Financial history is often cyclical. In the years following financial instability, regulators’ and policymakers’ memories fade. Families across the country don’t have that luxury. The economic and psychological damage inflicted by a crisis can linger for many years, and most people will not receive the type of extraordinary government assistance that large financial firms tend to receive.
Congress created the Financial Stability Oversight Council, in part, to “promote market discipline, by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the Government will shield them from losses in the event of failure.”1 More specifically, under Section 113 of the Dodd-Frank Act, the FSOC is tasked with designating systemically important nonbank financial institutions that could pose a threat to financial stability. A designated firm may be required to have more skin in the game to absorb losses, more cash on hand to mitigate the chance and impact of runs, and file “living wills” to demonstrate the firm can fail without a bailout.
Despite the large, complex, and interconnected universe of asset managers, hedge funds, private equity firms, nonbank mortgage companies, and insurers, the FSOC currently has a total of zero shadow banks designated as systemically important. In the past few years, this has led to a perception among many market participants that our statutory authority to designate is dead letter.
I strongly support today’s important step toward the goal of promoting market discipline. Removing the ill-advised procedural restrictions put in place in 2019 establishes a more appropriate and durable process for using the designation authority.
This action is not just a paperwork exercise. We should now turn to implementing the guidance by evaluating whether any shadow bank meets the statutory threshold for enhanced oversight. I doubt the answer is zero. This effort should build on the work that FSOC Committees, such as the Hedge Fund Working Group and Nonbank Mortgage Task Force, have already conducted in the context of sector-wide reviews.
The country re-learned a painful lesson in the 2008 financial crisis. Unchecked shadow banking risks can devastate households and small businesses across the country. A lax approach to these risks can also disadvantage smaller players and regulated institutions. Let’s not forget it again.
- Dodd-Frank Wall Street Reform and Consumer Protection Act, Section 112(a)(1)(B).