Biden’s Financial Stability Oversight Council launches regulatory assault on financial markets

The Biden administration is looking to relax policies that would make it easier to subject wealth management firms to tighter regulation. The guidance document and analytical framework proposed by the Financial Stability Oversight Council reverses improvements made in 2019 under the Trump administration.

FSOC was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) in response to the financial instability resulting from the 2008 financial crisis. The Dodd-Frank Act allows FSOC to designate certain non-bank financial companies, such as asset managers, stablecoin issuers, hedge funds, mortgage lenders, insurance companies, and private equity funds, as Systemically Important Financial Institutions (SIFIs), which are subject to prudential regulation and oversight by the Federal Reserve (Fed). This would allow the Fed to set capital and liquidity requirements and leverage limits for these companies — thereby limiting the return potential non-banks can offer investors and retirees.

The FSOC’s designation of non-banks would mean a significant expansion of the Fed’s regulatory powers over the financial sector. The Fed lacks accountability to Congress. It receives no funds from Congress, and members of the Board of Governors can be removed by the President “for cause” only if there is a reason for the removal of the board member, such as “inefficiency, dereliction of duty, or misconduct in office.” Strengthening the Fed’s authority over new companies, many of which are already regulated by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), would increase executive branch oversight over non-banks without the need for elected officials in Congress would do little to help.

The Dodd-Frank Act requires FSOC to designate non-banks as SIFIs if they are in “significant financial distress” or engage in activities that pose “a threat to the financial stability” of the US. New Banking Rules Constrained as a Result of the Dodd-Frank Act Banks’ ability to engage in certain lending practices is being hampered by the increased capital requirements associated with the rules. The government has wrongly clipped the wings of the banks, and a new source of organic credit has emerged from private debt funds.

The Fed’s most recent Financial Stability Review found that while private debt funds have “grown rapidly” since the 2008 financial crisis, “the funds typically use little leverage and investor redemption risks appear low.” In addition, the instability of money market funds (MMF) is “highly misleading”. In fact, certain SEC regulations, such as the ability for funds to levy liquidity fees or redemption blocks, may have “worked” on money market fund rounds during the COVID-19 pandemic.

Rather than subject these funds to Fed oversight, the SEC should repeal the regulations that created the self-fulfilling instability in the first place.

The most significant change from the 2019 FSOC guidance to the newly proposed guidance is the deletion of a cost-benefit analysis that was performed prior to the designation of non-bank SIFIs. Proposed guidance violates MetLife, Inc. v Financial Stability Oversight Council. The case’s rulings were incorporated into the 2019 guidance to mitigate government encroachment and to understand the benefits and costs of additional regulation for non-banks.

The ruling in the MetLife case noted that “FSOC did not consider the costs associated with designating MetLife as a SIFI.” The court also referred to Michigan v. Environmental Protection Agency, stating that FSOC must consider the cost of designating MetLife as a SIFI because “no regulation is ‘appropriate’ if it does significantly more harm than good.”

FSOC has also issued an analytical framework that highlights key factors to assess when evaluating non-bank designations. The risks presented in the vague analytical framework are prospective and there is a lack of evidence to support the claim that some of the factors warrant prudential regulation. The framework even acknowledges that “empirical data may not be available on all potential risks”.

Congress should pass legislation to limit FSOC’s authority. Rep. Andy Barr (R-Ky.) has a bill that would force FSOC to be more transparent with Congress. The bill also gives Congress the power to remove certain non-bank designations by introducing a process to vote on a joint rejection resolution. Congress should also consider codifying the cost-benefit analysis from the 2019 FSOC Guidelines.

If recent bank failures have taught policymakers anything, it’s that the Fed has already bitten off more than it can chew. Reinforcing the Fed’s irresponsibility and inadequate oversight is a recipe for disaster that should be avoided at all costs.