Of all the misbegotten provisions of the Dodd-Frank Act, the worst is probably the authority given to the Financial Stability Oversight Council (FSOC) to designate certain nonbank firms as “systemically important” because their failure may lead to instability in the U.S. financial system. These firms—insurance companies, securities firms, hedge funds, finance companies, and others—are then to be regulated specially and “stringently” by the Federal Reserve.
The whole idea runs counter to the notion that the Dodd-Frank Act—as its supporters claimed—was intended in some way to eliminate the problem that some financial institutions were too big to fail (TBTF). This is already an almost intractable problem in the banking industry, with continuing debate about how to address TBTF among banks. By authorizing the FSOC to designate certain nonbank firms as TBTF, Dodd-Frank will extend the problem to all other areas of the financial industry where it does not currently exist. This is because the financial markets will recognize that firms designated as systemically important will be protected by the government while their smaller competitors will not be—making the smaller competitors riskier credits. The result will be that the designated firms will have easier and cheaper access to funding and thus competitive advantages over the smaller firms in their respective markets.
On Thursday this week, Congressman Scott Garrett and Senator David Vitter introduced a bill to prevent the expansion of too-big-to fail beyond the banking industry. The bill, titled as the ‘‘Terminating the Expansion of Too-Big-To-Fail Act of 2012,’’ simply eliminates the authority of the FSOC to designate nonbank financial institutions of any kind as systemically important.
There is little chance that the legislation will be acted on in either House in this session of Congress. There isn’t enough time in the House, where the bill is likely to be viewed favorably, and it will not be given any attention in the Democratically-controlled Senate, which has not shown any willingness to reopen the Dodd-Frank Act.
However, the bill reflects a recognition by a substantial number of lawmakers that the FSOC could act before the end of the year, whatever the result of the elections in November. That action—in effect a government statement that the designated firms are TBTF—could be irreversible even if the Republicans gain control of the Senate and the presidency in November and thus have the ability to repeal the Dodd-Frank Act.
Senator Vitter and Congressman Garrett are now gathering co-sponsors among their colleagues. Support for the bill in the days ahead could be an indication of the strength of sentiment in Congress for heading off an expansion of TBTF to nonbank firms. With sufficient support in Congress, the FSOC might be induced to wait at least for the results of the election—and perhaps beyond that—before taking possibly irreversible action that could seriously damage our competitive financial system.