FSOC's New Proposals
Three quick thoughts on FSOC's approach to the MetLife decision, Chair Powell's change in position, and claims about the reinvigoration of FSOC
Last Friday the Financial Stability Oversight Council released two proposals relating to its approach to the designation of nonbank financial companies as systemically important. One of the proposals would adopt a new analytic framework for financial stability risk identification, assessment and response. The other would revise FSOC’s interpretive guidance on nonbank SIFI designation, in large part rolling back changes made to this interpretive guidance in 2019.
This is not meant to be a detailed post about the substance of the proposals. That will have to wait until later. For now, I’d like to focus on three other things I thought were interesting about Friday’s releases and related commentary.
A questionable, if unsurprising, treatment of the MetLife decision
In the debate around the utility of cost-benefit analysis in prudential financial regulation, I usually find myself sympathizing slightly more with the skeptical view (represented, for example, in this John Coates article asserting that “precise, reliable, quantified CBA remains unfeasible”).1
So when FSOC in its proposed revision to its designation guidance says the following, I do not really disagree with their bottom-line view.2
[T]he Council does not believe that prescribing a cost-benefit analysis prior to a determination under section 113 is useful or appropriate. This is in part because it is not feasible to estimate with any certainty the likelihood, magnitude, or timing of a future financial crisis. … The benefits of designation are potentially enormous and, in many respects, incalculable, representing the tangible and intangible gains that come from averting a financial crisis and economic catastrophe. The costs of any particular future financial crisis, and thus the benefits of its prevention through designation or other measures, cannot be predicted.
But in reaching this conclusion, FSOC characterizes the D.D.C.’s 2016 MetLife decision in a way that I am not sure totally holds up to scrutiny.
In the MetLife case, the U.S. District Court for the District of Columbia rescinded FSOC’s designation of MetLife as a nonbank SIFI. The court did so for two independent reasons:
The Court will rescind the Final Determination on two grounds. First, FSOC made critical departures from two of the standards it adopted in its Guidance, never explaining such departures or even recognizing them as such. That alone renders FSOC’s determination process fatally flawed.
Additionally, FSOC purposefully omitted any consideration of the cost of designation to MetLife. Thus, FSOC assumed the upside benefits of designation (even without specific standards from the Federal Reserve) but not the downside costs of its decision. That is arbitrary and capricious under the latest Supreme Court precedent.
In its proposed reinterpretation released last week, FSOC in a footnote describes the MetLife decision on cost-benefit analysis like this:
The U.S. District Court for the District of Columbia held that the Council should have considered the potential costs of designation before designating MetLife, Inc. under section 113, but the Court’s reasoning assumes that a company’s likelihood of material financial distress is itself a required consideration under the Council’s guidance in effect at that time. See MetLife Inc. v. Financial Stability Oversight Council (MetLife), 177 F. Supp. 3d 219, 239-42 (D.D.C. 2016) (discussing company’s argument that “imposing billions of dollars in cost could actually make MetLife more vulnerable to distress”). …. Under the Proposed Guidance, the likelihood of a company’s material financial distress would not be a consideration in a designation under section 113.
In other words, FSOC’s view is that the District Court’s analysis of the cost-benefit analysis question (the second independent ground for the court’s rescission of the designation) was dependent upon the court’s conclusion that FSOC was required under its 2012 guidance to consider the likelihood of material financial distress, and had improperly departed from that standard (the first independent ground for the court’s rescission of the designation).
The background here is that Section 113 of the Dodd-Frank Act provides FSOC with nonbank SIFI designation authority if it determines that “material financial distress at the U.S. nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the U.S. nonbank financial company, could pose a threat to the financial stability of the United States.” The statute then provides a list of factors FSOC should consider in reaching such a determination, including a catch-all provision directing FSOC to consider “any other risk-related factors that the Council deems appropriate.”
In 2016, FSOC’s argument against reading the statute to impose a cost-benefit analysis requirement was twofold. First, FSOC argued that the relevant provision of Dodd-Frank does not explicitly require FSOC to consider costs of designation, unlike other provisions of Dodd-Frank that do explicitly mention cost-benefit analysis. This argument is reprised by FSOC in last Friday’s proposal:
The Dodd–Frank Act does not require a cost-benefit analysis prior to the designation of a nonbank financial company under section 113. … The costs and benefits of a designation are not listed considerations in the statute and are not similar to any of the listed considerations. The statute is clear that the only required considerations are related to the potential impact the company’s material financial distress or activities could pose to U.S. financial stability
The District Court rejected this argument in 2016, relying heavily on Michigan v. EPA, a 2015 Supreme Court decision.
FSOC cites Michigan and Whitman for the combined proposition that “[w]here a statute ‘expressly directs [an agency] to regulate on the basis of a factor that on its face does not include cost, [it] normally should not be read as implicitly allowing the Agency to consider cost anyway.’” FSOC Reply at 45 (quoting Michigan, 135 S. Ct. at 2709; Whitman, 531 U.S. at 467).
The quote is accurate, but FSOC omits the next two sentences from Michigan:
That principle has no application here. “Appropriate and necessary” is a far more comprehensive criterion than “requisite to protect the public health”; read fairly and in context, as we have explained, the term plainly subsumes consideration of cost. 135 S. Ct. at 2709.
The same textual hook in 12 U.S.C. § 5323(a)(2)(K) (“appropriate”) would thus require FSOC to consider the cost of designating a company for enhanced supervision, provided that cost is a “risk-related” factor.
FSOC points to adjacent terms in Dodd-Frank that expressly mention cost. FSOC Mot. at 36 n.22 (citing 12 U.S.C. §§ 5493(d)(7)(A)(i)(IV), 5512(b)(2)). But the Michigan Court considered and rejected the same argument. See 135 S. Ct. at 2709 (“It is unreasonable to infer that, by expressly making cost relevant to other decisions, the Act implicitly makes cost irrelevant to the appropriateness of regulating power plants.”).
In other words, the District Court understood the Supreme Court to be saying that, where a statute requires an agency to take into account “appropriate” factors, this should generally be understood to require cost-benefit analysis of some kind. This is because, quoting Michigan v. EPA, “[i]n the end, cost must be balanced against benefit because ‘[n]o regulation is ‘appropriate’ if it does significantly more harm than good.’”
But there is a wrinkle in the Dodd-Frank statute that possibly made the analysis of Section 113 different from the analysis of the statute at issue in Michigan v. EPA. As mentioned above, under the nonbank SIFI designation provisions of the Dodd-Frank Act, FSOC is required to consider “appropriate” factors only if those factors are “risk-related.” In its proposal on Friday, FSOC argues that costs are not a risk-related factor.
The Council acknowledges that there may be costs associated with a designation or the resulting Federal Reserve supervision; however the Council does not consider the potential cost of a designation or of the resulting Federal Reserve supervision and prudential standards to be a “risk-related factor.” The Council believes that the statutory reference to a “risk-related factor” instead should be interpreted, consistent with the statutory standard for designation and the expressly enumerated considerations, as meaning a factor related to the risk to U.S. financial stability posed by the company or the company’s activities
This too is an argument that FSOC made and that the court considered and rejected in 2016.
FSOC argues that the “potential cost to a designated company cannot properly be considered a ‘risk-related’ factor, because it is unrelated to the question posed by the statutory standard: whether the company’s ‘distress . . . could pose a threat to the financial stability of the United States.’” … According to FSOC, several of the considerations in 12 U.S.C. § 5323(a)(2) “seek to assess the vulnerability of a nonbank financial company to financial distress.” 12 C.F.R. § 1310 App. A.II.d.1. FSOC’s ejusdem generis argument is thus belied by its own Guidance; the “risk” in § 5323(a)(2)(K) must refer both to the risk of destabilizing the market and the risk of distress in the first place. FSOC never responded to MetLife’s allegation (Compl. ¶¶ 131-32) or its argument (MetLife Mot. at 61) that imposing billions of dollars in cost could actually make MetLife more vulnerable to distress. Because FSOC refused to consider cost as part of its calculus, it is impossible to know whether its designation “does significantly more harm than good.” Michigan, 135 S. Ct. at 2707. That renders the Final Determination arbitrary and capricious.
With this language from MetLife in mind, let’s look at again at FSOC’s footnote from Friday that I quoted earlier.
The U.S. District Court for the District of Columbia held that the Council should have considered the potential costs of designation before designating MetLife, Inc. under section 113, but the Court’s reasoning assumes that a company’s likelihood of material financial distress is itself a required consideration under the Council’s guidance in effect at that time.
So FSOC’s argument seems to be that the above passage from 2016 is best read as the court grounding its view as to whether cost is a risk-related factor on the fact that FSOC’s own guidance (in the court’s view) required the Council to take into account likelihood of financial distress.
Is that really the best way to read the court’s discussion, though? I read the passage as the court saying that FSOC’s 2012 guidance is one reason that FSOC’s argument about costs not being a risk-related factor must fail, but not only the reason. Even without the 2012 guidance in the picture, I am not sure the court’s conclusion - which at its core was based on the court’s own interpretation of Section 113 itself - would have been any different.
The point of all this is not to say that FSOC, by sticking with arguments already rejected by a single district court, is doing something outrageous or atypical as a legal matter. As FSOC observes in the proposal:
The government appealed the district court’s decision in 2016, but agreed to dismiss its appeal in 2018. In the final settlement agreement between the Council and MetLife, the Council maintained that its designation of MetLife complied with applicable law. In the agreement MetLife expressly waived any right to argue that the cost-benefit portion of the district court’s opinion had any preclusive effect in any future proceeding before the Council or in any subsequent litigation.
And even where (unlike here) there is an appellate decision unfavorable to the government, it is not unusual for the government to decline to acquiesce to that appellate decision to any extent greater than that required by law.3
Therefore, although I would as always appreciate hearing counterarguments, I do not think there is anything here to suggest that FSOC is acting in bad faith by taking the ex ante view on cost-benefit analysis that it lays out in the proposed guidance.4 But on the forward-looking question of whether this view would hold up if challenged in court, even if you give no precedential weight at all to MetLife, I would not bet on that. For one thing, it is not like the court that decided Michigan v. EPA is now any more favorable to the administrative state.
For all these reasons, even if I agree with FSOC on the substance, I wonder if the Council is unnecessarily courting trouble with the stance on cost-benefit analysis that it has proposed to adopt.
Changing his mind
The 2019 FSOC interpretive guidance that 2023 FSOC now proposes to revise was not popular with most regulators who served during President Obama’s administration. For example, Janet Yellen, Jack Lew, Tim Geithner and Ben Bernanke argued against the 2019 guidance on the basis that, were it to be adopted, the guidance “would neuter the designation authority,” would “amount to a substantial weakening of the post-crisis reforms,” and “would make it impossible to prevent the build-up of risk in financial institutions whose failure would threaten the stability of the system as a whole.”
One person who did not share those negative views of the 2019 guidance was Federal Reserve Board Chair Powell. In 2019 when the guidance was proposed, Chair Powell voted in favor and said:5
I support an activities-based approach for addressing systemic risk and support releasing the amended guidance for public comment. Such an approach represents a disciplined framework for approaching financial stability. …
There are many cases when designating companies will not reduce market fragilities. … The activities-based approach envisions constructive engagement with the primary regulators who have the tools and expertise to address such fragilities. …
This guidance also preserves nonbank designations, which should be used sparingly but remain an important tool for addressing financial stability risks.
Later in 2019 Chair Powell voted for the final guidance, without further public comment.
FSOC’s 2023 guidance proposal takes a considerably less favorable view of the activities-based approach reflected in the 2019 guidance, saying support for prioritizing an activities-based approach can be “found nowhere in the Dodd-Frank Act”:
The Council stated in the 2019 Interpretive Guidance that it intended to use a prioritization scheme found nowhere in the Dodd-Frank Act, under which the Council would generally seek to use certain of its authorities before others. Consistent with the Council’s statutory purpose to respond to emerging threats to U.S. financial stability, the Proposed Guidance would remove this prioritization, allowing the Council the flexibility to use the most appropriate tool for addressing potential risks.
So how does Chair Powell feel about this criticism of the 2019 guidance he supported?
Would you have guessed “delighted”? From Friday’s meeting:6
I am delighted to support the revised process guidance and analytical risk framework. …
It has been over a decade since the Dodd-Frank Act gave the FSOC the power to designate nonbank firms. In that time, the FSOC has gained a great deal of insight into Section 113 designations. We’ve seen that the financial system continues its constant evolution, underscoring that no single solution can address every financial stability risk, and I believe it is fitting for the Council to regularly assess its tool kit and consider how best to use our full range of tools to respond to systemic risks, whether the risk arises from an activity, an event, or a firm. …
Overall, I believe that the changes proposed by the Council will create a balanced approach to addressing potential risks to U.S. financial stability and ensure that all the tools available to the FSOC will remain on equal footing.
This blog generally tries to avoid cheap gotchas, and I hope this is not taken as that. My general view is that it is fine, laudable even, for regulators to change their mind based on events or based on thoughtful reconsideration of their views.
But if a regulator is going to do this, I do think it would be helpful to explain what specifically led to the change of mind. It is one thing to say that a lot has happened since Dodd-Frank was enacted in 2010, but it is slightly different to say, as Chair Powell’s statement necessarily implies, that something has changed since 2019 in Chair Powell’s thinking about financial stability to no longer make an activities-based approach worthy of prioritizing.
Again, this is not to take issue as a general matter with the idea that a regulator could change his or her mind. The point here is more specific: the question of “How does the Chair of the Board of Governors of the Federal Reserve System analyze questions about financial stability?” seems like an important one that, at the least, has not been answered in full. A clearer articulation of Chair Powell’s thought process would be welcome, particularly in the context of an FSOC release which makes much of the Council’s commitment to transparency.
Rumors of FSOC’s reinvigoration
The Biden Administration has made a point of listing FSOC-related efforts among its key accomplishments. For example, in a January 2022 list of “Treasury’s Top Accomplishments During Year One of the Biden-Harris Administration,” there was:
Secretary Yellen reinvigorated the Financial Stability Oversight Council, which met seven times to assess potential risks including those related to climate change, digital assets, commercial real estate markets, housing markets, hedge funds, and open-end funds.
Then SEC Commissioner Allison Herren Lee also in January 2022 agreed that FSOC had been reinvigorated:
I hope the recent reinvigoration of the FSOC will continue apace so that financial regulators can work together within our complex financial ecosystem to maintain a laser focus on financial stability for investors and the broader American economy.
Or take Politico in May 2022:
Yellen’s defenders credit her with reviving negotiations around a major international tax agreement last year — the talks had stalled under Trump Treasury Secretary Steven Mnuchin — though the deal hasn’t yet been approved by the European Union and its fate in Congress is uncertain. …
She has led the implementation of last year’s massive Covid relief package, reinvigorated the council of regulators that monitors risks to the financial system and rebuilt alliances with global economic policymakers.
In comments on Friday, CFPB Director Rohit Chopra advanced these claims about FSOC’s reinvigoration a few steps further. FSOC has not merely been reinvigorated; it has literally been brought back from the dead.
We must constantly be on the lookout for regulatory amnesia. At the CFPB, which was established in the wake of the 2008 crisis, nonbank supervision is among the most important work we do. I know all of us on this Council are grateful to Secretary Yellen for leading this effort to bring the Financial Stability Oversight Council back to life. I am pleased to support the proposed guidance.
I have a ton of respect for the people who work for the Council or in related capacities, and as a general matter I think FSOC’s moves and pace of action have been appropriately cautious. So this should not be taken as me complaining that FSOC needs to be acting more aggressively or moving more quickly.
Instead, I highlight all these quotes just by way of idly wondering how someone reading them in the early 2010s would have reacted to them. Would this person, whether a conservative who overheatedly thought FSOC was going to be a “Firing Squad On Capitalism”7 or a liberal who had high hopes for FSOC as a muscular new financial regulatory force, really have agreed that FSOC’s “vigor” was best measured by how many meetings it had held, how many white papers it had released, or even its analytical framework and process for designations (as opposed to designations themselves)?8
Apologies are again in order for the longer-than-typical interval between posts. The plan is to again start posting with more frequency this week, but in the meantime thoughts, challenges, or criticisms are always welcome at bankregblog@gmail.com. As always, thanks for reading!
Equal time: see responses to Coates from Cass Sunstein and Eric Posner and E. Glen Weyl.
To nitpick, I probably would have gone with something more modest than “potentially enormous” as the chosen description for the benefits of designation.
[F]ederal agencies generally acquiesce to adverse circuit court decisions within that circuit. Yet they do not necessarily acquiesce to such judgments in other circuits. To the contrary, there is a long practice of agency non-acquiescence to adverse circuit court decisions in the rest of the country. One of my favorite examples of this concerns the “migratory bird rule” defining the scope of regulatory jurisdiction under the Clean Water Act. After the U.S. Court of Appeals for the Fourth Circuit affirmed a district court holding that this rule was not properly promulgated, the Environmental Protection Agency and U.S. Army Corps of Engineers were precluded from relying on this rule when enforcing the CWA within the Fourth Circuit, but they continued to rely upon it throughout the rest of the country until (some twelve years later) the Supreme Court invalidated the rule on substantive grounds.
Of course, as Professor Adler goes on to explain, this isn’t necessarily how it works when the D.C. Circuit is involved.
As it happens, if one challenger has the ability to challenge an agency action in the D.C. Circuit, it is almost always the case that every challenger does. What this means is that once the D.C. Circuit has held that an agency action is unlawful, every other would-be challenger may rely upon the precedent in a challenge of their own, and those challenges will also occur in the D.C. Circuit. So once the D.C. Circuit upholds a challenge to an agency action and vacates or “sets aside” the agency action, as a practical matter it has been set aside or vacated for the nation as a whole (unless, of course, the D.C. Circuit decides to remand without vacatur…)
One other argument not discussed in the text above: in the proposed guidance, FSOC says that, even assuming cost-benefit analysis is required at some point, determining costs at the designation stage does not make sense.
Further, even if the potential cost of designation were a “risk-related factor,” the Council does not believe that prescribing a cost-benefit analysis prior to a determination under section 113 is useful or appropriate. … Generally, specific regulatory requirements for designated nonbank financial companies have been determined after the designation, in order to enable the requirements to be appropriately tailored to risks posed by the company. As such, evaluating the potential costs and benefits of a designation with reasonable specificity is not possible before a designation, and it is unlikely that performing a cost-benefit analysis for a nonbank financial company would yield a balanced picture.
This too was an argument rejected by the MetLife court, but on grounds that (you could argue) are not necessarily applicable here.
The Michigan dissent made the same argument, but it was rejected by the majority:
This line of reasoning contradicts the foundational principle of administrative law that a court may uphold agency action only on the grounds that the agency invoked when it took the action. SEC v. Chenery Corp., 318 U.S. 80, 87 (1943). When it deemed regulation of power plants appropriate, EPA said that cost was irrelevant to that determination—not that cost-benefit analysis would be deferred until later. Much less did it say (what the dissent now concludes) that the consideration of cost at subsequent stages will ensure that the costs are not disproportionate to the benefits. What it said is that cost is irrelevant to the decision to regulate.
Secretary Mnuchin turns things over to Chair Powell for his comments around the 06:30 mark.
Secretary Yellen turns things over to Chair Powell around the 14:40 mark.
A little less dramatic than then-Commissioner Piwowar’s polemic but still interesting to look back on is this commentary from now-SEC Commissioner Peirce, then in academia, in 2014.
FSOC's managerial problems would not be a big concern were it a toothless agency, but it has the power to remake companies across the financial system through designations and regulatory recommendations.
With the benefit of hindsight in 2023, how many companies would you say that FSOC has “remade”?
For example, here is the legislative director of Americans for Financial Reform in a 2011 interview on the first anniversary of Dodd-Frank.
Regulators are moving unacceptably slowly in other areas. … The new Financial Stability Oversight Council (FSOC) hasn’t designated even a single non-bank financial entity for oversight yet, even the largest and most obvious ones. Indeed, the FSOC in general has gotten off to a slow start. The Council and its associated research arm (the Office of Financial Research, or OFR) were supposed to be the “central brain” of the regulatory system, and the answer to the fragmentation in financial oversight that contributed to regulatory failures before the crisis. We have not seen much action that matters from the FSOC thus far, and the Office of Financial Research does not yet have a director and has only hired minimal staff so far. It’s hard to see how regulators will stay ahead of a constantly evolving financial system unless they coordinate their efforts and their information centrally. Open engagement with the public on these issues is also crucial.