What You Need to Know
- The Fed says a spike in interest rates could hurt life insurer asset values and drive up contract surrenders.
- Sen. Elizabeth Warren asked about Trump-era limits on the ability of federal regulators to track nonbanks.
- Yellen said she wants the old authority back.
Federal regulators could try to regain their authority over nonbank financial institutions that look as if they could hurt the U.S. financial system.
Treasury Secretary Janet Yellen talked about regulators’ thoughts on designating some nonbanks as “systemically important financial institutions,” or SIFIs, on Tuesday at a Senate Banking Committee hearing on the Financial Stability Oversight Council’s annual report to Congress.
“We’re looking at this very carefully and examining what our options are,” Yellen told Sen. Elizabeth Warren, D-Mass., at the hearing, which was held in Washington and streamed live on the web. “We’ll be discussing this with other members of the council.”
Later, Yellen mentioned life insurers, in response to a question from Sen. Sherrod Brown, D-Ohio.
Although the Senate Banking Committee held the hearing to discuss the FSOC report, the Federal Reserve Board released its own financial stability report Monday.
Yellen — a former Fed chair — noted that the Fed expressed concerns about the possible effects of rapidly rising interest rates on banks.
The Fed “noted insurance companies and some hedge funds as leveraged entities that could could be vulnerable in a rising interest rate,” Yellen said.
The Great Recession and FSOC
Problems with mortgage lending, and securities and other instruments backed by mortgages, helped bring about the 2007-2009 Great Recession, including the financial system liquidity crunch that became apparent in 2008.
One of the central players was AIG.
Life insurers have argued that the AIG operations that ran into problems were involved in mortgage-related derivatives transactions, not traditional insurance or insurance portfolio management activities.
But when Congress developed the Dodd-Frank Act in response to the crisis, it noted that nonbanks had been involved.
The Dodd-Frank Act created the Financial Stability Oversight Council, or FSOC, to coordinate federal regulators’ efforts to track and regulate entities that looked as if they might pose a threat to U.S. financial stability.
FSOC has the authority to classify some entities that would normally be outside federal regulators’ reach as SIFIs. FSOC has a voting member with insurance expertise, and it also includes a nonvoting representative from the National Association of Insurance Commissioners.
Many life insurers originally accepted the idea that they could be “designated as SIFIs,” but they found that in practice, being designated was cumbersome, and they ended up fighting to escape from SIFI designation.
In 2019, during the administration of then-President Donald Trump, FSOC said it would back away from trying to designate nonbanks as SIFIs and rely mainly on regulating activities that looked dangerous, not the nonbanks themselves.
The Fed Report
Fed officials said in their financial stability report that life insurers’ level of leverage, or ratio of assets to equity, appears to be near its highest level in the past two decades.
“Life insurers continued to invest heavily in corporate bonds, collateralized loan obligations (CLOs), and CRE [commercial real estate] debt, which leaves their capital positions vulnerable to sudden drops in the value of these risky assets,” Fed officials wrote.