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May 28
09:09 2019

Public Policy Analysis & Opinion

By Kevin P. Hennosy


The short life and unsanctified passing of an effort to avoid financial collapse

This spring, the political death-rattle of the Financial Stability Oversight Council (FSOC) was heard up and down the Potomac Valley. The council will not suffer formal disbandment because that coup de grâce would require an act of Congress.

In legend, lore and science fiction, there is a concept of “the undead,” which describes a character who gives the appearance of being alive but really is dead. These sorry creatures appear with a flash of menacing violence, such as vampires and zombies who feed on the blood or flesh of living human beings.

In political arts and sciences, the undead also appear to live without being alive. Yet the political strain of the undead feign animation for the sole purpose of hiding their demise. Once a political or bureaucratic office appears on the list of the undead, it ceases to threaten anyone.

In a sense, the FSOC was always a bureaucratic specter—without the material shape or form of a regulatory agency—and still assigned a mission to save the world from greed and corruption.

For at least the next two years, the council will go through the motions of meeting, and possibly releasing a statement after those meetings. Nevertheless, these activities will not amount to anything in the realm of public policy. The FSOC is dead.

On March 6, 2019, the National Association of Insurance Commissioners (NAIC) issued a statement celebrating the FSOC’s passing over the signature of Maine Bureau of Insurance Superintendent and NAIC President Eric A. Cioppa:  “I’m pleased with the announcement of FSOC today. I am generally supportive of this proposal and look forward to the reactions of my insurance regulator colleagues. The most appropriate approach to addressing risks to financial  stability is for FSOC to work in conjunction with existing regulators to identify those risks, especially in the non-bank sectors. Mitigation is best handled by the regulators with authorities to address them in the first instance.”

Senator Sherrod Brown (D-Ohio), who serves as ranking member on the Senate Banking Committee, warned that the FSOC is moving in the wrong direction: “The new proposal ignores the damage done to our financial system during the last crisis and the risks still posed by shadow banks and other financial institutions. FSOC is no longer protecting financial stability or taxpayers.”

Bad prognosis

The FSOC’s existence never garnered a favorable prognosis. The council worked in a high-risk area, lacked a sturdy constitution, and faced strong enemies. The FSOC consisted of representatives of federal financial regulators and others and met under the auspices of the U.S. Department of the Treasury.

Drafters of the Dodd-Frank Wall Street Reform and Consumer Protection Act conceived of the FSOC to create a new office without triggering jurisdictional conflict with existing regulatory agencies.

The council consists of 10 voting members and five nonvoting members. The insurance sector receives representation on the council from an independent insurance expert appointed by the president, as well as the carriers’ Charlie McCarthy doll—the NAIC.

This loose affiliation of regulators and others received a rather hefty charge: the comprehensive monitoring of the stability of the United States financial system. In a sense, the FSOC was always a bureaucratic specter—without the material shape or form of a regulatory agency—and still assigned a mission to save the world from greed and corruption.

What could go wrong?

The salute

The same powerful political enemies who caused the Dodd-Frank Act draftersto flee from the goal of providing national regulation of operations that posed systemic risk then attacked the FSOC.

For several years, the 98-pound weakling known as the FSOC leveled a certain single-finger salute to the bullies that proverbially kicked sand in the council’s face. That salute took the form of the FSOC’s application of a designation of certain non-bank institutions as systemically important financial institutions (SIFI).

The SIFI designation applied to non-bank institutions based on the knowledge that no matter how warm and fuzzy banking “supervision” is in the United States, the public oversight of non-bank financial institutions is even less severe. Sometimes the non-bank institutions operate in the dark corners of financial markets, where the light never shines until the smoke and flames can no longer be ignored.

In the case of insurance, the state-by-state “regulatory system” assesses premium taxes, diverts consumer complaints to bureaucratic limbo, and provides public relations and government affairs services to the largest local companies. The premium tax revenue, the investment capacity, the employment numbers, and the offer of future employment to state officials complete the deal for “regulatory capture” of insurance regulation.

As Assistant Professor of Business Law Jeremy Kress, of the University of Michigan Ross School of Business, observed in a paper titled, The Last SIFI: The Unwise and Illegal Deregulation of Prudential Financial, “Insurance companies, investment banks, and other nonbank financial firms were primary culprits in the 2008 financial crisis.”

Bat country

It is also important to note the use of the word “deregulation” in the title of the professor’s paper. The state-based system of insurance regulation simply cannot “regulate” these large firms. As this column has observed, these mega firms become “too big to regulate” before they become “too big to fail.”

This inability to do the job is not always based on corruption. In some cases, the state officials simply lack thebrain power or intellectual curiosityto gather the gumption to tell a large insurance company “no.” In some cases,the official just seems confused. Submit-ted for your approval, the laughable example of testimony delivered to Congress, after the 2008 financial collapse, on behalf of the NAIC by a then-Pennsylvania insurance superintendent who asserted under oath that AIG was not an insurance company.

When an insurance regulator cannot even recognize what was then “the world’s largest insurance company” as an insurer, there is a problem with public oversight—to borrow a vision from Hunter S. Thompson’s Fear and Loathing in Las Vegas—and what follows is a savage drive into “bat country.”

To protect the financial viability of SIFI institutions, the FSOC adopted rules that kept secret the reason behind each SIFI designation. By keeping this information from the public, the FSOC sought to protect the risk-laden institutions. The FSOC tried to avoid panic. They wanted to avoid starting a run by investors, sales forces, and customers. Such a panic could cause the very financial failure and capital flow disruption that the FSOC hoped to avoid in the public interest.

By refusing to make the source or scope of the problem public, the FSOC took a centrist approach to public policy. The FSOC persuaded the management of AIG, MetLife, and GE Capital to “slim down” and reduce their weight of risk, which placed strain on the financial system. After the designation, the FSOC engaged in a terrific amount of “jawboning” rather than ordering changes.

Yet, instead of thanking the FSOC for saving the institutions from their own unwise addiction to risk, their lobbyists and public relations offices—including certain state insurance departments—derided the “lack of transparency” in the FSOC operations. Some of the financial sector-funded think tanks described the FSOC with terms usually reserved for Stalinist terror.

Maybe the FSOC did make a mistake with its low-key, centrist style when dealing with the SIFI firms. When lobbyists complained of harsh treatment for their employers and clients, maybe FSOC should have provided a point of comparison?

After all, the home offices of the SIFI companies were not surrounded by yellow crime tape, the doors were not chained shut, and the senior officers were not handcuffed and led from the building before assembled cameras. Government accountants, lawyers, and marshals did not fan out through the offices sealing file cabinets and seizing assets, like a scene out of the movie Casino. Not once did federal officials arrive in black helicopters. Not one federal jack-booted thug popped a canister of tear gas or Mace. No one from the FSOC shouted into a bullhorn outside a SIFI home office: “This is what transparency looks like!”

And to this day, neither the financial product-purchasing public nor investors know what risk those institutions posed to the economy–like several firms posed in 2008, which triggered widespread financial collapse. Consumers cannot make that informed choice that is so necessary to play-act in the American fairytale known as “regulation by competition.”


The council began its final passage to the undead in 2017. Stakeholders pushed hard on the FSOC to re-designate the non-bank SIFIs.

Professor Kress opines that most of the non-bank SIFI designates responded to the enhanced regulation and presented less systemic risk—but he does not believe that is true for all the designated companies. The professor does not believe Prudential improved its systemic risk condition.

Late last year, the council reversed its designation of Prudential Financial, and Professor Kress published the paper noted above in the December 2018 Stanford Law Review. In that paper, Professor Kress presents the argument that the reversal of the SIFI designation for Prudential was both wrongly taken and illegal.

In March 2019, the deregulatory chants grew louder as the FSOC further weakened its condition. The FSOC proposed changing its approach to systemic risk. Instead of focusing on institutions or entities, the council will focus on particular “activities.”

Even if one welcomes the activities-based approach, it would require more regulatory assets than the council has ever received. In addition, focusing on a single activity would not assure the oversight would grasp how those activities interact with other parts of the firm or sector. A risky compound may seem inert until it is mixed with other compounds in the back room.

Furthermore, the new FSOC rules will not seek to act affirmatively to protect the public interest by precluding accumulation of dangerous concentrations of systemic risk. The new rules suggest that the FSOC should only act when there is an apparent emergency, and not until.

In short, the new FSOC policy promises to designate catastrophic activities only when they become an emergency. If the council really follows that policy, the designation will come at the worst possible moment for the financial system. Such an emergency designation would trigger a panic that would shock the economic system. Who really thinks that the FSOC will trigger a panic that shocks the system?

Insurance is a business based on trust, and placing a ghost in charge of guarding trust is a fool’s errand.

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 regulatorycompliance office of Nationwide Insurance Cos. 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.

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