There’s a new sheriff of Wall Street in town, with the power
to overrule the Treasury Department, Federal Reserve, and all the other banking
regulators. She can determine to impose or withdraw oversight of financial
institutions, and analyze whether financial regulations make sense for the overall
The only problem is that nobody elected her or charged her with that duty.
Our new super-regulator is named Rosemary Collyer. She’s a George W. Bush-appointed federal district court judge in Washington, D.C. Last week she announced that insurance giant MetLife should not be subject to enhanced supervision and larger capital requirements imposed by the Financial Stability Oversight Council (FSOC), a group of regulators tasked under Dodd-Frank with monitoring the overall financial system. MetLife sued to overturn FSOC’s ruling designating it a systemically important financial institution (SIFI) and subjecting it to stronger regulations along with three other non-bank institutions (AIG, Prudential, and GE Capital). All of those designations are now threatened by Judge Collyer’s MetLife opinion, as this opens them up to legal challenge.
Collyer didn’t release her reasoning for why MetLife should be let off the hook until yesterday. The opinion reveals a textbook example of judicial activism, with a federal magistrate inserting her judgment in place of the entire U.S. financial regulatory apparatus. But it also reveals a weakness of laws like Dodd-Frank, which relinquish discretion to regulators to set the rules rather than defining them rigidly. This inherently subjective approach always falls victim to conflicting opinions, and the resulting chaos can open our economic system to unnecessary risk.
In her 33-page opinion, Judge Collyer states that when FSOC designated MetLife as systemically important, it “focused exclusively on the presumed benefits of its designation and ignored the attendant costs” to MetLife. But FSOC was not statutorily required to perform a cost-benefit analysis. Their role is to determine which financial institutions present a risk to the financial stability of the United States, not whether that creates costs that outweigh benefits.
The very good reason for why you wouldn’t want a systemic risk regulator to do a cost-benefit analysis is that it’s impossible to carry out accurately. The financial industry is constantly evolving, adjusting to how both regulations and changes in the market impact their business. Any cost-benefit analysis would be only a snapshot in time, and obsolete the moment it was printed.
And while carrying the imprimatur of objectivity, cost-benefit analyses of financial regulations cannot help but be subjective. Would the analysis of MetLife’s SIFI regulation include reducing risks to MetLife policyholders, for example? If MetLife faces financial distress and cannot pay its claims, losses would flow to its “counter-parties,” those entities on the other side of their transactions. Counter-party risk was a primary reason why FSOC determined that MetLife threatened financial stability. If the costs and benefits are confined to MetLife, however, that counter-party benefit would be nullified.
Judge Collyer cited a 2015 Supreme Court opinion, Michigan v. EPA, saying that omitting of consideration of the costs made the FSOC designation “arbitrary and capricious.” But consider this: Industry-friendly types in Congress are working right now to subject all financial regulation to a cost-benefit standard. Why would they feel the need to do that if, as Judge Collyer seems to believe, regulations must inherently involve a cost-benefit analysis, even ones that didn’t require it in the statute?
The other argument Collyer offers is that FSOC needed to show whether MetLife had a likelihood of financial distress before determining whether that distress would spread throughout the financial system. This would require a deep analysis into risks at MetLife, which the company itself might not even have a handle on. “That clairvoyant quantification duty would require FSOC to have a crystal ball,” said Dennis Kelleher, CEO of the reform group Better Markets, in a statement. Judge Collyer claims FSOC committed to making this determination in its initial guidance to MetLife. FSOC denies it.
FSOC’s fundamental task is not to prevent financial institution failures, but to stop them from spreading through the economy. An analysis of AIG before the financial crisis might not have picked up on the vulnerabilities of its securities lending business or its credit default swaps on mortgage-backed securities. But it certainly would have recognized the massive list of counter-party exposure—the other side of all those trades—and how failure at AIG would have a ripple effect. This was what FSOC was built to monitor.
Judge Collyer, by contrast, isn’t a bank regulator, and it shows in her analysis. She complains that “every possible effect of MetLife’s imminent insolvency was deemed grave enough to damage the economy.” But that’s precisely what good regulators should do: subject firms to adverse scenarios to determine risk. Collyer’s judicial review function looks more like a regulatory one, and it’s unclear why we should substitute her judgment in place of FSOC’s.
The government is appealing the case, and may win that next round. But whatever the outcome, this kind of subjective meddling was predictable. Dodd-Frank was less a law than a promise to have a collection of regulators write a law later through the rule-making process. Congress guided that future rule-making, but imposed few specifics; they didn’t write rules directly into the statute. As Judge Collyer says in her opinion, “the phrase ‘could pose a threat to the financial stability of the United States,’”—the key FSOC determinant of whether to designate a financial institution a SIFI—“is open to numerous interpretations.” Without statutory guidelines, those interpretations can be challenged, and now they are.
During the Dodd-Frank debate, Senator Ted Kaufman, the Delaware Democrat, warned about Congress being too vague. “If Congress fails to draw hard lines that deliver on real systemic reforms, regulators cannot be counted upon to do what is needed,” Kaufman said. “We must create a system, as the saying goes, of laws and not of men. … We must provide these agencies with the statutory clarity and the bright lines they need to enforce the law.”
Absent those hard lines, big banks have leeway to use the rule-writing process to upend Congress’ intent. They can find friendly judges like Collyer, who fashion themselves market regulators, to overturn things they don’t like. They can lobby and sue and use whatever means at their disposal to make sure the passage of Dodd-Frank didn’t end the ballgame.
It was a mistake to allow this, and the MetLife fiasco is only one example why. Incidentally, Bernie Sanders’s legislation to break up the banks, which relies on the Secretary of the Treasury making a similar determination on which banks pose a threat to financial stability, would suffer from the same problem.
One alternative would be a “size cap,” barring all financial institutions from holding more than a threshold level of assets on their balance sheet. That “big dumb rule,” to borrow a term from Felix Salmon, is far less open to interpretation and well within Congress’ authority. Instead, Dodd-Frank opted for a technocratic approach, which by its nature creates legal uncertainty.
You can draw hard lines in the law, or you can rely on regulatory discretion. The former is better able to withstand an industry onslaught; the latter leaves you at the whims of people like Judge Rosemary Collyer.