DEEPENING THEIR EXPERTISE

By Kevin P. Hennosy

Financial oversight; the very mention of the term will brighten any party. Amaze your friends and be the envy of your neighborhood when you demonstrate your knowledge of financial oversight of nonbank institutions!

Okay. This must stop. If we go much further down that path, we will be treading on literary territory best left for Monty Python’s Flying Circus, which would not be an entirely unacceptable trip; however, the Pythons and the British Broadcasting Corporation (BBC) retain American law firms to police potential copyright infringement.

So, rather than dusting off all those old court decisions defining “The Fair Use Doctrine,” let us move on to the boring stuff.

The drone

The banker and former Secretary of the Treasury Timothy Geithner—no one’s idea of a “radical lefty”—provided the following advice to those interested in the financial sector:

There is a basic lesson on financial crises that governments tend to wait too long, underestimate the risks, want to do too little. And it ultimately gets away from them, and they end up spending more money, causing much more damage to the economy.

One influential U.S. senator takes those words to heart.

Senator Sherrod Brown (D-Ohio), chair of the Banking Committee is employing his oversight powers to encourage and support the Treasury Department in providing a backstop for the regulators of “Wall Street,” otherwise known as financial institutions.

Senator Brown, who stands for re-election this year, increasingly looks and sounds like “Senate Lions” of yore, such as Robert Marion “Fighting Bob” La Follette Sr. (June 14, 1855 – June 18, 1925). La Follette famously observed: “Men must be aggressive for what is right if government is to be saved from men who are aggressive for what is wrong.”

Senator Brown is aggressive, and he uses a tone and tenor of an earlier era. Brown’s style is not one endorsed by many political consultants in the Age of Small Screen Campaigns. Who cares?

On February 8, 2024, Senator Brown opened a hearing entitled “The Financial Stability Oversight Council (FSOC) Annual Report to Congress” with a reminder of why Congress created the council in the Treasury Department.

“[The FSOC] plays a critical role in stopping the next AIG from blowing a hole in our economy,” observed Senator Brown. The Buckeye State U.S. Senator continued to describe a dystopian hellscape of job losses, credit crunches, and foreclosures.

“A mess that started in New York board rooms with big, barely supervised Wall Street companies then spread to neighborhoods around the country, swallowing up Americans’ jobs and homes and livelihoods,” said Senator Brown.

To add insult to injury, mistakes by executives rarely cause the financial failures that shock the American economy. Postmortems on failed financial institutions usually find that executives did exactly what they were hired to do on behalf of the shareholders. “That’s what financial fiascoes boil down to: The Wall Street system encourages bad decisions—and leads to an economy of excess for executives and a shrinking middle class,” charged Senator Brown.

Following financial failures, Congress and state legislatures create regulatory frameworks to police various lines of the financial sector. Yet, as soon as officials construct one regulatory framework the financiers find nooks and crannies between the structures to fill with money and risk.

Senator Brown explained, “Right now, nonbank financial companies–hedge funds, private equity firms, insurance companies, clearinghouses–hold nearly 20 trillion dollars in assets.”

This is why the senator places great importance on the role of the FSOC. “When Wall Street tries to shapeshift to evade the watchdogs we depend on, FSOC must be there to take action to protect our economy,” Brown said.

The FSOC plays the role of a drone flying over the parochial jurisdictions, looking for systemic risk. “These are risks we’ve talked about on this Committee before—risks like digital assets, cybercrime, the changing climate, and artificial intelligence—as well as the old risks that are as present as ever, like shadow banks,” said Senator Brown.

And, the senator continued, “FSOC makes Wall Street nervous—nervous that FSOC could bring oversight and accountability to parts of Wall Street that wouldn’t otherwise get [oversight].”

This is not to say that the chairman of the Senate Banking Committee assumes that every financial institution is a coven for the practice of Dark Arts. He simply wants the power of the financial services sector to serve the interests of the largest possible population. Senator Brown told Treasury Secretary Janet Yellen at the February 8 hearing, “We need an economy where hard work—not financial speculation—pays off.”

What seems to get under Senator Brown’s skin is perpetual resistance to regulatory compliance. The financial sector’s resistance to public oversight means that implementation of regulatory policy is open-ended. “Of course, it’s not a surprise that Wall Street and its well-funded allies have always wanted to kill anything that tries to hold it accountable,” opined Senator Brown.

The senator recounted how the financial sector’s “lobbyists viciously fought to try to stop us from implementing the Dodd-Frank reforms.” Then, after passage of the law, “the chief lobbyist for the Financial Services Roundtable said, ‘now it’s halftime.’”

Senator Brown observed, “And now they’ve tasked their lobbyists with trying to block the Council from doing its job, forcing it to sit on its hands as risk builds up.” He continued, “They want to take away some of our most important tools for keeping our economy safe from reckless Wall Street behavior.”

Yellen

The FSOC seems to welcome Senator Brown’s observations and encouragements. In 2023, after two regional banks failed, the FSOC not only reversed the previous administration’s jurisdictional limits on the Council but expanded the ability of the FSOC to oversee nonbank entities.

In written testimony submitted to the Banking Committee, Secretary of the Treasury Yellen explained, “[T]he Council is focused on risks from the banking sector and from nonbank financial institutions.”

“We Need an economy where  hard work -not financial speculation – pays off.”

– Senator Sherrod Brown (D-Ohio)

Regarding nonbank financial institutions, Secretary Yellen wrote, “Nonbank financial institutions are an important source of capital in financial markets but also pose potential risks to the financial system, including risks related to liquidity mismatch and leverage.”

Also, according to Yellen’s testimony, the FSOC is “focused on member agencies enhancing assessment efforts and increasing coordination around climate-related financial stability risks from increasingly severe and frequent climate related events.”

Beyond the effect of climate-related events on solvency regulation, the FSOC encourages financial regulators “to promote disclosures that allow investors and financial institutions to consider these risks in their investment and lending decisions.”

This encouragement to disclose climate-risks information to investors or policyholders is not likely to receive a vigorous response from the membership of the National Association of Insurance Commissioners (NAIC). A material portion of the membership, if not a majority, denies the existence of climate change as a source of “increasingly severe and frequent climate related events.” These members allow the NAIC leadership to add climate-related issues to committee charges, but that is the extent of the association’s activity.

Secretary Yellen’s testimony also cited cybersecurity issues as a priority for the FSOC. “The Council promotes sharing timely and actionable cybersecurity information, including through ongoing partnerships between state and federal agencies and the private sector.”

The testimony also listed as priority topics Artificial Intelligence (AI) and various forms of Digital/Crypto Assets.

Regarding AI, Secretary Yellen observed that both the public and private sectors continue to learn, “deepening their expertise” in this area. (Which means, neither practitioners nor regulators know what AI can do and will not be surprised if the computer from 2001: A Space Odyssey starts shutting down life support operations.)

Yellen wrote, “[T]he council is closely monitoring the increasing use of artificial intelligence in financial services, which brings potential benefits such as reducing costs and improving efficiencies and potential risks like cyber and model risk.” She said, “Congress should pass legislation to provide for the regulation of stablecoins and of the spot market for crypto-assets that are not securities.”

She explained, “[T]he Council is focused on digital assets and related risks such as from runs on crypto-asset platforms and stablecoins, potential vulnerabilities from crypto-asset price volatility, and the proliferation of platforms acting outside of or out of compliance with applicable laws and regulations.” That should make anyone with an investment fund feel really secure.

The HAL 9000 may soon exclaim: “This conversation can serve no purpose anymore. Goodbye.”

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.