Financial regulation calls for 20/20 vision – Antonio Weiss and Simon Johnson

MIT Sloan Professor Simon Johnson

Harvard Kennedy School Senior Fellow Antonio Weiss

From Bloomberg

One of the central pillars of financial reform, the Financial Stability Oversight Council (FSOC), is under political attack and at risk of coming undone.

In the past, the balkanized U.S. financial regulatory system has consistently failed to address risks that took root in its jurisdictional gaps. The FSOC was created to solve that problem, bringing regulators together to make sure they have the tools to protect the economy from financial crises. It is already making an important difference.

Unfortunately, earlier this month the House Financial Services Committee passed the Financial Choice Act (CHOICE Act), which threatens to reverse that progress. It would, for example, all but eliminate the FSOC’s ability to prevent the regrowth of an unsupervised shadow banking sector that might once again threaten our financial stability and economic resiliency. At the same time, the administration of President Donald Trump has signaled that it may use the council to pursue deregulation, rather than its core mandate of financial stability, and to reverse or limit its ability to designate systemically important non-banks for enhanced supervision. Meanwhile, MetLife Inc., the largest U.S. life insurer, recently asked the courts to delay ruling on an appeal filed by the Obama administration seeking to reinstate the firm’s designation as a systemically important institution requiring prudential oversight by the Federal Reserve.  The Trump administration has agreed to put the appeal on hold.

In light of these actions in the executive, legislative and judicial branches, it’s worth revisiting why the FSOC was created in the first place, and why its core mandate is so important.

Many of the vulnerabilities at the heart of the 2008 crisis can be traced to the growth of activities outside the core banking system, in the so-called “shadow banking” system. Regulators did not have sufficient legal authority to oversee shadow banking activities. As a result, risks metastasized outside their view.

The failures of Bear Stearns Cos. and Lehman Brothers, two such shadow banking firms, and the $182 billion bailout of American International Group Inc. (AIG), an insurance company, made clear that regulators needed better tools to address threats that such activities posed to financial stability.

Read the full post at Bloomberg.

Antonio Weiss is senior fellow at the Harvard Kennedy School’s Mossavar-Rahmani Center for Business and Government.

Simon Johnson is the Ronald A. Kurtz (1954) Professor of Entrepreneurship at the MIT Sloan School of Management, where he is also head of the Global Economics and Management group and chair of the Sloan Fellows MBA Program Committee.

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