Secretary Yellin Touts Economy, Senator Brown Says FSOC Must Keep Us Safe from Wall Street
Commentary by Steven Lofchie
In the annual report to Congress of the Financial Stability Oversight Council ("FSOC"), Treasury Secretary Janet Yellin touted the resilience of the U.S. financial system in the face of "a wide range of risks, including risks stemming from the commercial and residential real estate sectors and from global geopolitical conflicts and technological developments."
In her testimony, Ms. Yellin highlighted five areas of ongoing work detailed in the Report. These include:
(i) reviewing whether "capital measures appropriately reflect a banking institution’s ability to absorb losses; improve resolvability at large, complex, or interconnected banks; and address vulnerabilities from uninsured deposit levels and depositor composition;
(ii) enhancing assessments and coordination around climate-related financial stability risks from increasingly severe and frequent climate- related events;
(iii) bolstering protections against cybersecurity risks;
(iv) monitoring the development of artificial intelligence in financial services;
(v) monitoring digital asset risk, crypto-asset platforms and stablecoins, and potential vulnerabilities from crypto-asset price volatility.
At the Senate hearing, Banking Committee Chair Sherrod Brown urged the Secretary to ensure that the FSOC be present to protect the economy when Wall Street tries to evade regulations. He warned against prioritizing profits over prudent risk management, saying that Wall Street "could make even bigger bets by exploiting gaps in our regulatory system—always enticed by huge bonuses." Senator Brown said Wall Street is not going to give up finding new ways to circumvent rules in order to make bigger profits, all while attempting to hide risky behavior. The Senator raised additional concern regarding concentration among nonbank financial companies, including hedge funds, private equity firms, insurance companies and clearinghouses that hold nearly $20 trillion in assets. He warned that a single entity's failure could drag down the entire financial system.
Commentary
FSOC has not proved successful at anticipating risks to the economy. Its 2022 Annual Report was full of dire warnings about climate change and largely missed the risk of inflation, which turned out to be the not-so-hidden killer of SVB and two other significant banks, as well as necessitating the FDIC essentially having to guarantee the deposits of every bank in the country.
The future of the FSOC as currently configured is worthy of some discussion. The FSOC is a partisan group, composed only of representatives of the President's political party. As an overtly political entity, it can damage our collective ability to understand economic risk. An argument can be made for dismantling FSOC entirely. Certainly, its arbitrary authority to impose bank-like regulation on entities even in the absence of explicit legislative authority should be revoked. (See, e.g. FSOC Finalizes Guidance on Designating Nonbanks for Regulation.) At very least, FSOC's membership should be made bipartisan, which would allow for the publication of a minority party report. Better two partisan reports than one.