Self-Serving and Conflicted — FSOC Annual As Forthcoming As Expected
Maybe it’s because I am just back from vacation, but reading the Financial Services Oversight Council’s first annual report certainly hasn’t helped my mood. In fact, the FSOC’s voluminous annual report — a mere 192 pages — provides ample justification for why we and others were so against this type of political structure when it was first proposed back in 2009. Namely, the report is not so much a forum for uncovering emerging systemic problems as it is a means of shifting blame for regulatory failure.
The FSOC, for those lucky few not immersed in Dodd-Frankese, was the compromise structure set up to monitor systemic risks on a national and global basis. The Federal Reserve insisted on having its fingers in the process given its role as central banker. Fair enough. But along with the Fed came the Treasurer of the United States, the heads of the Office of the Comptroller of the Currency, Securities and Exchange Commission, Federal Deposit Insurance Corp., Commodity Futures Trading Commission, Federal Housing Finance Agency, National Credit Union Administration, and the newly formed Consumer Financial Protection Bureau. The 10th member, intended to be an independent with insurance experience, would be appointed by the president. The latter two — the head of the CFPB and the independent insurance member — were not part of this first annual report as their status remains in limbo.
A Compromised Structure
This college of regulators was specifically rejected by, among others, the high-level Investors’ Working Group that CFA Institute and the Council of Institutional Investors created to consider investor-based responses to the 2007-2008 financial crisis. The problem IWG members saw with this type of arrangement was that the same regulators who oversaw the industry while problems were developing would then sit in judgment of their own decisions. It wouldn’t be difficult to figure how that process might resolve itself.
Instead, the IWG sought creation of an entity that would be separate from the banking and markets regulators. This separation would permit it to take a more independent look at the decisions of regulators and policy makers and give a less-jaundiced view of what was happening in the market. Senators Bob Corker (R-Tenn.) and Mark Warner (D-Va.) were behind a similar structure in early 2010, together with a bankruptcy-based orderly resolution authority that would have truly eliminated the U.S. taxpayer support for failed financial institutions.
What we got, on the other hand, was a bastardization of both. The new Office of Financial Research was supposed to take on the role of independent systemic risk research agency, except that it shared its budget with the FSOC, its offices with the Treasury, and received direction from the FSOC. In other words, the output could be predictable CYA.
Glossing Over the Biggest Systemic Risks
Sure enough, the inaugural annual didn’t disappoint in that regard. Take the issue that has been in the headlines for the last month — the federal debt situation in the United States. This is, in nominal terms, one of the biggest potential systemic issues facing global financial markets in many years, if ever. Its effects could have affected (and may still) investment portfolios from Asia to the Middle East, not to mention Sacramento and Springfield. It could have seriously damaged the balance sheets of commercial banks, both domestic and foreign, despite, as the FSOC reports, the U.S. having “substantially stronger capital and liquidity buffers than before the crisis.”
In describing the issue in the executive summary, the FSOC says that “long-run sustainability of the national budget is crucial to maintaining global market confidence in U.S. Treasury securities and the financial stability of the United States.” Pardon my asking, but what budget? It seems to be referring to the legally required annual budget for the U.S. government. Unfortunately, the government hasn’t abided by that requirement and has instead operated largely under continuing resolutions for most of the last three years.
Then, in the body of the report, the perfunctory discussion about the U.S. fiscal crisis covers a mere two pages with six accompanying graphs. The discussion about the Euro crisis covers similar limited real estate in the report.
The FSOC did express concern about pension plans for states and local governments, though the concern was muted. This forthrightness included a comment that some of these governments “appear to face funding shortfalls over the long run.” The taxpayers in California and Illinois will no doubt be glad to hear this.
Trust Us: No More Government Bailouts
The report also touts the new “orderly liquidation authority” incorporated within Dodd-Frank as a mechanism to disabuse market participants of any expectation that the U.S. federal government would come to the rescue of a failing financial institution. Uh huh. Just like Dodd-Frank itself warned investors that they could no longer count on a federal bailout all the while explicitly giving the FDIC authority to guarantee the assets and liabilities of failing financial institutions (See Sec. 204(d)).
Yes, there are some interesting bits in the report. The report indirectly states that coordinated global regulatory standards may lead to greater systemic risk rather than less. (See Box J on page 132.) It even goes so far as to point out a real potential systemic risk. The tri-party repo market, they say, poses significant systemwide risks given the likelihood of investors like money market mutual funds to exacerbate the funding issues for a troubled dealer. The problem described is that the funds typically can’t take possession of the collateral in the event of a default and therefore have to withdraw their funds to avoid loss.
All in all, though, there isn’t much here that investment professionals haven’t already known for some time. But it is the back-patting manner in which it is presented, however, that failed completely to surprise.
Glad I came back for this.
