The following scene (colored by some creative license) took place at MetLife headquarters last month, when the Financial Stability Oversight Council (FSOC) declared MetLife to be a systemically important non-bank financial company. As a consequence, MetLife will be regulated by the Federal Reserve using Dodd-Frank's prescriptive, bank-like regulatory framework.
"Our future who?"
"Your future favorite financial regulator."
The door is pushed open by a motley group wearing "FSOC"-emblazoned jackets. With the path thus cleared, the Fed marches in: "We're here to regulate you, MetLife."
"But we already have regulators — lots of them."
"Yes, but we're the Fed, and you're systemic, so now we get to regulate you, too."
"Why are we systemic?"
"Because FSOC says you are, of course."
"FSOC just thinks you are. You're really big. You deal with lots of other companies and have lots of customers. Something really bad might happen to you, which would be really bad for the financial system."
"But the insurance experts on FSOC don't think the council's crisis scenarios are realistic."
"Well, everyone else on FSOC does, including our consumer financial protection and housing finance experts. The international Financial Stability Board — of which your favorite new regulator happens to be an active member — thinks you are systemic, too."
"What do we have to do to be non-systemic in FSOC's eyes?"
"We won't tell you."
"But we don't want to be systemic."
"Then sue us."
And that is exactly what MetLife did earlier this week. MetLife is the first designated entity to take this step. The legal challenge raises important concerns about FSOC — a central part of the post-crisis regulatory framework. MetLife raises important constitutional and procedural concerns about its designation. The complaint, for example, describes FSOC's cavalier approach to assessing the likelihood that the insurer would run into serious problems and the consequences to the broader financial system if it did. At every turn, FSOC appears to have assumed the worst, even when its assumptions flatly contradicted one another.
FSOC's scenarios and assumptions are conveniently imprecise. According to the complaint, FSOC discounted MetLife's evidence and relied instead on vague prophecies of doom. For example, in looking at how exposed other firms are to MetLife, FSOC ignored the collateral these firms hold to protect themselves. The legal challenge explains that FSOC's imprecision and its reluctance to reveal its thinking to MetLife made it difficult for MetLife to prove it is non-systemic.
As the complaint points out, FSOC's rationale for designating MetLife would seem to require "the designation of virtually any large financial company." FSOC's nonvoting state insurance commissioner, Adam Hamm, explained it this way: "Identifying outer boundaries of exposures and claiming they could impact a nebulously defined market is not robust analysis; it simply means the Council has identified a very large company."
MetLife's legal challenge unfortunately does not touch some deeper questions regarding the validity of FSOC and the wisdom of systemic designations. FSOC is an odd and unwieldy agency. It is made up of 10 voting members, some of whom are the heads of commissions or boards. The other politically appointed members of these commissions and boards are not entitled to vote on designations and cannot even attend FSOC meetings. They have less say at FSOC than do staffers in their own agencies. FSOC conducts much of its business behind closed doors. As the Government Accountability Office observed in a November report, FSOC would do well to make its designation process "more systematic and transparent." Also potentially compromising the validity of FSOC's actions, the nonvoting members of FSOC include state (as opposed to presidential) appointees, which raises constitutional concerns.
Systemic designations were part of the Dodd-Frank plan to empower regulators to prevent financial crises. But singling out specific firms in this manner conveys to the markets that the government will not permit these firms to fail. In fact, systemically important financial institutions have begun marketing themselves to customers as super-safe. In this way, the systemic designation skews the competitive landscape and opens taxpayers up to the prospect of future bailouts of these too-important-to-fail firms.
Legal challenges to Dodd-Frank are difficult. The statute was written in an open-ended manner to maximize discretion to regulators. FSOC has taken full advantage of its nebulous congressional permission slip to go forth and designate. But MetLife raises serious procedural and constitutional issues. Even in this age of great deference to agencies, a process as arbitrary and consequential as the one the FSOC employs in singling out financial institutions merits close attention from the courts.