of systemic importance for banks is clear-cut, since Dodd-Frank stipulates that any bank with over $50 billion in assets qualifies. However, for non-bank financial institutions such as hedge funds and insurance companies, regulators need to make the designations themselves. The Dodd-Frank law merely lays out suggested criteria for that designation, including the firm’s size and interconnectedness to other parts of the financial system.

The FSOC proposed a rule in January for how it would designate non-bank firms, but lawmakers argued Thursday that all it did was rehash the suggestions already laid out in Dodd-Frank.

Rep. Randy Neugebauer (R-Texas), chairman of the oversight subpanel of the House Financial Services Committee, accused the FSOC of hiding documents about how it would make the designation.

“That’s not transparency to me,” he said.

He was joined in that critique by the panel’s ranking member, Rep. Michael Capuano (D-Mass.), who said the FSOC’s current approach is “not transparent by any fair definition of the term.”

“We’ve never regulated some of the people we’re about to regulate, I think it’s only fair to give them an opportunity to respond,” he added.

While members of both parties criticized regulators, a partisan rift remained over whether financial firms stood to gain or lose from being designated as systemically important.

Going back to the debate as Dodd-Frank was being drafted, Republicans have argued that if a company is named systemically significant, they stand to gain. Such a designation would indicate to the market that the firm has implicit government backing as “too big to fail,” which would grant them an inherent advantage over competitors, the GOP has argued.

“The moral hazard implications of the designations of this power, I think, can’t be overstated,” said committee Chairman Spencer Bachus (R-Ala.) at the hearing. “The stamp of systemically important will be interpreted by many market participants as the designation of too big to fail.”

However, Democrats, in particular ranking member Rep. Barney Frank (D-Mass.), swung back, saying no firm believes it stands to gain from that designation.

“It is seen as more of a burden than a license by the institutions,” said Frank.

Frank went so far as to poll the seven regulators testifying on how financial firms have lobbied the FSOC on the issue. All but one official said firms had lobbied not to be designated, and none of them said they have heard from firms pushing to be designated.

“This supposed advantage of being too big to fail doesn’t exist,” he said. “That pretty conclusively answers this question.”

The hearing also played host to some internal FSOC dissent as one of the witnesses criticized the council for limiting input from insurance experts.

Missouri insurance commissioner John Huff, who serves as an FSOC member, critiqued the council for weighing issues affecting the insurance industry as two of three seats reserved for insurance experts are unfilled. Another insurance expert will join the FSOC in June.

He also complained that the FSOC was not allowing him to consult with other state insurance regulators in the course of his work, saying the Treasury Department has taken a “very narrow and … incorrect” view.

“It contradicts logic and reason,” he added.

Both Neugebauer and Frank backed Huff in his claim, saying the Treasury, which chairs the FSOC, should take a more flexible view on the matter.

“Please err on the side of inclusion,” Frank said. “Let’s not get too bureaucratic.”