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Trump’s Treasury Proposes ‘Too Big to Fail’ Changes

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U.S. Treasury Department officials agree with U.S. life insurers that the Financial Stability Oversight Council should communicate better, and show more of its work when it’s deciding whether to classify a nonbank financial company as “too big to fail.”

Treasury officials offer recommendations for changing the FSOC process for designating “systemically important financial institutions,” or SIFIs, in a new report.

Treasury officials prepared the report in response to an executive memorandum President Donald Trump put out in April 

(Related: Insurers Get 180 Days of SIFI Designation Relief)

If the Trump administration changes the SIFI rules, that could help agents and brokers, by keeping the biggest issuers in the market, industry groups say. MetLife Inc., put its historic individual life and annuity operations in a separate company, Brighthouse Financial, and made other major changes in its corporate structure, after FSOC designed it as a SIFI.

Supporters of the current system, including Better Markets, have argued that the kinds of changes Treasury is proposing could eventually hurt agents and brokers, by leaving federal regulators without the information and tools they need to prevent, or handle, a future financial crisis.

Children of Dodd-Frank

Members of Congress created FSOC, and the SIFI designation program, in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The drafters were responding to the Great Recession that started in 2007. In 2007, many homeowners began having trouble with making their mortgage payments. Mortgage defaults hurt the performance of mortgage-backed securities. The problems in the mortgage-backed securities hurt the performance of the credit default swaps that were supposed to protect the mortgage-backed securities holders against default risk.

Economists had taught students for years that homeowners would do everything possible to keep making mortgage payments. The increase in the default rate in 2007 shocked the lenders and the holders of the mortgage-backed securities. Managers at the credit default swap issuers, who once thought they were writing instruments comparable to alien abduction insurance, suddenly found themselves facing demands for cash collateral.

Some of the companies that wrote the credit default swaps were insurance companies and other companies outside the banking and securities sectors.

Money (Image: Thinkstock)

(Image: Thinkstock)

Dodd-Frank drafters tried to protect the U.S. economy from a repeat of the Great Recession, and problems erupting in markets outside of federal regulators’ field of vision, by creating FSOC.

Federal regulators were already hearing about bank industry problems from federal bank regulators, and about securities problems from the U.S. Securities and Exchange Commission.

FSOC is supposed to supplement the reports of the bank regulators and the SEC, by scanning the U.S. economy as a whole, for trends or entities that could wreck the economic system. FSOC is also supposed to designate any entities critical to economic stability as SIFIs, and to give federal regulators tools they can use to address potential systemic risk problems.

Supporters of FSOC and the current SIFI designation system say the federal government needs something like FSOC program to keep track of any problems building up outside the banking and securities sectors.

FSOC supporters also say that federal regulators need to have the flexibility to cope with new sorts of problems, and to deal with any important companies that use legal tricks to try to stay out of federal and state regulators’ reach.

Critics say the SIFI system has been too complicated and too expensive; was created by officials who showed too little understanding of how nonbank financial companies operate; and is appears to give some types of companies an unfair advantage over other types of companies.

Today, FSOC SIFI designations “result in increased regulatory costs for firms, which may be passed on to customers in the form of increased prices,” Treasury officials write in the new report. “Higher prices could lead customers to switch to more competitively priced products offered by less-regulated companies, causing a migration of activities outside the regulatory perimeter that could eliminate the financial stability that the council’s action is intended to achieve.”

In the new Treasury report, Treasury officials call for four changes to the current FSOC SIFI designation system.

Transparency (Image: Thinkstock)

(Image: Thinkstock)

The four changes proposed are:

  1. Look at how likely an entity really is to run into financial problems.

  2. Analyze the costs and benefits of designating an entity as a SIFI.

  3. Improving communication with SIFI candidates and their main regulators.

  4. Creating a clear way for a SIFI to stop being a SIFI.

Treasury Secretary Steven Mnuchin included a matter-of-fact statement about the proposed changes in the press release announcing the availability of the report.

“We identify several ways to improve FSOC’s processes for designating nonbanks and financial market utilities,” Mnuchin said in the statement. “Our recommendations include enhancing FSOC’s analytical process, implementing cost-benefit analysis, and increasing transparency.”

In the report, Treasury officials say they consulted several insurers, including American International Group Inc., John Hancock Financial, MetLife Inc. and Prudential Financial Inc.

The official also consulted with the American Council of Life Insurers, the Financial Services Roundtable, and some individuals and groups that support the current FSOC SIFI designation process, such as Better Markets and Daniel Schwarcz.

The ACLI praised the Treasury Department.

“While ACLI is reviewing the entirety of the report, we are strongly encouraged by the emphasis on improved engagement and transparency in the designation process,” Dirk Kempthorne, the ACLI’s chief executive officer, said in a statement.

At press time, the groups that back the current FSOC SIFI designation process were still digesting the report and had not yet come out with detailed reactions. 

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