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THE ARBITRARY AND INCONSISTENT 

NON-BANK SIFI DESIGNATION PROCESS 

HEARING 

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT 

AND INVESTIGATIONS 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

FIRST SESSION 

MARCH 28, 2017 

Printed for the use of the Committee on Financial Services 

Serial No. 115–10 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

PATRICK T. MCHENRY, North Carolina 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

LEE M. ZELDIN, New York 

DAVID A. TROTT, Michigan 

BARRY LOUDERMILK, Georgia 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MacARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

DAVID KUSTOFF, Tennessee 

CLAUDIA TENNEY, New York 

TREY HOLLINGSWORTH, Indiana 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

CHARLIE CRIST, Florida 

RUBEN KIHUEN, Nevada 

KIRSTEN SUTTON MORK, Staff Director 

(III) 

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

ANN WAGNER, Missouri, Chairwoman 

SCOTT TIPTON, Colorado, Vice Chairman 

PETER T. KING, New York 

PATRICK T. MCHENRY, North Carolina 

DENNIS A. ROSS, Florida 

LUKE MESSER, Indiana 

LEE M. ZELDIN, New York 

DAVID A. TROTT, Michigan 

BARRY LOUDERMILK, Georgia 

DAVID KUSTOFF, Tennessee 

CLAUDIA TENNEY, New York 

TREY HOLLINGSWORTH, Indiana 

AL GREEN, Texas, Ranking Member 

KEITH ELLISON, Minnesota 

EMANUEL CLEAVER, Missouri 

JOYCE BEATTY, Ohio 

MICHAEL E. CAPUANO, Massachusetts 

GWEN MOORE, Wisconsin 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

CHARLIE CRIST, Florida 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

March 28, 2017 ................................................................................................. 1 

Appendix: 

March 28, 2017 ................................................................................................. 31 

WITNESSES 

TUESDAY, MARCH 28, 2017 

Holtz-Eakin, Douglas, President, American Action Forum .................................. 4 

Kupiec, Paul H., Resident Scholar, American Enterprise Institute .................... 5 

Pollock, Alex J., Distinguished Senior Fellow, R Street Institute ....................... 9 

Zaring, David, Associate Professor, Legal Studies and Business Ethics, The 

Wharton School, University of Pennsylvania .................................................... 7 

APPENDIX 

Prepared statements: 

Holtz-Eakin, Douglas ....................................................................................... 32 

Kupiec, Paul H. ................................................................................................. 39 

Pollock, Alex J. ................................................................................................. 45 

Zaring, David .................................................................................................... 51 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Wagner, Hon. Ann: 

Written statement of the American Council of Life Insurers ....................... 64 

Written statement of the Property Casualty Insurers Association of 

America .......................................................................................................... 69 

Wall Street Journal Commentary by Adam J. White entitled, ‘‘Does ‘Too 

Big to Fail’ Mean Too Big for the Rule of Law?’’ ........................................ 75 

(1) 

THE ARBITRARY AND INCONSISTENT 

NON-BANK SIFI DESIGNATION PROCESS 

Tuesday, March 28, 2017 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON OVERSIGHT

AND INVESTIGATIONS, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:05 a.m., in room 

2128, Rayburn House Office Building, Hon. Ann Wagner [chairwoman of the subcommittee] presiding. 

Members present: Representatives Wagner, Tipton, Ross, Messer, 

Zeldin, Trott, Loudermilk, Kustoff, Tenney, Hollingsworth; Green, 

Cleaver, Beatty, Gottheimer, and Gonzalez. 

Ex officio present: Representatives Hensarling and Waters. 

Chairwoman WAGNER. The Subcommittee on Oversight and Investigations will come to order. 

Without objection, the Chair is authorized to declare a recess of 

the subcommittee at any time. 

Today’s hearing is entitled, ‘‘The Arbitrary and Inconsistent NonBank SIFI Designation Process.’’ 

The Chair now recognizes herself for 4 minutes for an opening 

statement. 

The financial crisis nearly 10 years ago was born as a result of 

poor government housing policy that encouraged excessive risk-taking at taxpayer expense, as well as an inability of financial regulators to properly identify systemic risk and promulgate appropriate regulations. 

As a response to the crisis, the Dodd-Frank Act doubled down on 

the failed approach and created a new super-regulator with enormous power, the Financial Stability Oversight Council (FSOC), 

which was tasked with identifying systemic risk. 

Additionally, Dodd-Frank enshrined too-big-to-fail. It enshrined 

its policy in creating a new group of entities called systemically important financial institutions (SIFIs), which are subject to enhanced prudential standards by the Federal Reserve after an FSOC 

designation. If the financial crisis taught us anything, it was that 

relying on government regulators in Washington to identify and 

root out systemic risk will always end in failure. 

Instead, government regulators should come up with responsible 

regulations that enforce market discipline and ensure that institutions are not excessively leveraging themselves at the risk of taxpayers. The CHOICE Act, which this committee is currently drafting, provides such a framework, not for deregulation, but for smartVerDate Nov 24 2008 17:54 Jan 08, 2018 Jkt 027251 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\27251.TXT TERI
2 

er regulation that will open up our economy, while ending taxpayer-funded bailouts and imposing tougher penalties on those who 

commit fraud. 

For a long time, the actions and deliberations of FSOC were a 

mystery. Most meetings, nearly two-thirds conducted by FSOC, 

take place in executive sessions that are closed to the public, even 

though FSOC’s governance documents encourage it to hold public 

meetings whenever possible. Additionally, FSOC meetings are 

closed to Members of Congress, as well as to regulators who are not 

FSOC members. 

And finally, there is very little documentation kept regarding 

meetings in executive session that the FSOC does convene, making 

it very difficult to determine the rationale behind FSOC decisions, 

which oftentimes have significant effects on the U.S. economy. 

For instance, reports show that the annual consumer cost of designating a non-bank financial institution as a SIFI could range 

from $5 billion to $8 billion. Yet, FSOC additionally fails to conduct 

any cost-benefit analysis when designating a firm as a SIFI. 

For this reason, the Oversight and Investigations Subcommittee 

began a review last Congress of the FSOC’s designations of nonbank SIFIs by obtaining non-public internal FSOC documents and 

soliciting testimony from FSOC officials. 

After analyzing these documents, we released a staff report last 

month which found the FSOC’s non-bank designation process to be 

arbitrary and inconsistent. First of all, the FSOC does not follow 

its own rules and guidance in many ways. The staff report also 

found that FSOC’s analysis of companies has varied among firms 

eventually designated and firms that FSOC chose not to designate 

in considering different factors and weighing some factors differently among different companies. 

Ultimately, the staff report verifies what we have already known: 

that Washington simply is unable to accurately identify and define 

systemic risk. Instead, government bureaucrats have acted very 

subjectively with very little transparency or accountability in exerting their power to the detriment of U.S. enterprises, their customers, and the economy in general. 

I now recognize the gentleman from Texas, the distinguished 

ranking member of the subcommittee, Mr. Green, for 5 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. And congratulations again on becoming the Chair of the subcommittee. 

Madam Chairwoman, in my opinion, a better title for this hearing would be, ‘‘Another repeal bill.’’ We have seen the financial crisis that almost brought this country to its knees, the Great Recession. I think it does merit some reflection so that we can better understand the crisis that caused Dodd-Frank to come into being. 

In 2008, financial institutions fell by the wayside. In 2008, Countrywide was bought out. Bear Stearns was bought out. IndyMac 

failed. Merrill Lynch was bought out. Lehman Brothers went bankrupt. AIG had an $85 billion rescue. Washington Mutual failed. 

And then on September 29th of 2008, we had the greatest 1-day 

decline in the stock market in history. 

Under the Bush request for a $700 billion bailout, at the time we 

were voting in the House of Representatives we could see the votes 

as they were being tallied. And as the votes were being tallied, we 

3 

could also see the stock market in the cloakroom. And as the votes 

were being tallied and the bill was going down, the stock market 

was going down as well. The stock market fell 777 points that day. 

Again, the greatest 1-day fall in the market ever. That 1-day decline caused billions of dollars to be lost. 

I remember how my constituents responded the day before we voted. My constituents wanted us to vote against the $700 billion 

bailout, as it was called. There were hundreds of calls from people 

who were opposed to the bailout. Constituents were concerned 

about taxpayer dollars being used. 

After the bailout, the next day the calls were in the hundreds, and they wanted to know why we failed to support the $700 billion 

bailout. Constituents have the luxury of being here today and there 

tomorrow. We in Congress have a responsibility to evaluate the evidence and come to reasonable and prudent conclusions. We did 

pass that $700 billion rescue bill. And that bill caused us to turn 

this economy around, along with some other things. 

But I remember the auto industry, that the ‘‘Big Three’’ were 

here, and they needed help. Many of my friends across the aisle 

said, ‘‘Let them fail.’’ Let them fail. It was a responsibility of Democrats to stand and protect the auto industry, and we did. 

Democrats have been the party of, ‘‘Yes, we can.’’ Our friends 

across the aisle have been the party of, ‘‘No, we can’t.’’ The latest 

indication is what happened with health care. The party of repeal 

voted more than 60 times in one way or another to repeal the Affordable Care Act, had the perfect plan. For 7 years, they have had 

a perfect plan to replace the Affordable Care Act. But when it was 

time to produce, when it was time to build as opposed to repeal, 

they could not produce. They could not replace. They are very good 

at repealing, but very poor at replacing. 

So today, on the heels of the failure to repeal and replace—they 

could have repealed it to find a replacement—we have yet another 

opportunity for them to repeal. They want to repeal the Consumer 

Financial Protection Bureau (CFPB), the bureau that is designed 

to protect consumers, they would repeal it. They now want to repeal the economic disaster prevention agency. It is called FSOC, 

but it is there to prevent another AIG. And it did so with G.E. 

This bill will do more repealing than replacing. I am against it, 

and I am going to stand up for Dodd-Frank. 

I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the Vice Chair of the subcommittee, 

the gentlemen from Colorado, Mr. Tipton, for 1 minute for an opening statement. 

Mr. TIPTON. Thank you, Chairwoman Wagner. 

It is incredibly concerning to learn that the counsel and its staff, 

while evaluating institutions for potential SIFI designation, failed 

to heed their own guidance, inconsistently applied criteria to firms, 

and fundamentally misunderstood what could cause financial distress in non-bank institutions. 

Further, it is disturbing to read that the designation process was 

often conducted on an ad hoc basis with no clear guidance for 

FSOC or its staff and little hard evidence to justify designation decisions. These critiques do not come from the committee alone. Last 

4 

year, the D.C. circuit court overturned a SIFI designation based in 

part on the failure of FSOC to conduct a cost-benefit analysis. 

A recent GAO report came to similar conclusions, finding that 

the FSOC did not develop a process for identifying specific criteria 

to apply to analytical framework in evaluating companies. Yet 

again, we find regulators are quick to regulate, but slow to analyze. 

I look forward to learning more in this hearing about ways to reform the designation process to encourage a data-driven approach. 

Thank you, and I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

We now welcome our witnesses. First, Dr. Doug Holtz-Eakin is 

currently the President of the American Action Forum. He has previously served as Chief Economist of the President’s Council of Economic Advisers as well as Director of the Nonpartisan Congressional Budget Office, and as a Commissioner on the Financial Crisis Inquiry Commission. 

With that, Dr. Holtz-Eakin, you are now recognized for 5 minutes. 

STATEMENT OF DOUGLAS HOLTZ-EAKIN, PRESIDENT, 

AMERICAN ACTION FORUM 

Mr. HOLTZ-EAKIN. Thank you, Chairwoman Wagner, Ranking 

Member Green, and members of the subcommittee. It is a privilege 

to be here today to discuss the non-bank SIFI designation process. 

I want to make three simple points, and then I look forward to 

your questions. 

First, as the staff report makes clear, there are deep weaknesses 

in the FSOC’s designation process. But I would emphasize that 

even if there was a good process, there is a mistaken emphasis on 

designating financial institutions as opposed to the activities and 

instruments that they that they operate. 

The second is that the designation process has costs, it has consequential cost for the firms, for their customers and for the economy as a whole, and it is a mistake to ignore these costs in making 

the designations. 

And the third main point is that, thus far, only insurance companies have been designated as non-bank SIFIs, and I would urge the 

committee to consider removing the FSOC’s authority to do so as 

it appears to be redundant at best. Let me expand on each of those. 

First, with regard to the process, as the committee knows, there 

are three stages in the designation process. Stage one consists of 

essentially a series of quantitative flags that the FSOC staff checks 

to see if a firm qualifies. And then it moves to stage two, without 

the firm knowing it, to undertake an analysis that is based on size, 

leverage, interconnectedness, liquidity and maturity mismatch, 

substitutability, and the existing regulatory apparatus surrounding 

that firm. 

As the report makes clear, it is not at all obvious what weights 

are attached to each of these factors. It is pretty clear that they are 

applied differently to different firms and that there is anything but 

a systematic process by which firms are designated. 

And then in stage three, it is an in-depth analysis of a firm and, 

as I emphasized at the outset, the focus on firms is a mistake in 

5 

the FSOC to begin with and, thus, it repeats this mistake in the 

final stage of its analysis. 

The second main point is that there are costs associated with 

this, and I would emphasize there some economic costs. In the 

same industry, you will have non-bank SIFIs designated for a higher standard of regulation and the costs that come with it. That produces an un-level playing field for competition and financial services. It is also true that across the globe, U.S. firms will be at a 

disadvantage in competing for global markets. These are all important costs to consider. 

The Oliver Wyman study that was mentioned by the chairwoman 

indicates that a single non-bank SIFI designation could cost consumers somewhere between $5 billion and $8 billion. And that is 

a cost that the courts have indicated that the FSOC should take 

into consideration, and it has simply failed to do so. 

And the last point is, what should be the path forward? First and 

foremost, I think it is important for the FSOC to move away from 

a focus on designating firms as systemically important and instead, 

undertake an activities-based analysis. It has indicated its interest 

and willingness to do so, but it now has an inconsistent approach 

across industries. That doesn’t make a lot of sense. 

And with regard to the non-bank SIFIs that have been designated thus far, as I mentioned, they are all insurance companies. 

And if you look at the way the designation process is played out, 

essentially what they have done is taken these insurers and imposed on them a second round of essentially prudential safety and 

soundness type regulation. Each of these insurers has a consolidated regulator at the State level. 

The report indicates that these regulars were not consulted adequately. Going forward, it looks as if the FSOC is essentially imposing simply a second layer of the same kind of regulation. It is 

not obvious that makes a lot of sense. And we may want to think 

about removing the FSOC’s capacity to designate, at a minimum, 

insurance companies and perhaps rethinking the designation process as a whole. 

So I look forward for the chance to answer your questions, and 

I thank you for the privilege of being here today. 

[The prepared statement of Dr. Holtz-Eakin can be found on 

page 32 of the appendix.] 

Chairwoman WAGNER. I thank the witness. 

Our next witness is Dr. Paul Kupiec. Dr. Kupiec is a resident 

scholar at the American Enterprise Institute. Prior to that, Mr. 

Kupiec was Director of the Center for Financial Research at the 

FDIC, as well as Chairman of the Research Task Force of the Basel 

Committee on Banking Supervision. 

Dr. Kupiec, you are now recognized for 5 minutes. 

STATEMENT OF PAUL H. KUPIEC, RESIDENT SCHOLAR, 

AMERICAN ENTERPRISE INSTITUTE 

Mr. KUPIEC. Chairwoman Wagner, Ranking Member Green, and 

distinguished members of this subcommittee, thank you for convening today’s hearing. 

In my oral remarks, I will summarize my written testimony, and 

I will use a simple analogy from everyday life. On my commute 

6 

home, I drive west on K Street. If I see a flash of light as I approach the 22nd Street underpass, I instinctively check my speedometer, remember the 25-mile-an-hour speed limit, and try to 

guess whether it was my car that triggered the speed camera. 

Now imagine that you are a CEO of a large, successful, non-bank 

financial firm. One day you receive an e-mail from the FSOC saying that your institution is selected for a stage-three FSOC review. 

Stage-three review, you ask, who even knew the FSOC put us 

through a stage-two review? Your institution is profitable, well-capitalized, and growing. Your State regulators, and you have regulators in every State where you do business, have given you a clean 

bill of health. Your staff has no idea why the FSOC picked you. 

Keeping now with my speeding ticket analogy, ask yourself, is 

there a speed limit for the institution? How fast is the firm actually 

going? How fast does the FSOC think the firm is going? Where can 

the institution find out answers to these questions? The situation 

becomes more surreal when you discover that there are no definite 

answers to any of these questions. 

The FSOC has the power to set individual speed limits for each 

and every non-bank financial institution under its jurisdiction. 

Moreover, the FSOC does not have to disclose your institution 

speed limit to your institution, even if you pay your white-shoe law 

firm to make a formal request. They don’t have to tell you. 

More troubling, the FSOC is the only agency authorized to measure the speed of non-bank financial institutions. And now you, as 

a target of a stage-three review, the FSOC scientists are already 

measuring your institution’s speed using an unknown process and 

without any impartial witnesses present. If this nightmare of jurisprudence reminds you of a ‘‘Twilight Zone’’ episode, it is called, 

‘‘The Dodd-Frank Act.’’ 

I could mention specific troublesome details of the FSOC stagetwo and stage-three designation decisions, and I do so in my written testimony. But the bottom line is, the subcommittee’s report 

shows the FSOC has no common methodology or uniform standards 

or assumptions that are used in individual firm SIFI designations. 

Each FSOC designation decision is an outcome of an ad hoc process. The lack of standardization means that identical firm characteristics can be and have been evaluated differently in different 

FSOC designation cases. 

An example will bring clarity to this problem. Say that the FSOC 

staff separately examines two firms with nearly identical characteristics. Let’s call these two firms equally tall. They are firm one 

and firm two. In examining firm one, the FSOC staff decides that 

firm one is a safe firm because of its height; it can reach the high 

fruit on trees and it will never starve. The FSOC concludes that 

firm one is not a SIFI. 

In a separate case and time, the FSOC examines firm two and 

decides that tall firm two is risky because it is at risk of being 

struck by lightning. FSOC decides the tall firm two is a SIFI. If 

this designation process sounds unjust, it is. But can’t firm two appeal the FSOC’s decision? Yes, it can, but remember, only some 

FSOC SIFI designation decisions are made public. There is no public record of FSOC decisions unless a firm is actually designated. 

7 

So, tall firm two has no idea of the processes and arguments the 

FSOC used to evaluate tall firm one, nor does it even know that 

the FSOC evaluated tall firm one. Tall firm two lacks the case law 

it needs to defend itself against an FSOC designation. While I have 

purposely omitted technical jargon, I have not exaggerated the 

deep-flawed nature of the Dodd-Frank FSOC designation process. 

I myself doubt there is a need for an FSOC SIFI designation 

process. But even if you would disagree with me on this point, I 

still doubt you would defend the current FSOC process as a legitimate way to go about making SIFI designations. 

The subcommittee has done invaluable work acquiring and analyzing confidential FSOC records that have made transparent the 

flaws in the FSOC designation process. The process is arbitrary 

and broken. It should be repealed or, at a minimum, fundamentally 

reformed. 

Thank you very much, and I look forward to your questions. 

[The prepared statement of Dr. Kupiec can be found on page 39 

of the appendix.] 

Chairwoman WAGNER. I thank the witness for his testimony and 

analogies that I can very much relate to. My apologies for your 

waiting in the rain to get in, Mr. Kupiec, but we are so glad that 

you are here. 

Our next witness is Professor David Zaring. Professor Zaring is 

an associate professor of legal studies and business ethics at the 

Wharton School. Previously, Professor Zaring was with the Washington Lee University School of Law, the New York University 

School of Law, and he clerked on the U.S. Court of Appeals for the 

D.C. circuit. 

Professor Zaring, you are now recognized for 5 minutes. 

STATEMENT OF DAVID ZARING, ASSOCIATE PROFESSOR, 

LEGAL STUDIES AND BUSINESS ETHICS, THE WHARTON 

SCHOOL, UNIVERSITY OF PENNSYLVANIA 

Mr. ZARING. Chairwoman Wagner, Ranking Member Green, 

thank you for inviting me. 

At Wharton, I study financial regulation, and I have written an 

article on the administrative procedure of the Financial Stability 

Oversight Council with Daniel Schwartz, who is a professor at the 

University of Minnesota. That article is forthcoming in the University of Chicago Law Review. 

And in my testimony on the procedures followed by the FSOC 

today, I want to focus on three points and make a few additional 

observations. First, the report prepared by the Republican staff of 

the Committee on Financial Services subjects the Council to a degree of after-the-fact review that is inconsistent with the flexibility 

Congress gave the Council in the Dodd-Frank Wall Street Reform 

Act. 

In that statute, Congress charged the Council with designating 

non-bank financial companies as systemically significant on the 

basis of, among other things, a ten-factor test; it did not specify 

how those factors should be weighed, and it emphasized that the 

Council should apply ‘‘any other risk-related factors that the Council deems appropriate’’ to its designated decisions in addition to 

those identified in the statute. 

8 

The Republican staff report identifies portions of the written 

memoranda of the Council, where it emphasizes some safety and 

soundness factors more heavily than it did other factors. It also 

identifies cases where the Council considered the riskiness of a financial institution as a general matter as indicative of the risk institution would pose when the economy was stressed. 

There is nothing arbitrary about emphasizing some factors more 

than others in such circumstances, nor is it arbitrary to presume 

that a non-bank, risky in normal conditions, would also be risky 

when times are difficult. 

Second, the report, while a real contribution into how the Council 

makes decisions, attempts to isolate particular aspects of the Council’s analysis and makes arguments about inconsistency based on 

those aspects. But this sort of picking and choosing is really not 

consistent with the way that FSOC designations work. 

The designation decision is meant to be a holistic one, utilizing 

a number of different factors in a way that enables the Council to 

consider a full picture of any particular non-bank’s position and of 

the effect that stress in that non-bank would have on the broader 

financial markets and greater economy as a whole. 

FSOC has its constraints. It can only act given a super majority 

of its members, it can only designate financial companies as that 

term is defined in Dodd-Frank, and it must revisit all of its designations annually. These constraints are real and they cabin the 

ability of the Council to go rogue. 

But the factors that Congress told it to consider when it is making any particular determination decision of those institutions that 

fall within its jurisdiction are, by a necessity and sensibly, broad 

and open to interpretation. 

Third, the Council itself has been given the responsibility for taking a broad view of the safety of the financial system and it is the 

only part of the Federal Government with the power and the capability to do that. It has chosen to make designations in a manner 

that makes it possible to revisit those designations. Only the three 

largest insurance companies in America have been designated as 

systemically significant, as well as one large financing company. 

But it is important that the Council retains its flexibility to adjust its assessments of risk in the future. Second-guessing small 

portions of large decisions is inconsistent with the necessary flexibility that Congress gave the Council. 

Finally, the costs of designation are real, but they are easy to 

overstate. While G.E. Capital transformed itself in an effort to 

move away from designation, it is clear that there were business 

judgment reasons to restructure the company anyway. And it is important to remember that FSOC rescinded the designation of that 

company. As the CEO of AIG has observed, designation ‘‘just simply isn’t a binding constraint on our capital returns and our objectives, so we don’t spend too much time worrying about it.’’ 

For that insurance company, designation has not been a burden, 

but rather a regulatory requirement that has not imperiled its 

business or its ability to make plans in the future. FSOC has only 

designated four companies. It has removed one of those designations. There are two designations that are currently active and one 

of them is an extremely large insurance company, and the other is 

9 

AIG, the company that collapsed so spectacularly during the financial crisis. 

There is no indication right now that more designations are contemplated. That does not look like arbitrary exercise of government 

power. Instead, to me, it looks quite cautious indeed. And it certainly doesn’t look entirely subjective. 

With that, I thank the subcommittee, and I look forward to your 

questions. 

[The prepared statement of Professor Zaring can be found on 

page 51 of the appendix.] 

Chairwoman WAGNER. Thank you, Professor Zaring. 

Our final witness today is Mr. Alex Pollock. Mr. Pollock is a distinguished senior fellow at the R Street Institute. Previously, Mr. 

Pollock was with the American Enterprise Institute, and was president and CEO of the Federal Home Loan Bank of Chicago. 

Mr. Pollock, you are now recognized for 5 minutes. 

STATEMENT OF ALEX J. POLLOCK, DISTINGUISHED SENIOR 

FELLOW, R STREET INSTITUTE 

Mr. POLLOCK. Thank you, Madam Chairwoman, Ranking Member Green, Vice Chairman Tipton, members of the subcommittee, 

and full Financial Services Committee Chairman Hensarling. 

To begin with, let me compliment the committee staff for their 

detailed specific paper on FSOC’s non-bank designation process. 

This embodies what I think is a very good analytical idea, namely 

to compare the FSOC evaluation memoranda against each other, to 

measure their consistency. The comparison shows they have been 

characterized by multiple inconsistencies and anomalies, as we all 

agree. 

The paper says these examples cast doubt on the fairness of 

FSOC’s designation process. They do, but, in my opinion, a more 

important point than fairness is that these observations cast doubt 

on the objectivity of the FSOC’s work. 

As we know, Federal District Judge Rosemary Collyer ruled that 

FSOC’s MetLife action was ‘‘arbitrary and capricious,’’ strong 

words, and that FSOC ‘‘hardly adhered to any standard when it 

came to assessing MetLife’s threat to U.S. financial stability.’’ This 

sound and sensible judicial decision was appealed by the previous 

Administration. 

I believe the current Treasury Department should immediately 

request the Department of Justice to withdraw the appeal and the 

Department of Justice should do so as soon as it can. 

Just today, the Treasury Department received a letter from 10 

members of the Senate Banking Committee, including the chairman, which says, in part, the FSOC’s process for designating nonbank SIFIs ‘‘lacks transparency and accountability, insufficiently 

tracks data, and does not have a consistent methodology.’’ So we 

seem to have the two Chambers tracking together here. 

Going back to the FSOC designation, the independent member of 

FSOC, Roy Woodall, who is a true expert in insurance, voted 

against the SIFI designation of MetLife, objecting that ‘‘the analysis relies on implausible, contrived scenarios.’’ Well, implausible, 

contrived scenarios are what we don’t want. 

10 

Ed DeMarco, a distinguished financial regulator, joined Mr. 

Woodall’s earlier dissent on Prudential and also pointed out that 

key FSOC arguments lacked evidence. We certainly do want evidence. 

Was there a substantive discussion among the members of FSOC 

about these issues? I am told that there was not. But the whole 

point of FSOC is supposed to be a committee for deliberation and 

development of insights together in discussion. 

I directly asked one former senior FSOC insider from the previous Administration if the meetings of the FSOC members had 

ever produced a new insight into financial issues. After thinking a 

minute, he gave me a candid answer: no. The underlying problem, 

it seems to me, is the structure of the FSOC itself. 

So the procedural issue leads us to a bigger structural issue. The 

shortcomings of designation point us to the question: what about 

the FSOC itself? We know they are primarily a group of individuals, each from a regulatory agency, each with turf to protect from 

intrusions by the others and a regulatory record to defend. At the 

meetings, they bring along helpers and allies. At the FSOC meeting that approved the MetLife SIFI designation, there were, according to its minutes, 46 people sitting around the room. I don’t think 

they had a serious give-and-take, substantive discussion with 46 

people. 

The composition of the FSOC makes it a necessarily political 

body. That is why FSOC’s evaluations tend to make inconsistent 

analyses. It is because the decisions made are inherently 

judgmental with inherently subjective elements. 

We might call those ‘‘holistic,’’ Professor Zaring. 

What that means is FSOC actually acts as a little legislature, 

and I think that is a bad idea. 

Madam Chairwoman, you mentioned Fannie Mae and Freddie 

Mac, which are obviously systemically important and, without 

question, systemically extremely risky. But Fannie Mae and 

Freddie Mac are never studied as possible SIFIs by the FSOC staff 

in spite of the fact that they obviously are SIFIs. Why not? Because 

the Secretary of the Treasury controls who gets studied and would 

not allow the staff to look at Fannie and Freddie, even though they 

are pure cases of the government shielding creditors and counterparties from losses, not only as a hypothetical, but as a vast fact. 

Protecting creditors in this fashion is something that the DoddFrank Act instructs FSOC to eliminate. 

So FSOC needs some immediate actions on its procedural issues, 

as we have discussed. But it also needs structural reform for the 

longer term. 

Thank you very much for the chance to share these views. 

[The prepared statement of Mr. Pollock can be found on page 45 

of the appendix.] 

Chairwoman WAGNER. I thank all four of our witnesses. 

And without objection, the witnesses’ full written statements will 

be made a part of the record. Each member of the subcommittee 

will now have 5 minutes within which to ask questions. 

The Chair now recognizes herself for 5 minutes. 

11 

Dodd-Frank, in directing the FSOC to identify systemic risk, 

tasked a number of prudential financial regulators, such as the 

Federal Reserve, the FDIC, and the OCC, as members of FSOC. 

Mr. Pollock, since you arrived first, I would like to first start off 

in asking how these financial regulators have fared in the past in 

identifying risks to the financial stability of the United States? 

Mr. POLLOCK. Thank you, Madam Chairwoman. Of course, they 

haven’t done very well. I was just reading two wonderful 

quotations from the then-Chairman and the current Chairman of 

the Federal Reserve from the end of 2007 and January 2008, forecasting that there would not be a recession at that point. Of course, 

as we know, the recession had already started. We have numerous 

examples of regulators failing to see the disaster that was coming, 

as other people and other forecasters failed to see it. 

Because the financial future, in particular, is inherently uncertain, we certainly can’t put faith in any bureaucratic bodies to protect us from that. Personally, I would prefer to put faith in higher 

capital. 

Chairwoman WAGNER. Thank you. 

Dr. Holtz-Eakin, I would like to follow up on this as well in asking if there is a simple way to measure systemic risk? 

Mr. HOLTZ-EAKIN. There is not; in fact, there is no agreement on 

exactly how to measure it and what it looks like. If you can’t measure something, you can’t manage it. And it is far from obvious what 

the FSOC is trying to do in those circumstances. I think that is a 

fundamental flaw in the entire idea behind the FSOC. 

Chairwoman WAGNER. If you can’t measure it, you can’t manage 

it. How then can Congress evaluate whether the FSOC is properly 

performing its job? 

Mr. HOLTZ-EAKIN. The only way to evaluate the FSOC would be 

to get some transparency about its procedures so that it at least 

does whatever it is doing the same way every time and to everybody. And all the evidence we have thus far is that it is not doing 

that. 

Chairwoman WAGNER. Another issue, I believe, that impedes 

Congress from evaluating whether FSOC is performing its job is 

simply the lack of information and transparency from the Council. 

From our previous work on this committee, we have known the 

FSOC to be one of the least transparent Federal entities, providing 

very little oversight for Congress and the public into the deliberations of Council meetings. 

These are quick, and we will switch it up. 

Dr. Kupiec, I will start with you. It wasn’t until the release of 

this committee’s staff report that we started to actually see the rationale, and in many instances, lack of rationale, for the decisions 

made by the FSOC. Dr. Kupiec, should the FSOC be made more 

transparent? 

Mr. KUPIEC. I think the subcommittee report makes it very clear 

that transparency is long overdue. I think from the designations, 

from the public documents we saw associated with the various designations, there were strong suspicions that the FSOC decides on 

a designation and kind of makes up a story afterwards to justify 

it. It is, sort of, an attempt at writing financial fiction. 

12 

What I think we have seen with the subcommittee’s report where 

it actually goes through and analyzes the stage-two documentation 

that was not publicly available or known to anyone is in fact this 

whole characterization, that it is an after-the-fact story made up to 

justify a decision or a non-decision to designate I think comes out 

very clearly in the subcommittee report. 

Chairwoman WAGNER. Let’s go down the line, starting with Dr. 

Holtz-Eakin, all four of you, yes or no, should the FSOC publicize 

its internal process? 

Mr. HOLTZ-EAKIN. Yes. 

Mr. KUPIEC. Yes. 

Mr. ZARING. No. 

Mr. POLLOCK. Yes. 

Chairwoman WAGNER. Should FSOC allow observers at its meetings, such as participants from member agencies or Congress? 

Mr. HOLTZ-EAKIN. Yes. 

Mr. KUPIEC. Absolutely. 

Mr. ZARING. No. 

Mr. POLLOCK. Strongly yes. 

Chairwoman WAGNER. Should FSOC keep detailed minutes and 

transcribe their meetings, like the Fed’s Federal Open Market 

Committee does? 

Mr. HOLTZ-EAKIN. Yes. 

Mr. KUPIEC. Yes. 

Mr. ZARING. No. 

Mr. POLLOCK. Yes, it would be a good idea. 

Chairwoman WAGNER. I thank you all. 

While our committee is considering broader reforms and changes 

to the structure and powers of FSOC, what are some other actions 

that Treasury Secretary Mnuchin could make right now at FSOC, 

to bring more transparency and accountability to its action? 

Dr. Holtz-Eakin? 

Mr. HOLTZ-EAKIN. I think that FSOC showed some improvement 

with its 2015 guidance, and Secretary Mnuchin could pursue greater transparency and greater consistency in its actions. 

Chairwoman WAGNER. Dr. Kupiec? 

Mr. KUPIEC. I think since systemic risk is such an elusive construct and really can’t be identified, in my opinion, that the FSOC 

ought to move towards specific thresholds and evaluate firms along 

guidelines that are observable and can be defended or not. 

Chairwoman WAGNER. Thank you. My time has expired. 

The Chair now recognizes Mr. Cleaver for 5 minutes. 

Mr. CLEAVER. Thank you, Madam Chairwoman, and Ranking 

Member Green. 

Mr. Kupiec, I do analogies in my real life quite a bit. And so I 

was struck by your analogy of the traffic light catching somebody 

for speeding and getting a ticket for speeding. And then you compared that with the non-bank financial firm suddenly getting a notice of a stage-three evaluation. Did I restate your analogy correctly? 

Are you aware that the Council published supplemental procedures with 17 changes and a larger, increased transparency in the 

designation process? Are you aware that they did that? 

13 

Mr. KUPIEC. Yes, I am aware that following testimony in the Financial Services Committee, which is very critical of the FSOC’s 

process, they did publish some changes and try to improve transparency, yes. 

Mr. CLEAVER. But no matter why they did it, they did it, right? 

Mr. KUPIEC. But they didn’t do it out of their own good will. That 

would matter. 

Mr. CLEAVER. Okay, you don’t know why they did it. You have 

no idea. You have absolutely no idea why they did it. All we know 

is that they did it in 2015. And you said transparency is long overdue, 2015. Now, how do you know that you know why they did it? 

Mr. KUPIEC. I testified in the hearings that led up to the—maybe 

I am mistaken, but that would be my judgment, that— 

Mr. CLEAVER. Okay, and that is fine. That is judgment, and I 

like judgment, except if it has ‘‘they’’ on the end of it. But the point 

I am trying to make is that you are calling for transparency, and 

we have had transparency. And that is just a little confusing. Have 

you looked at the website? 

Mr. KUPIEC. Excuse me? 

Mr. CLEAVER. Have you looked at the FSOC website? 

Mr. KUPIEC. Yes, sir. I have read the designation decisions. 

Mr. CLEAVER. Yes, and you also know— 

Mr. KUPIEC. And the court court cases, the MetLife court case. 

Mr. CLEAVER. And you know they detailed the criteria they use 

in stage one— 

Mr. KUPIEC. Yes, in fact I was involved in the stage-one designation process when I was at the FDIC as the head of the economics 

group there. 

Mr. CLEAVER. But you know that is on the website, don’t you? 

Mr. KUPIEC. Yes. 

Mr. CLEAVER. Okay. I don’t understand the ‘‘pants on fire,’’ which 

was your testimony. Then you are now admitting that they have 

a transparent—Professor Zaring, can you confirm that FSOC announced that they will notify a company within 30 days of activating a review in stage two? 

Mr. ZARING. That is right. They have this elaborate three-stage 

process, and if they take a company into the third stage of that 

process, the company has every opportunity and so far, as far as 

I know, has taken every opportunity to interact with the Council 

in either fighting or responding to an inquiry by the Council that 

suggests that the stage-three review is beginning. That includes 

meeting with Council members, turning over documents to the 

Council. 

The Council vote is public, of course, after which comment and 

a hearing can be or—the tentative decision is public, of course, 

after which the designated institution can provide comments. There 

is an opportunity for a public hearing. I think there is a great deal 

of process attached to this designation decision. 

Mr. CLEAVER. And then stage two, Professor Zaring, do the companies have the opportunity to present information to the Council? 

Mr. ZARING. They do after a stage three. In stage two, the Council tries to figure out which companies to ramp up to this adversarial determination. 

14 

Mr. CLEAVER. I am trying to figure out this lack of transparency, 

just that people are going into bunkers to do business. I don’t understand this. 

Mr. ZARING. I agree. To me, the Council is providing the very few 

institutions that it has designated with a strong amount of process. 

Mr. CLEAVER. Thank you very kindly. I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the gentleman from Colorado, Mr. Tipton, the Vice Chair of the subcommittee, for 5 minutes. 

Mr. TIPTON. Thank you, Chairwoman Wagner. 

Dr. Kupiec, when the FSOC is conducting an assessment on an 

institution’s potential for creating systemic risk, does the Council 

consider the existing supervisory process regulating that entity? 

Mr. KUPIEC. They are supposed to consider the supervision and 

regulation in place, but I would say the designation decisions that 

have been made thus far do not take account of those in any way. 

Mr. TIPTON. Thank you. How were the current non-bank SIFI 

firms supervised then prior to their designation? 

Mr. KUPIEC. AIG was actually supervised by a primary Federal 

regulator, the Office of Thrift Supervision, actually, and State insurance commissioners in all the States that AIG does business. 

And the other insurance companies, all their insurance subsidiaries 

are supervised by the State insurance regulators. And some of the 

designated SIFIs, at one time, had bank subsidiaries which were 

supervised by both State regulators and a Federal regulator. It varies case by case. 

Mr. TIPTON. Now, have these regulators raised issues about financial health or safety of the current SIFI non-bank institutions 

prior, during, or after their designation? 

Mr. KUPIEC. The short answer is no, I am not aware of that. 

AIG, of course, did get in trouble in the financial crisis, but I am 

not aware that it was under any kind of warning signs from the 

Office of Thrift Supervision. I think they basically weren’t really 

looking at AIG. They were the ones responsible for the Financial 

Products Group in London, which was actually the part of the firm 

that wasn’t supervised by a State insurance regulator. And that is 

the part that caused the troubles. 

Mr. TIPTON. So just to be clear, the whole series of regulators are 

lined out, going through, they have raised no concern about the 

health, the safety of the institutions that were in place going forward. But now with the FSOC going in, we are seeing them choosing to designate? 

Mr. KUPIEC. Yes, and the designations for the insurance companies, the way the FSOC makes it, is very unusual in that it treats 

the products of insurance companies as if they were bank depositlike liabilities that could be withdrawn, that people would line up 

and withdraw the residual value of their life insurance policies or 

whatever. And they are not bank deposit-like products, and there 

is really no evidence that there have been any institution-wide 

runs on all the various subsidiaries at any time in the past. 

So the story is a very fictional story that the FSOC uses to make 

the designation. 

Mr. TIPTON. Now, did the FSOC do any sort of cost-benefit analysis as part of the SIFI designation process? 

15 

Mr. KUPIEC. None that I am aware of and none that they specifically state in public documents. And their opinion is that they don’t 

have to, is their opinion in the legal case, that they are not required to make any cost-benefit analysis. 

Mr. TIPTON. In your opinion, does this undermine the credibility 

of the FSOC’s conclusions, the fundamental aspects of the assessment process are flawed, and the impact of its SIFI designation 

was not extensively studied prior to the beginning of the designations? 

Mr. KUPIEC. I don’t think the FSOC or anybody has the capacity 

to scientifically that identify one firm is a SIFI and another firm 

isn’t a SIFI. I do not think the science of statistics or economics or 

finance is sufficiently advanced that you can definitively separate 

out firms into those that are a source of systemic risk and those 

that aren’t until perhaps after they blow up. 

But ahead of time, I don’t have any confidence that regulators 

have that ability, or any academic or any person anywhere at this 

point in the science of risk measurement. 

Mr. TIPTON. Thank you. 

Mr. Pollock, I gather you agree with Mr. Woodall’s conclusions in 

regards to designation of MetLife and Prudential. Why is that really important? Is it important to be able to have somebody who actually has experience in an industry playing a role in these designations? 

Mr. POLLOCK. Congressman, I think to have somebody who actually is an expert in the industry is extremely important. And Mr. 

Woodall’s dissents, in my opinion, were very articulate and substantive. 

Mr. TIPTON. Once a firm is designated as a SIFI, they are overseen by the Federal Reserve Board. How much experience does the 

Federal Reserve have in insurance regulation? 

Mr. POLLOCK. Very little, and it certainly by no means could be 

considered an expert. 

Mr. TIPTON. Thank you. 

And, Madam Chairwoman, my time has expired. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the gentleman from Texas, Mr. Gonzalez, for 5 minutes. 

Mr. GONZALES. I will be yielding the balance of my time to Representative Al Green. 

Mr. GREEN. Thank you for yielding, and thank you for being such 

an outstanding member of the committee. We greatly appreciate 

your service. 

Let’s start with Mr. Holtz-Eakin. Sir, you talked about the cost 

of designating a bill as a SIFI. And I think that is worthy of consideration. But what about the cost of not designating an entity as a 

SIFI? AIG was not designated as a SIFI and AIG cost the country 

a good deal of stress, an $85 billion rescue effort, and it was paid 

back by the way. Don’t you think that the cost of not doing it is 

important, as well? 

Mr. HOLTZ-EAKIN. If we could, as a matter of science— 

Mr. GREEN. Let’s examine that, if we could. Because we can’t do 

it perfectly, we should not do it at all, seems to be your thought 

processes. But it seems to me that FSOC is working. FSOC, by the 

16 

way, is the economic disaster prevention agency. It is in business 

to look over the economy and to spot these AIGs. 

By the way, Mr. Kupiec, how was AIG regulated? 

Mr. KUPIEC. AIG was an international insurance company— 

Mr. GREEN. Okay, it was an insurance company. You seem to 

have some concern about insurance companies being regulated. 

AIG is the ultimate example of why we have to regulate some of 

the insurance companies, some of them, not all of them, some of 

them. Let me move on. 

Mr. KUPIEC. AIG was regulated. 

Mr. GREEN. Excuse me, let me move on. I am going to my next 

witness, if I may, please. 

Mr. Zaring, is this economic disaster prevention commission, if 

you will, is it working? 

Mr. ZARING. So far, since the passage of Dodd-Frank, we haven’t 

had a financial crisis, despite the fact that around the world there 

has been plenty of financial turmoil. There is every reason to believe that financial institutions, especially non-banks, are more solvent and have better protections in place for a crisis. And I think 

a lot of that has to do with the fact that they know that FSOC is 

watching. 

So FSOC is being very cautious about its designations, but because it has the power to reach out and get risky behavior by financial institutions, it has had a salutary effect on those institutions as a whole. 

Mr. GREEN. And can you give an example of not only designation, 

but also de-designation? Because FSOC has the ability to designate 

and it has the ability to allow a company to take the necessary 

steps to eliminate risk and de-designate. Can you respond, please? 

Mr. ZARING. That is right. In the case of G.E. Capital, the firm 

was designated, and it was engaged in lots of marketplaces, which 

meant that a lot of its financing was very runnable. Financing and 

insurance companies also do practices like securities lending, and 

get into markets where the financial assets and stake in those markets are runnable as well. 

So G.E. Capital transformed itself from an institution that relied 

on these runnable assets for financing into a much more stable institution that did not. And the Council responded by revoking the 

designation. It has an annual responsibility to review every designation for revocation, and there is every indication that FSOC 

takes that responsibility very seriously. 

Mr. GREEN. As a matter fact, looking at G.E. Capital, they were 

into consumer credit. They had a consumer credit arm. They had 

a commercial lending business. They had a real estate assets business. They had online deposits. They had an asset management 

arm. They had hotel financing. They had restaurant financing. 

They had transportation financing. They had health care financing. 

They were all over the place. 

Mr. ZARING. Right, and I might add that it didn’t seem to me 

that G.E. Capital was well-supervised by any regulator, given all 

these various and potentially risky businesses it was in. FSOC provided a backstop that I think was an important source of stability 

in the way that it supervised G.E. Capital and persuaded it to 

17 

change its business in, I think, ways that were good for the American economy. 

Mr. GREEN. Does that cause you to hearken back to AIG and how 

it was regulated and supervised? 

Mr. ZARING. Big companies like AIG can get involved in new and 

creative markets with levels of risk that they don’t really understand. FSOC is a barrier against that kind of thing. 

Mr. GREEN. Thank you. I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the gentleman from Tennessee, Mr. 

Kustoff, for 5 minutes. 

Mr. KUSTOFF. Thank you, Madam Chairwoman. 

Dr. Holtz-Eakin, thank you for being here this morning, and 

thank you for your past public service. 

As we have seen with the implementation of Dodd-Frank and the 

creation of FSOC, it has been authorized to notice and implement 

final rules to determine whether a non-bank company will pose a 

threat to the financial stability of our country. 

Undeniably, this authority has allowed for FSOC to impose guidance on what it considers its own definition for what actually constitutes a threat to financial stability, a definition, in my opinion, 

which is inconsistent in their rulemaking and, more specifically, 

their designation of systematically important financial institutions. 

These independent agencies are created by Congress and staffed 

with presidential employees. As such, we expect these individuals 

to create rules and regulations objectively and independently. Do 

you believe that the FSOC is capable of acting as an independent 

regulatory agency? 

Mr. HOLTZ-EAKIN. It could be a better regulator in the sense of 

having processes that were more systematic, that were uniform, 

that were transparent, and where you could have objective criteria 

that they sought to meet. I do not think that the science exists to 

fulfill its basic mission which is to identify systemic risk and reduce it. 

As you know, I served on the Financial Crisis Inquiry Commission. I think all the time in the narrative of that crisis and in the 

events as they unfolded, had there been an FSOC, would it have 

known how to stop it? And the answer is no, it would not have. 

It is the activities that went on, the interconnectedness of those 

activities, not just among firms, but across the globe that is the 

most striking feature of the crisis. That took place in many different regulatory environments. None of them were smart enough 

to foresee the forces that combined to produce the financial crisis. 

And FSOC would not have been smart enough either. 

Mr. KUSTOFF. As a follow-up, if I could, last year Chairman Hensarling introduced the Financial CHOICE Act which would eliminate the FSOC’s ability to designate SIFIs. What additional reforms would you recommend to this committee that would remedy 

the FSOC’s unchecked authority to make these designations? 

Mr. HOLTZ-EAKIN. I think there are several levels of reforms. 

First, is one that we have mentioned several times about the process by which it operates: making it more transparent; more uniform; with a clear exit ramp from SIFI status; and making sure 

that the burden doesn’t fall on firms that are too small. 

18 

The second would be limiting its scope to designate non-bank 

SIFIs. I, for example, think that in many cases, all we are getting 

out of the regulation of these insurance companies is a second layer 

of what the consolidated State regulars are doing anyway. And 

they are ignoring that, so I don’t see why we should do that. 

And then the third thing, level of reform, I think, would be to 

really pull back on its ability to do this at all. It has been given 

a mission that it can’t fulfill. It has enormous authorities and can 

impose large costs on the economy. That strikes me as a very bad 

regulatory arrangement and ought to be scaled back entirely. 

Mr. KUSTOFF. Thank you very much. I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the gentleman from New Jersey, Mr. 

Gottheimer, for 5 minutes. 

Mr. GOTTHEIMER. Thank you. I yield my time to Mr. Cleaver, 

Madam Chairwoman. Thank you. 

Mr. CLEAVER. Thank you very much. 

I want to kind of keep going in the direction I was going. When 

the financial crisis hit—when Treasury Secretary Hank Paulson, 

Sheila Bair from the FDIC, Ben Bernanke from the Fed, and Chris 

Cox from the SEC were here—I was in here that day, it was late 

in the day. I was sitting right over there next to that empty seat 

on the end when they came in—half of the Members were gone already—to tell us what was happening to the economy. I was in 

here. 

I get the impression that there are those of you on the panel who 

would suggest we should have just walked out and said, I hope 

things turn out on Monday. We were warned that if we didn’t start 

acting, that the U.S. economy, by the time the Asian markets 

opened after the weekend, that the world economy could very well 

fall into shambles. 

Mr. Holtz-Eakin, are you guys saying we should have said, well, 

whatever happens is fine, we want the free market to just kind of 

do what it does and see you later; and walk out and catch our 

planes? Because I was in here, and I guess sometimes I get disturbed when people say, ‘‘You guys should have done this, and you 

should have done that.’’ I was here, and I know the tension that 

was going on. I saw what was happening firsthand. 

And so I am just curious, if you had been sitting in here, what 

would you have said to Hank Paulson, who said that President 

Bush asked him to come over? Would you have said, well, go back 

and tell him, let’s let the free market just kind of roll? 

Mr. HOLTZ-EAKIN. I have been on record as saying it would have 

been irresponsible for the Congress to do nothing and we saw that 

in the aftermath of the first failed TARP vote significant economic 

damage. I am not— 

Mr. CLEAVER. I watched that as well. I watched it in real time 

going down on the TV in the cloakroom. 

Mr. HOLTZ-EAKIN. That is different from saying I think the response was the most effective response possible, which I don’t think 

the TARP turned out to be. I do think it is important to recognize 

that the Federal Reserve was the single-most effective response to 

the financial crisis. It essentially followed the oldest central bank’s 

19 

playbook and was remarkably creative in lending against any reasonable collateral and flooding markets with liquidity. 

That has always been the recipe in a financial crisis. They did 

it again, and the speed with which financial markets recovered is 

a tribute, I think, primarily to that response. 

Mr. CLEAVER. Since that legislation was passed, how many nonbanks have been designated as SIFIs? 

Mr. HOLTZ-EAKIN. There have been a total of four. 

Mr. CLEAVER. Like one, two, three, four? 

Mr. HOLTZ-EAKIN. Yes. 

Mr. CLEAVER. Yes. This is just amazing. 

Mr. Zaring, can you explain why—we are talking about this traffic light, getting a ticket for speeding. What is— 

Mr. ZARING. I agree with you, there is no sense that the Council 

is going rogue here, with only 4 designations in 6 years of existence. And then, of course, it rescinded one of those designations. 

And the reason I don’t think a traffic light camera is an apposite 

is precisely for the reason that Dr. Holtz-Eakin suggested. This Financial Stability Oversight Council occupies a precautionary role in 

American regulation, because we do not know where the next financial crisis will emerge from. 

But we do know that the downside risk, as you have just stated, 

Congressman Cleaver, is extremely high and extremely serious. It 

makes sense to create an institution that can take precautionary 

approaches to the possibility of that extreme downside risk coming 

in some way that we don’t precisely know will occur. 

And that is what FSOC does. The fact that financial crises are 

not reducible to some sort of arcane or particular mechanical measure, it seems to me, is a good reason to have a regulator to take 

the broad view that FSOC has. 

Mr. CLEAVER. Thank you. 

Mr. Kupiec, if you re-thought your analogy, would you rather 

have a flashing yellow light? 

Mr. KUPIEC. No, sir, I think my analogy is completely apt, and 

I would say that the FSOC has done nothing on regulation. They 

have designated four firms. The Federal Reserve Board has not 

promulgated any regulation specially for insurance companies. And 

I fail to see how anybody would argue that just merely designating 

four firms has made the world safer against a financial crisis. 

As far as I can tell, they have done nothing. The costs caused 

G.E. Capital to jettison what had been a very profitable line of 

business over many years. I don’t see why destroying a profitable, 

well-run firm and making it split apart is a success. I would disagree with all those things that were said. 

Chairwoman WAGNER. The gentleman’s time has expired. 

The Chair now recognizes the gentlelady from New York, Ms. 

Tenney, for 5 minutes. 

Ms. TENNEY. Thank you, Chairwoman Wagner. 

And I thank the panel for being here today on this very important issue. 

You have heard from my colleagues about the inconsistent, arbitrary designation of SIFIs. And for the record, I just want to say 

that a systemically important financial institutions because it just 

sounds so vague and bureaucratic. And I think that instead of sayVerDate Nov 24 2008 17:54 Jan 08, 2018 Jkt 027251 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 K:\DOCS\27251.TXT TERI
20 

ing SIFI and FSOC, I think we need to let the public know just 

exactly the nature of the vagueness, but the costs associated and 

increased burdens that are involved. 

I would like to touch on a couple of off-ramp strategies specifically for the non-banks, systemically important financial institutions, I have to get it all out there. 

Dr. Holtz-Eakin, in your testimony you pointed out that FSOC/ 

Financial Oversight Stability Council, another vague title, only designated insurance companies as non-bank SIFIs and you believe 

they provide no additional financial stability. 

FSOC has made it their mission to identify threats to America’s 

financial stability. But when they are blindly designating companies based solely upon inconsistent and arbitrary standards, that 

is a clear indication of poor structure and management in the nonbank SIFI destination process. Again, more vagueness. 

I think you make a fair argument by calling for the removal of 

FSOC’s authority to regulate those non-bank financial institutions 

because these companies are already being heavily regulated at the 

State level. And I can speak for that as a former State assembly 

member who actually voted ‘‘no’’ on the consolidation of the banking and insurance agencies into one financial services agency in the 

State of New York, which has just caused more regulation and just 

evidence of the incredible oversight and regulation that we already 

have in New York State. 

But let me add that FSOC has been criticized for failing to provide clear standards, again, we are back at vagueness, for de-designation and for failing to provide affected companies with a clear 

path or exit ramp of actions the company could take to take to 

change its business to get the designation removed. 

So let me address my first question to Dr. Kupiec. If there is no 

clear standard for designation, how can there be a clear standard 

for de-designation? Or to put the question another way, does the 

fact that FSOC cannot clearly state what will lead to de-designation mean that the entire designation process is arbitrary? 

Mr. KUPIEC. I think that is an accurate statement. To the best 

of my knowledge, the FSOC does not give the designated firms 

clear guidance on what they would have to do to not be a SIFI. The 

designation documents themselves paint a very arbitrary and fictional story about how the FSOC gets into trouble. 

There is no way that you can, based on those stories and narratives, decide how you would change your business to escape that 

narrative. So I think it is very, very true that there is no off-ramp, 

no specific off-ramp. G.E. negotiated one somehow over time, took 

a very drastic step by getting out of the financial services industry 

entirely. The FSOC couldn’t regulate it anymore. It fell below the 

85 percent threshold. 

So it wasn’t like the FSOC did something, G.E. did it. They got 

out of the financial services business period. And the FSOC fell 

below the 85 percent threshold. And the FSOC couldn’t designate 

it anymore. So I wouldn’t say that was a great day in the FSOC 

history where they de-designated a firm. The firm did it themselves 

and it was very costly and painful. 

Ms. TENNEY. Thank you. 

21 

Let me follow that up. So would you then say that the—do you 

trust that FSOC has been fair in evaluating the de-designation 

process? 

Mr. KUPIEC. No. 

Ms. TENNEY. Evaluating companies in the de-designation process. 

Mr. KUPIEC. I think the subcommittee report does a very big 

service to the public by making public the decision process for the 

stage two non-designation decisions which you couldn’t know without the committee getting ahold of those documents, and even with 

the very heavily redacted discussion of it we can tell that the FSOC 

makes up a story and an ad hoc analysis for each firm on any given 

day. And then they are never consistent and there is no set standard that they follow. 

Ms. TENNEY. Thank you. 

Dr. Hultz-Eakin, do you agree that we would have to have a complete overhaul of the SIFI process or designating process? 

Mr. HOLTZ-EAKIN. I very much do. 

Ms. TENNEY. Okay. 

Mr. HOLTZ-EAKIN. From the sort of arbitrariness of the analysis 

from firm to firm, from the ignoring of the experts in the insurance 

business during the designation of insurance companies, and from, 

I want to emphasize, the point that Dr. Pollock made at the outset, 

which is, how can you not at least look at Fannie Mae and Freddie 

Mac, which are the living, breathing definition of dangerous financial institutions and have proven it through time? 

Chairwoman WAGNER. The gentlelady’s time has expired. 

Ms. TENNEY. Thank you very much. I appreciate it. 

Chairwoman WAGNER. The Chair now recognizes the ranking 

member of the full Financial Services Committee, the gentlelady 

from California, Ms. Waters, for 5 minutes. 

Ms. WATERS. Thank you very much, Madam Chairwoman. 

And I thank the panelists for being here today. 

One of the main arguments that opponents of the FSOC make 

is that it simply has too much power, and Congress, through DoddFrank, has given the agency unlimited authority to determine 

which non-bank institutions are systemically important. However, 

directly included in Dodd-Frank are 10 specific factors that the 

FSOC must consider prior to designating a firm as systemically important. 

Can you discuss—and this is for Professor Zaring—these factors 

and how they serve as a check on FSOC’s ability to declare any institution a SIFI? 

Mr. ZARING. That is right. The factors that Congress gave it give 

it some flexibility, but also some instruction as to how it is supposed to make particular designation decisions. And, of course, 

FSOC can only designate companies that qualify as financial companies. It can only designate them upon a super-majority vote. And 

it can only designate them after going through this three-stage 

process at which the companies have time to respond. 

FSOC has to find that a firm could pose a threat to the financial 

stability of the United States, either in the event of material financial distress or due to the nature, scope, size, scale, concentration, 

interconnectedness, or mix of its activities. Those factors and the 

22 

other ones that it has considered are guidance to FSOC as to what 

it should consider. And I don’t think it means that FSOC is arbitrarily applying that guidance if they emphasize some factors over 

other factors when it comes to figuring out whether a particular institution poses a great deal of downside risk. 

Ms. WATERS. So this discussion about being arbitrary with unlimited authority just does not ring true, based on the fact that 

there are these 10 specific factors that you just helped to explain. 

Now, doesn’t the fact that the FSOC has only designated four 

non-banks as SIFIs since 2010 confirm that the FSOC is not arbitrarily imposing SIFI designations on all non-bank financial firms, 

but instead acting responsibly to protect taxpayers and our financial system from another devastating financial crisis, Mr. Zaring? 

Mr. ZARING. I agree, Congresswoman. I very much agree with 

that. FSOC has not designated any more than four institutions. It 

has only designated four institutions. And those designations, once 

again, made a great deal of sense. They were the three largest insurance companies in the United States, including AIG, which was 

the insurance company that collapsed during the financial crisis 

necessitating a massive and painful bailout. And if that is not systemically risky, then I am not sure what is. 

And then the final company that was designated was G.E. And 

as we have discussed earlier, G.E. was poorly regulated by any 

other regulator, was engaged in many different markets, had a real 

risk of runnable financing that creates systemic risk; at the very 

least, we know that. And so it was accordingly designated and 

changed its business accordingly. 

So I think that FSOC is being cautious in its designation power 

use. It is being clear about the kinds of things it is worried about. 

It only hasn’t tried to create some sort of a standard which informs 

some non-bank financial institutions that they will never be designated, thereby encouraging them to take on systemic risk after 

they get a free pass. 

Ms. WATERS. This may not be a fair question, but why is it opponents of FSOC have forgotten the lessons of AIG? Can you speculate on that? 

Mr. ZARING. To me, it is a real concern. AIG had a AAA credit 

rating. And it is not that their regulators were the only people to 

miss its riskiness, so were its investors, its managers, and the 

broader capital markets as a whole. So the idea that we can rely 

on the free market, to the extent that one exists in financial services to begin with, to uncover risks like AIG, I think is naive. 

What AIG did, in addition to its runnable securities-lending business, was get involved in a new industry or a new business, writing 

credit default swaps where it didn’t understand the risks posed in 

that business. That is the kind of thing that a regulator is supposed to be able to step in and caution a firm that it should pay 

attention to. And I think that forgetting the lessons of AIG is unwise to the extreme. 

Ms. WATERS. Thank you very much. 

And I yield back the balance of my time. 

Chairwoman WAGNER. The gentlelady yields back. 

The Chair now recognizes the gentleman from Michigan, Mr. 

Trott, for 5 minutes. 

23 

Mr. TROTT. Thank you, Chairwoman Wagner. 

And I thank the panel for being here. 

Professor Zaring, so what happened in the MetLife case? You 

have been singing the praises of FSOC all morning and what happened there? Is it just some rogue judge who doesn’t understand, 

or what happened there? 

Mr. ZARING. I disagree with the judge’s decision in that case. And 

I think in that case, the judge made a decision to require FSOC 

to conduct a cost-benefit analysis that is plainly not required by the 

language of the statute and that doesn’t really make sense for 

FSOC as a whole. And here is why. I will be brief, I know you have 

more questions. 

But the costs of designation, and that is something that is pretty 

easy to calculate, but the benefit of designation is the goal is to 

avoid a financial crisis or a calamity. It is really difficult to quantify that, though it is a real benefit. So FSOC does apply a costbenefit analysis, but it doesn’t apply a quantified one in the way 

that the judge seemed to prefer, and I disagree with that imposition. 

Mr. TROTT. You have testified this morning that you are really 

not in favor of any kind of transparency, that you don’t feel they 

need to disclose their decision-making criteria, and you are fine 

with FSOC exercising broad discretion and authority basically 

shrouded in secrecy. So let me ask you this question, have you ever 

run a business? 

Mr. ZARING. I have not. 

Mr. TROTT. Have you ever been accountable to shareholders? You 

were in the Justice Department, and you have been in academia, 

but you have never run a large corporation, correct? 

Mr. ZARING. That is for sure. 

Mr. TROTT. How would these corporations expect to proceed? And 

the hypocrisy of this whole thing is illustrated from the deposition 

testimony of Patrick Pinschmidt, who is the executive director. And 

they are asking about the different criteria that he looks at in 

terms of designating a SIFI. And in his answer, he says, ‘‘Again, 

I am sort of doing this on the fly, here. The paragraph above acknowledges that obviously, if something bad were to happen to this 

particular company, that would probably be factors that would impact all other companies in the same industry.’’ 

Boy, that is just clear as mud, isn’t it? That is his answer on his 

criteria when he looks at an industry. 

Mr. ZARING. All I will say is corporations and government agencies don’t have to disclose their internal deliberations. The key 

question is, what is the decision you make, and is there a basis for 

the decision that is made? FSOC provides that to any designated 

institution. 

It is definitely the case that the members of FSOC, because of 

their expertise and because of the factors that have been given it 

from Congress, can come to their own conclusions about what 

counts as too risky and appropriate for designation and not risky 

enough. 

Mr. TROTT. And those conclusions, you don’t believe, can be arbitrary, right? They are always well-reasoned and there is no chance 

24 

of any kind of arbitrary outcome that provides for a disparate impact on companies within the same industry. 

Mr. ZARING. I think the best way to measure the arbitrariness 

of any designation decision is to look at the basis for the decision 

that FSOC supplies and in the four cases where it has made a designation, that basis hasn’t looked at all arbitrary to me. 

Mr. TROTT. Can you understand some of our concern here? And 

let me know if you disagree with any of the following premises. We 

are dealing with bureaucrats who yearn to be relevant because that 

is how they keep a job. We are dealing with unelected bureaucrats. 

We are dealing with bureaucrats who really have no budget. We 

are dealing with the Department of Justice that has no litigation 

budget when they decide to fight. And it is also hard to fight the 

government. 

So can you sort of understand? And maybe you don’t accept any 

of those statements, but if you accept any of them, can you sort of 

understand why this designation process gives us pause? 

Mr. ZARING. I worry about bureaucrats not making sensible decisions, but that is why I think that they have to be in a position 

to explain those decisions. And I think that FSOC has done that 

in this case. 

Mr. TROTT. Speaking of explaining their decisions, in our report 

we said that since they don’t follow their own rules and guidance 

in most multiple ways, Dr. Kupiec, the concern is that they treat 

the companies in the same industry differently. Do you think that 

is a risk of the way they are currently preceding? 

Mr. KUPIEC. I think the evidence that the subcommittee found in 

terms of second-stage designations exactly goes to that point, where 

they found that collateral, in some cases, was treated as a positive, 

as a risk mitigant. And in other cases, collateral was the worst 

thing that could ever happen, it was going to cause the end of the 

world. 

So, yes, they looked at the same phenomenon for two different 

firms and came to exactly opposite conclusions. I think this is my 

story of the two tall firms. 

Mr. TROTT. When I was in business, all I wanted to know was, 

tell me what the rules are and treat everyone the same and let us 

go get about our business and see if we can make money. And 

those two factors don’t seem to be in play. 

Mr. Pollock, one quick question, my time is running out. Professor Zaring is not concerned about the cost of compliance. Can 

you just speak briefly to the effect that has on the stock price and 

reputational risk and cost of compliance and the overall effect on 

the economy? 

Mr. POLLOCK. I think, Congressman, you are right about all of 

those. Clearly, the cost of compliance is substantial and affects 

value. We are looking here at these arbitrary decisions and I would 

just like to repeat, the biggest arbitrary decision of the FSOC was 

not to look at the biggest, most obvious SIFIs in the country, which 

are Fannie Mae and Freddie Mac. They get a free pass. It is unbelievable. It is, in my opinion, a purely political decision of the previous Administration. 

Chairwoman WAGNER. The gentleman’s time has expired. 

Mr. TROTT. Thank you. 

25 

Chairwoman WAGNER. The Chair now recognizes the gentleman 

from Indiana, Mr. Hollingsworth, for 5 minutes. 

Mr. HOLLINGSWORTH. Good morning. Thanks so much for all of 

you being here. 

Mr. Pollock, you continue to bring up something that disturbs me 

as well. When I think about systemic risk, I think about those 

things that are risks to the entire system itself. And what I keep 

coming back to is the world’s largest debtor, the world’s largest balance sheet are all held by institutions of this government. And I 

want to make sure that we are not creating adverse incentives and 

creating more systemic risk by government policy itself. 

Can you talk a little about maybe instead of, as my colleagues 

continue to say, that it is lack of regulation that created the financial crisis, instead maybe it is this distortion that is caused by government getting involved in markets. And now here we are talking 

about even more distortion and even unclear, unaccountable distortion. 

Mr. POLLOCK. Congressman, I think that is absolutely right. 

There is no doubt that a very important part of the crisis was what 

the government did itself in the way of promoting credit, expanding 

credit, driving up housing prices and, in general, inflating the bubble. Many parts of the government were involved in that, but, of 

course, in particular, Fannie Mae and Freddie Mac, pushing on 

credit and pushing up house prices. 

I say in my testimony that there are two overwhelming factors 

in systemic risk. One is highly leveraged real estate and the other 

is the moral hazard created by government credit policy and government implicit or explicit guarantees. Fannie Mae and Freddie 

Mac are that to the max, but somehow they are not SIFIs. 

Mr. HOLLINGSWORTH. Right. Do you think that we have taken 

adequate steps thus far to remove some of those misaligned incentives or other challenges that are created in the market through 

the efforts that have been undertaken in the last 7 or 8 years? 

Mr. POLLOCK. No, Congressman, I don’t. As a matter of fact, one 

of the biggest problems with FSOC’s being even able to think about 

systemic risk is it has to think about systemic risk created by the 

government. 

Mr. HOLLINGSWORTH. Right. 

Mr. POLLOCK. If you want a body to think about the massive systemic risk created by the government itself, you need a different 

body than FSOC. 

Mr. HOLLINGSWORTH. An independent body? 

Mr. POLLOCK. Yes. 

Mr. HOLLINGSWORTH. Something that would be able to look at all 

the participants, not just the private participants and the issues 

created there? 

Mr. POLLOCK. Yes, I think so. 

Mr. HOLLINGSWORTH. Yes. 

And then the second thing I wanted to talk about a little bit is 

some of the costs around this gray-area regulation. And maybe this 

goes to Dr. Holtz-Eakin. 

I used to deal with a lot of contractors. And I knew one thing 

for sure, when I handed out a scope of work that was incomplete 

or unclear in any way, I knew I was going to get a wider bid beVerDate Nov 24 2008 17:54 Jan 08, 2018 Jkt 027251 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 K:\DOCS\27251.TXT TERI
26 

cause they would protect themselves. They wanted to stay further 

away from the line. The more exact the rules of the game were, the 

further they could go in getting to that line. 

And so it is not just the immediate costs of compliance, but it is 

the cost of not knowing and wanting to stay further back and wanting to curtail business activities that might or might not be viewed 

by FSOC as problematic. 

Can you talk a little bit about, in your view, how not only the 

idea of FSOC being there, but the lack of clarity around it is creating this gray area that companies are being forced to operate in 

and how that might incur more costs than we even know? 

Mr. HOLTZ-EAKIN. I think that is a real issue. One of the things 

we do at the American Action Forum is we actually add up the selfreported compliance costs that agencies put to regulations. And so 

over the past 8 years, it was $800 billion. That is what they estimate it to cost businesses to comply. 

Mr. HOLLINGSWORTH. Yes. 

Mr. HOLTZ-EAKIN. And as you point out, that is the easy part. 

You actually know what you have to do there, fill out paperwork 

and things. It is the business decisions that are affected that are 

the genuine economic costs, whether they are capital expansions 

you don’t undertake because you don’t want to grow and get too big 

and become a target, you don’t hire, whatever it may be, those are 

genuine losses. And once the designations are made, you now have 

different firms being treated differently in the same industry and 

you don’t have a single set of rules and you don’t have a fair competition. 

Mr. HOLLINGSWORTH. Yes. One of the big things that I have consistently pushed is, by more and more regulation, especially more 

and more regulation from a variety of regulators, we continue to 

herd companies in the financial services sector into one corner. We 

continue to push companies that do and have the same portfolios 

and same exposures because that is what we want them to have. 

But we should be darn sure if we are doing that, that they are 

the exposures we want them to have because systematic risk is 

really about dominoes toppling over. And the more these firms look 

like each other because regulators have forced them to look like 

each other, the more easily issues migrate from one firm to another. 

So I would just like maybe you, Dr. Holtz-Eakin, and Mr. Pollock, to comment on that. 

Mr. HOLTZ-EAKIN. It is a huge irony because the basic lesson of 

finance is to diversify. 

Mr. HOLLINGSWORTH. Correct. 

Mr. HOLTZ-EAKIN. And that is a very undiversified view of the 

universe. 

Mr. HOLLINGSWORTH. Yes. 

Mr. Pollock? 

Mr. POLLOCK. I think that is a great example of systemic risk 

created by government regulation, Congressman. An excellent example. 

Mr. HOLLINGSWORTH. Right. And so my concern, again, is, as we 

herd these into a corner, we are going to find that the risk really 

comes from something we didn’t expect, and then we have perfectly 

27 

lined up all the dominoes ensuring that one is transmitted to the 

other, whether that is through mark to market accounting because 

they all hold the same portfolio securities, et cetera. 

So thank you for your time this morning. 

I yield back to the Chair. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the distinguished ranking member of 

the subcommittee, Mr. Green, for 5 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. 

Let’s start with Mr. Zaring. Mr. Zaring, let’s talk about this cost 

of compliance and juxtapose it to the cost of not finding another 

AIG. Could you give us some intelligence on this, please? 

Mr. ZARING. The costs of compliance with financial regulation to 

make financial institutions safe and sound are real, but the benefits are much more real, in my view. And what FSOC is doing with 

its limited designation so far is, in my view, looking around at 

firms where, if there was a collapse, their collapse would likely 

break down the rest of the financial sector in potentially unpredictable ways, and making sure that those institutions are adequately 

regulated. 

It is hard to know just how much of a benefit an avoided financial crisis is, but I think we can all presume that benefit is extremely high, very large, and very difficult to quantify. 

Mr. GREEN. If FSOC, which is the economic disaster prevention 

agency, had had the opportunity to examine AIG with the cost-benefit analysis, would it be such that it would have been beneficial 

to find out what AIG was doing and see it as systemically important? 

Mr. ZARING. One of the advantages of FSOC is that it brings together every financial regulator in the government, including the 

newly created Federal Insurance Office and an insurance representative. 

The ability of all of those regulators to take a look, not just at 

some aspect of AIG, its thrift business or some other financial activities in a particular place, but all aspects of the business, make 

it more likely that the regulators would have realized that AIG was 

writing credit default swaps in a relatively unhedged manner. 

And we don’t know what would have happened. But we do know 

that AIG was a business failure and was never scrutinized holistically by regulators in the way that FSOC promises to do. 

Mr. GREEN. You make a good point, and I would like for you to 

elaborate on it for just a moment, because there is a contention 

that there are other prudential regulators that would find these 

flaws in the system. 

But it didn’t happen with AIG and it didn’t happen with Bear 

Stearns. It didn’t happen with Countrywide. It didn’t happen with 

a whole host of financial industry entities. Would you elaborate, 

please? 

Mr. ZARING. That is right. And one of the things that a designation is supposed to do is increase capital, which is one way of making sure that these institutions are prepared for a shock, even a 

shock that comes from somewhere surprising. 

But for the AIG story, the idea that the Office of Thrift Supervision in overseeing its, I think, New York’s chartered savings and 

28 

loan, which was a very small part of what AIG did, was supposed 

to catch what was going on in London is, I think, naive. 

But on the other hand, if you get a team of rivals and a group 

of regulators together in a room, to the extent that they are rivals, 

you make catching that kind of new and creative financial businesses all the more likely. 

Mr. GREEN. Let’s talk about proprietary information. Does that 

have something to do with releasing information with reference to 

an evaluation? 

Mr. ZARING. I don’t think that the institutions that the Council 

has considered and carefully considered would want all of the information that they provide the Council in discussing and indeed 

sometimes contesting their designations to be released to the public 

and to their competitors and to the financial marketplace, more 

generally. 

Some of the things that FSOC does that some of the witnesses 

here seem to believe are sort of secret are the kinds of secrets that 

businesses want the government to keep. And I think it is responsible for FSOC to keep those secrets for the businesses they are reviewing. 

Mr. GREEN. Speaking of keeping secrets, there is a desire on behalf of some to have Congresspersons in the room when these deliberations are taking place. Is that going to be beneficial to secrecy, and how do you think that will impact the process? 

Mr. ZARING. No, I don’t think agencies or businesses benefit from 

having their deliberations, internal deliberations before a decision 

is rendered, being open for nitpicking or after the fact. It is, at 

worst, Monday-morning quarterbacking. What you should do is 

evaluate the decision and expect that decision to be carefully articulated. 

Mr. GREEN. I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

The Chair now recognizes the gentleman from Florida, Mr. Ross, 

for 5 minutes. 

Mr. ROSS. I thank the chairwoman. 

Interesting, of the four non-bank financial institutions, three, of 

course, were insurance companies and we have discussed today 

through your testimony that although there may not be that great 

at transparency and there might not be the best, well, rules in 

place in order to assess the vulnerability, there are experts. FSOC 

has experts. 

And yet, in the assessment of the SIFI designations, there are 

two experts, one a voting member in the insurance industry or 

arena, and two a nonvoting member, both of whom were ignored 

by the designations with regard to whether these insurance companies should be considered a SIFI. 

Now, Dr. Holtz-Eakin, was there any discussion in this FSOC’s 

determination as to whether these insurance companies were not 

properly regulated by their State insurance regulators? 

Mr. HOLTZ-EAKIN. No, they didn’t take that adequately into consideration. 

Mr. ROSS. And do we not have the best form of regulation, by 

way of our State regulators, of any other system in the world? 

29 

Mr. HOLTZ-EAKIN. The insurance system has proven to be very 

well-regulated and it is also true that these same institutions are 

regulated in other countries where they do business. There is an 

enormous amount of regulatory oversight already prior to designation. 

Mr. ROSS. And I guess my point is, is this not, this action by the 

FSOC of designating these three insurance companies, is it not an 

indictment of the State-regulated base form of insurance regulation 

that we have in this country? 

Mr. HOLTZ-EAKIN. It is a mystery to me what the Federal Reserve believes it will know that a consolidated regulator in New 

Jersey, for example, doesn’t already know about the operations in 

these insurance companies. 

Mr. ROSS. And wouldn’t you say that if we are going to go this 

route and allow for FSOC to ignore its experts and indict a Statebased system of insurance regulation that we are essentially setting up possibly a two-tiered system, one of which that once you 

are designated, you are going to have increased regulation, and 

would that not impact the free market of insurance sale? 

Mr. HOLTZ-EAKIN. I have mentioned this several times. I am very 

worried about the fact that we are going to end up with an uneven 

playing field in financial services markets if we continue down this 

path. 

Mr. ROSS. And who is going to get hurt the most? 

Mr. HOLTZ-EAKIN. The consumer. 

Mr. ROSS. The consumers are. And so, has there ever been a run 

on an insurance company in the history of the United States? 

Mr. HOLTZ-EAKIN. No. One of the mysteries of this designation 

has been ignoring the history of successful regulation of insurance 

companies and also the use of scenarios which are completely unrealistic for that insurance business. 

Mr. ROSS. Dr. Kupiec, risk-based capital is used to assess the 

systemically important nature of an insurance company. Would you 

agree that there is no reason to deviate from the State-based system that we have today, where we have never seen a run on an 

insurance company, where a whole different method of assessment 

and analysis of your risk is used as opposed to financial institutions? 

Mr. KUPIEC. I don’t think insurance merits a SIFI designation. 

I think AIG was a special case. 

Mr. ROSS. It was a special case. There wasn’t even a regulator 

then at the time. 

Mr. KUPIEC. And I think— 

Mr. ROSS. So let me ask you this, Dr. Kupiec, because you hit 

on it with General Electric. Now, we have discussed also the designation. And it is like going to the doctor, you are sick, but we are 

not going to tell you why you are sick or how you got sick or how 

you can get better, but we will let you know when you are dead. 

It’s the same way with SIFI designation. 

We tell you you are now designated, but we don’t tell you how 

to get off. Where is the exit ramp? And it appears to me that the 

only exit ramp that we have been able to see in this regard has 

been the total sell-off like they did with G.E. Capital. Is that a funVerDate Nov 24 2008 17:54 Jan 08, 2018 Jkt 027251 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\27251.TXT TERI
30 

damentally good method of having an off-ramp, not only for the 

business, but also the consumer? 

Mr. KUPIEC. No, I think if you think about my analogy, you are 

a well-run, growing company, this becomes a penalty for well-run, 

growing companies, that you might become the object of an FSOC 

stage-three review. You have no idea why. You get good marks 

from all your— 

Mr. ROSS. You get no answers. You don’t know why you are 

there, but you know that you are being investigated and you have 

an obligation to your shareholders as well as your consumers. And 

so what you do? You divest yourself from that particular operation. 

That is the off-ramp. 

Mr. KUPIEC. One firm did that. Whether the insurance companies, which are—G.E. Capital was part of G.E., which has non-financial parts to it. Whether an insurance company can actually divest its way out of this is maybe a bridge too far. 

Mr. ROSS. At least one went to court and was successful. And I 

think one insurance company went to court and was successful, 

MetLife. And I think that what we have to do is we have to be able 

to allow for not only the review, but also the ability to be de-designated, the ability to have the off-ramp. 

And I see my time is up, so I yield back. 

Chairwoman WAGNER. The gentleman yields back. 

I would like to thank our witnesses again for their testimony 

today. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

This hearing is now adjourned. 

[Whereupon, at 11:40 a.m., the hearing was adjourned.] 

(31) 

A P P E N D I X 

March 28, 2017 

32 


27251.001

The Arbitrary and Inconsistent Non-Bank SIFI Designation Process 

United States House of Representatives 

Committee on Financial Services 

Oversight and Investigations Subcommittee 

Douglas Holtz-Eakin, President* 

American Action Forum 

March 28,2017 

*I thank Meghan Milloy for her assistance. The views expressed here are my own and not those 

ofthe American Action Forum. 
33 


27251.002

Chairman Wagner, Ranking Member Green, and members of the Subcommittee, thank you for 

the opportunity to appear today and share my views on the Financial Stability Oversight 

Council's (FSOC) non-bank designation process. And thank you for your work on the report 

released earlier this month. I've found it useful in highlighting and explaining both the 

procedural and substantive problems with FSOC. 

FSOC's mission is to identify, monitor, and address threats to America's financial stability. Yet, 

the current process by which non-bank financial companies are designated as systemically 

important financial institutions (SIFis) and the heightened oversight and regulation they fall 

subject to thereafter, is inherently flawed and risks losing the confidence of the public and 

policymakers and burdening the economy without any notable benefits. In my testimony, I wish 

to make three main points: 

• FSOC's process, inconsistent or not, has prioritized designation and regulation of institutions, 

often arbitrarily, over the identification of activities that pose systemic threats and has done 

so in a fundamentally flawed manner. I applaud the Subcommittee for making a critical 

investigation into this process and all its implications. 

• Designating a non-bank financial institution as a SIFI is consequential for both the 

institutions and the institutions' customers. Those consequences include, but are not limited 

to, decreased international competitiveness for American companies in the international 

market and increased costs with decreased benefits for consumers. 

• Thus far only insurance companies have been designated as non-bank SlFis. A good 

argument can be made for removing FSOC's authority to regulate those non-bank financial 

companies, as these companies are already being regulated at the state level. The increased 

burdens from FSOC's oversight are unnecessary and provide no additional financial stability. 

Let me expand on each in turn. 

FSOC's designation process was authorized by Dodd-Frank. Title I, Subtitle A, of the DoddFrank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) established FSOC, 

outlined the Council's powers, and introduced factors that must be considered when designating 

NBFCs as SIFis. Because banking companies with over $50 billion in assets are automatically 

considered SIF!s in the Dodd-Frank Act, key issues involving designation revolve around nonbanks. 

Specifically, Section 113 of the Dodd-Frank Act gives FSOC the authority by two-thirds vote 

(including the chairperson) to bring a NBFC under increased supervision and regulation by the 

Federal Reserve Board (FRB) if the Council determines that "material financial distress at the 

U.S. non-bank financial company, or the nature, scope, size, scale, concentration, 

interconnectedness, or mix of the activities of the U.S. non-bank financial company, could pose a 

threat to the financial stability of the United States." 1 In making that determination, the Dodd1 12 U.S.C. § 5323 (a)(!). 
34 


27251.003

Frank Act lists ten criteria for FSOC to consider along with "any other risk-related factors that 

the Council deems appropriate."2 Given that, FSOC has broad authority statutorily when 

evaluating companies for SIFI designation. In April2012, FSOC released a final rule and 

interpretive guidance on the process it uses to designate SIFis.3 The Council recently voted to 

supplement that process during its February 2015 meeting following an internal review and input 

from the public and stakeholders.4 

The three-stage evaluation process FSOC developed is intended to narrow the pool of companies 

potentially subject to designation by applying specific thresholds based on 1 l criteria included in 

Section 113 of the Dodd-Frank Act The II criteria have been incorporated into six overarching 

framework categories that FSOC considers: (I) size, (2) interconnectedness, (3) leverage, (4) 

substitutability, (5) liquidity risk and maturity mismatch and (6) existing regulatory scrutiny. 

Table l highlights how thresholds in these categories are applied and how scrutiny increases as a 

company advances through each stage. However, in practice, it is not clear the weight given to 

certain factors over others or what makes a designation more likely. 

TABLE 1. FSUC DESIGNATION PROCESS 

STAGE 1: APPLYQUANTITAT/J!E THRESHOLDS 

A NBFC moves on to Stage 2 if it has: 

(1) $50 billion in total consolidated assets, and 

(2) One of the following; 

S30 biHion in gross notational credit default swaps outstanding fur which a NBFC is the reference entity; 

$3.5 billion of de-rivative liabilities; 

$20 billion in total debtout>"tanding; 

15 to I leverage ratio of total consolidated assets (excluding separate accounts} to total equity; or 

10 percent short-term debt ratio of total debt outstanding with a maturity of less than 12 months of total 

consolidated assets: l exduding separate accounts}. 

Note: FSOC reserves the right to .. evaluate .any NBFC based on other firm-spedfic qualitative or quantitative factors. 

irrespective -of whether such company meets: the thresholds. .. s 

STAGE 2: QUANTITATIVE & QUALITATIVE ANALYSIS 

In further detail, FSOC applies it'i .six-category framework: 

Size 

Leverage 

lntercnnneetedness 

UquJdity Risk & Maturity Mismatch 

Substitutability 

Existing Regulato-ry Scrutiny 

The Coundl evaluates the risk profile and characteristics of each NBFC using indus:try~ and company-spedfk f.actors1 

\.,,.ith com{ld:ny inform.ation bt>ing gathered from existing regulators and public s:aun~es as w~H a.'i inronnation 

sub-mitted volunbrily by rompanies under consideration. 

STAGE 3: IN·DEPTH ANALYSIS OF COMPANY 

With previously ama.<>:sed inform.atlon, FSOC performs an in-depth analysis of t.he company based on the six*category 

framework, Through OFR. FSOC further collects confidential data obtained from the firm to Incorporate in its analysis. 

2 12 U.S.C. § 5323 (a)(2)(K). 

'"Authority To Require Supervision and Regulation of Certain Non-bank Financial Companies; Final Rule 

and Interpretive Guidance," 77 Federal Register 70 (April 11, 2012) pp. 21637-

21662; https://federalregister.gov/a/20 12-8627. 4 FSOC, "Supplemental Procedures Relating to Non-bank Financial Company Determinations," (February 4, 

2015); http://www.treasury.gov/initiativeslfsocldesignations/Documents/Supplemental Procedures Related to 

Non-bank Financial Company Determinations February 2015.pdf. 5 "Authority To Require Supervision and Regulation of Certain Non-bank Financial Companies; Final Rule and 

Interpretative Guidance," 77 Federal Register 70 (April11, 2012) pg. 21661; https:/lfederalregister.govlaL2012-

8627. 
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27251.004

Table 2 includes a summary of all changes adopted in 2015, many of which attempt to 

address the need for increased transparency and communication. Items shaded in gray are 

substantially similar to reforms previously highlighted in past work by the American Action 

Forum.678 

TABLE 2. SUMMARY OF FSOC'S SUPPLEMENTAL PROCEDURES ADOPTED IN FEBRUARY 2015 

CATEGORY 1: ENGAGEMENT WITH COMPANIES UNDER CONSIDERATION BY FSOC (IN STAGES Z & 3) 

Company to be notified in Stage 2 when it annes under active review 

Company in Stage Zllas the opportunity to submit relevant information to the <.oundl artd meet with FSOC 

staff 

When requested, FSOC st1ff should provide a company under consideration with a list of the public sources of 

information from which FSOC derives its decision 

Company notified in writing if it is not advanced tn Stage 3 (though FSOC reserves the reconsider the company 

again in the future J Staff would meet with a companies' representatives at the start of Stage 3 to explain the evaluation process, 

framework for analysis, and specific activities and operations viewed by FSOC st1ff as the primary focus of 

their Stage 2 evaluation 

FSOC will explain the purpose of requested information in Stage 3 in relation tn the risks being analyzed 

Companies can rontinue to submit material they deem relevant and request meetings with FSOC staff during 

Stage 3 

FSOC intends to grant hearing requestS from companies subject to a proposed designation 

FSOC will eng~e with a company's primary !luanda! regulatory, including notifying the regulator when a 

company romes under active review in Stage 2 and beginning the consultation process before any vote tn 

advance a t:omp.any to Stage 3 

CATEGORY Z: THE ANNUAL REEVALUATION OF DESIGNATED COMPANIES 

Designated company is given the opportunitY to meet with FSOC staff prior to annual reevaluation ofits 

designa:~io-n. discuss scope and process of reviewt and present them \\<ith any relevant information that rould 

cbange the need for a systemically important determination 

FSOC will issue an explanation of its decision {addressing the company"s objections) to maintain a systemically 

important designation if a company c011tests fultnwing its annual reevaluation, and inform the company, itS 

primary regulator, and tne primary regulator of itS significantsub;idiaries 

FSOC will provide a company subject to determination the opportunity for an oral hearing once every five 

vears to .contest its designation 

CATEGORY 3: TRANSPARENCY TO THE BROADER PUBUC REGARDING THE DESIGNATWN PROCESS 

If a mmpany publicly announces lt is in active review in Stage 2 ur 3, FSOC will ronfirm it upon request 

FSOC will include more public information on the bases of its designations 

FSOC will publish more information during its annual report including the number of non banks FSOC voted tn 

move or not move on to Stage 3. became subject to a proposed or final determination! and th€" aggregate 

number of companies subject to a. final detennination 

FSOC will publish further detall on ho-w the Stage 1 thresholds are calculated 

Even ifFSOC were following the rules and designating NBFCs fairly, consistently and with 

good reason (which the Committee's report suggests in not always the case), the process FSOC 

has developed to designate NBFCs as SlFis can disrupt markets and impose unnecessary 

regulatory burdens and costs that outweigh its benefits to the economy. So despite slight 

improvements made two years ago, FSOC's process is still fatally flawed (as I have testified 

6 Satya Thallam, "Reform Principles fur FSOC Designation Process," (November II, 

20 14) http:/ I americanacti onfuru m.org/research/reform -princi pies-for-fsoc-desi gnation-process. 7 Scutt Harrington, "Systemic Risk and Regulation: The Misguided Case oflnsurance S!Fls," (September 20, 20 16) 

https://www.americanactionforum.0rg/research/systemic-risk-regulation-misguided-case-insurance-3lfig. 8 Meghan Milloy, "Congress: FSOC is 'Arbitrary and Inconsistent'," (March 23, 2017) 

https://www.americanactionforum.org/insight/congress-fsoc-arbitrary-inconsistent/. 
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before the House Committee on Financial Services previously).9 The fact that FSOC is using its 

considerable power with little to no uniformity and reason to designate NBFCs, putting them and 

their customers at risk of serious financial consequence, is reason to doubt whether FSOC should 

be able to designate NBCFs at all. It is important to take a look at exactly what those 

consequences entail. 

AAF has noted that FSOC's regulatory designation "imposes direct costs and risk on the 

designated institutions. The magnitude of the costs is uncertain, especially given that the 

specific rules and capital requirements have largely yet to be determined, but it cannot be 

presumed negligible." More worrisome is the fact that FSOC's "two-tiered system will alter 

competitive dynamics in the insurance sector. .. Other things being equal, the increased costs 

of enhanced supervision will reduce their ability to compete effectively, plausibly shifting 

some amount of business and risk to entities not subject to the additional level of regulation, 

and destabilizing rather than stabilizing the market. Large banks who compete with each 

other are all under the same regulatory umbrellas." Such is not the case with FSOCdesignated SIFis. 10 

The arbitrary and inconsistent designations should also raise questions of regulatory scale, 

scope, and overreach. At a very basic level, it should be obvious that FSOC's decisions to 

regulate insurers, capricious or not, disregard the role that state regulators already play in 

overseeing insurance companies. As Scott Harrington wrote in a paper for AAF, 11 "[FSOC] 

largely ignores the historical solvency record, pays little attention to the history of 

improvements in solvency regulation, and dismisses states' ability to issue stays on 

policyholder withdrawals because doing so 'could' undermine financial stability during an 

unspecified crisis. The treatment reflects the notion that the lack of a true consolidated 

regulator at the state level trumps any argument for the effectiveness of state regulation, 

including changes in response to the crisis." 

Similarly, given FSOC's failure to perform a basic cost benefit analysis, it failed to consider 

even the costs of its macroprudential regulation to consumers of those companies' products. 

In a 2013 report 12, Oliver Wyman explains how FSOC's heightened capital requirements on 

insurance companies result in increased costs to consumers. The report shows that 

designated insurers will reduce their capacity or exit the market entirely, leaving the 

remaining insurers to increase their prices. And in markets with higher barriers to entry with 

a high market share by the designated insurers, the ability for the undesignated insurers is 

even greater, leaving consumers with significantly increased costs for the same or fewer 

9 Douglas Holtz-Eakin, "FSOC Accountability; Non-bank Designations," (March 25, 20 15) 

http://americanactionforum.aaf.rededge.com/uploads/filcs/insights/sbc testimony on fsoc final.pdf. 10 id. at Note 8. 11 id. at Note 7. 12 Oliver Wyman, "The Consumer Impact of Higher Capital Requirements on Insurance Products," (Aprii!O, 2013) 

http;//www.responsibleregulation.com/wpcontenti.!Ploads/20!3/05/)'_ricing-impact-~tl!<lrOiiver-Wy_man-Aprii-.)_Q_, 

2013.pdf. 
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27251.006

benefits. Specifically, the report shows that the annual consumer cost of designating a 

NBFC as a SIFI could range from $5 billion to $8 billion. 

Recommendations and Conclusion 

The first obvious fix for FSOC is greater transparency and accountability. FSOC simply 

cannot continue to arbitrarily designate companies without consequence. Aside from that, 

the alternative and better approach to developing enhanced supervision to mitigate systemic 

risk is not to designate specific companies as systemically risky. Rather it is to focus on the 

underlying activities in different sectors that could lead to systemic risk. If there is 

sufficient evidence to show that an activity is creating systemic risk without adequate 

regulatory constraints, then this approach would lead to the development of new regulations 

governing the activities throughout a sector or across multiple sectors. It would allow bodies 

like FSOC to focus on underlying risk with systemic potential and would address all entities 

participating in that particular activity. It would consider systemic risk without an 

unnecessary attention to potential distress at a single company, thereby better reflecting the 

potential accumulation of risk across entities. If an activities-based approach had been in 

effect during the mid-2000s, it's conceivable that the financial crisis would have been 

substantially less severe or even inexistent. 

Policy debate over systemic risk in asset management has considered the same underlying story 

for insurance- that some shock could lead to liquidity problems, runs, and liquidations with 

systemic consequences. 1314 The Financial Stability Board has moved to an activities-based 

approach for asset managers, and the FSOC should be doing so as well. 15 

In closing, to quote Scott Harrington, who has written extensively on this issue, "Although the 

domestic and international insurance SIFI trains have left the station, the U.S. train is 

currently down to two cars, and there is a long way to go in terms of developing and 

implementing insurance specific standards for enhanced supervision under Section 

113. There is no compelling evidence that any life insurer poses a threat to the financial 

stability of the United States, and the Section 113 regime is flawed in concept and 

execution. A better approach would be to return to the station and change destinations. If 

the United States were to shift towards an activities-based approach for insurers, it might 

have positive spillover effects globally." 16 At a minimum, FSOC must conduct its business 

13 FSOC, "Financial Stability Oversight Council Update on Review of Asset Management Products and Activities" 

(2016) 

https://www.treasury.gov/initiatives/fsoc/news/Documents/FSOC%20Update%20on%20Revi~w"/o20of%20Asset%2 

0Management%20Products%20and%20Activities.pdf 

14 Office of Financial Research, "Asset Management and Financial Stability" (September 2013) 

https://www.financialresearch.gov/reports/files/ofr asset management and financial stability.pdf 15 Financial Stability Board, "Consultative Document- Proposed Policy Recommendations to Address Structural 

Vulnerabilities from Asset Management Activities," (June 22, 2016) h!!n://www.fsb.o.rgbv.Q:£Q_ntent/uploads/FSBAsset-Management-Consultative-Document.pdf 

16 id. at Note 7. 
38 


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in a way that is analytically sounder and better grounded in date and regulatory history, with 

a clear path away from SIFI designation for non-banks. 

Thank you, and l look forward to answering your questions. 
39 


27251.008

Is there a uniform standard for 

FSOC designation? 

Paul H •• , ...... "' .... f~esident 
40 


27251.009

Chainnan Wagner, Ranking Member Green, and distinguished members of the subcommittee, 

thank you for convening today's hearing on the FSOC non-bank SIFT designation process, and 

for inviting me to testify. I am a resident scholar at the American Enterprise Institute, but this 

testimony represents my personal views. My research is focused on banking, regulation, 

financial stability and systemic risk. I have prior experience working on these issues at the 

Federal Reserve Board, the IMF and the FDIC, including as chainnan of the Research Task 

Force of the Basel Committee on Banking Supervision. It is an honor for me to be able to testify 

before the committee today. 

I want to begin my testimony with an analogy that explains the deficiencies in the FSOC 

designation process using an everyday commuting experience to which many can relate. 

When you or I are driving west on K street in Washington DC, and we see a bright burst of light 

as we approach the 22"d street underpass, 1 we instinctively check our speedometers, recall the 

posted speed limit, and quickly try to assess whether it was our vehicle that triggered the photo 

ticketing camera. 

Now instead imagine that you are the CEO of a large, very successful, nonbank financial firm. 

One day you experience a sudden spike in blood pressure when you receive an email from the 

FSOC infonning you that your institution has been selected for a stage-three FSOC designation 

review. 

Stage-three review, you ask? We had no idea the FSOC had already concluded a stage-two 

examination. Our institution is profitable, well-capitalized and growing. Our state regulators 

have given us a clean bill of health. No one on staff can imagine what our institution may have 

done to trigger the FSOC's ire. 

Keeping with the speeding ticket analogy, now ask yourself: Is there a speed limit for the 

institution? How fast is the finn going? How fast does the FSOC think the firm is going? Where 

can the institution find out answers to these questions? 

And then you discover---there are no definite answers to these questions. 

TI1c FSOC has the power to set individual speed limits for each and every nonbank financial 

institution under its designation jurisdiction. Frustration builds when you learn that the FSOC 

does not have to disclose your institution's speed limit-even if you pay your white-shoe law 

finn to make a fonnal request. Worse still, you learn that the FSOC is the only agency that has 

the authority to measure your finn's velocity, and since your firm is in a stage-three review, the 

FSOC's "scientists" are already measuring your institution's speed using an unknown process 

without any impartial witnesses present. 

If this nightmare of jurisprudence reminds you of the twilight zone, the episode you are watching 

is entitled 'The Dodd-Frank Act." 

1 https:f/www.youtube.com/watch?v=G2qiifHB03o 

2 
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A central tenet of the Dodd-Frank Act (DFA) is idea that some financial firms are too big or too 

important to fail, and that these so-called "systemically important financial institutions" (SIFis) 

must be identified and subjected to supplemental government supervision. This tenet is rooted in 

the mistaken belief that the financial crisis was caused by the failure of large financial 

institutions. 

In truth, the financial crisis was caused by a number of factors including poorly designed capital 

regulations that allowed excessive financial institution leverage and misguided government 

housing policies that encouraged consumers to overextend themselves purchasing real estate 

using poorly underwritten mortgages. Financial institutions ultimately failed because the firms 

took on excessive leverage to buy securities backed by the debt of overleveraged consumers. 

Underlying imbalances--excess consumer leverage and excess financial sector leverage--

caused the financial crisis. The large financial firms that failed in fall of 2008 were a casualtynot the cause--of the financial crisis. 

To be clear, the pre-crisis problem was not that financial regulators has insufficient powers to 

require minimum standards for safety and soundness of the firms that they regulate. Instead, the 

problem was that regulators exercised poor judgement and promulgated weak regulations. Even 

before the financial crisis, regulators themselves set the minimum regulatory capital standards 

that applied to the financial institutions under their charge. Regulators could have chosen to 

exercise their powers and adopt a more prudent standard, but they didn't. They had the power to 

set stricter standards without the DFA-they just did not exercise this power prudently. 

Post DFA, regulators still set the minimum capital standards that apply to firms under their 

charge. In that regard, nothing has changed. DF A merely adds an additional requirement that 

designated institutions be subjected to enhanced capital and liquidity standards. However, the 

DF A does not specify the actual standards that apply to designated institutions. Instead, as it did 

before the crisis, the design of the enhanced capital and liquidity standards for designated firms 

is left to regulators-in this case the Federal Reserve Board. 

In the case of bank holding companies, the DFA language itself identifies the SIFis that are to be 

subjected to Dodd-Frank's "too-big-to-fail" regulatory regime. With regard to non-bank financial 

firms, the DF A delegates SIFT identification to the financial stability oversight council (FSOC) 

and delegates the Federal Reserve Board with the duty to develop and impose an appropriate toobig-to-fail regulatory regime for non-bank SlFJs. 

The DFA Act identifies bank holding company S!Fls on the basis of consolidated balance sheet 

size alone. In the case of non-bank SIFis, the DFA includes specific criteria to guide the FSOC 

in its duty to identify non-bank SIFis. A non-bank financial firm must have a minimum share of 

its assets (85 percent) invested in financial activities or earn a minimum share of its revenues (85 

percent) from financial services to be eligible for FSOC designation. Among non-bank firms 

that meet this threshold, the FSOC may designate a firm if: (I) its financial distress could pose a 

threat to the financial stability of the United States; or, (2) the nature, scope, size, scale, 

concentration, interconnectedness, or mix of activities of the company could pose a threat to the 

financial stability of the United States. 

3 
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27251.011

Aside from specifying the criteria the FSOC may use to identify non-bank SIFis, the DFA is 

silent regarding any specific thresholds regarding size, market concentration, leverage, credit 

ratings, the nature of activities, scope of activities or any other factors that should trigger a 

designation. The FSOC is left to devise the rules, processes and detailed guidelines that it will 

use to designate non-bank institutions as SIF!s. 

When the FSOC designates an institution, it provides a public background brief that explains the 

FSOC's rational for designation.2 Many, including appellant judges, have been critical of the 

level of detail that has been provided in these public justifications. To date, FSOC designations 

that have been made have argued that the institution's financial distress could pose a threat to the 

financial stability of the United States. However, in its designation justifications, the FSOC has 

provided few details-too few to convincingly support its designation conclusions. 

For example, in its designations to date, the probability that the designated financial institution 

might face financial distress is never explicitly assessed or discussed. The FSOC begins its 

assessment assuming that the firm being designated experiences financial distress. This 

assumption would seemingly violate the FSOC's legal responsibility to assess an institution's 

potential for creating systemic risk taking into account the supervisory processes and regimes 

that are already in place. To date, all FSOC-designated firms are supervised by (numerous) state 

insurance regulators. To the best of my knowledge, none of the state insurance regulators with 

jurisdiction have raised concerns regarding the solvency status of the insurance subsidiaries of 

FSOC-designated institutions. 

The FSOC's assumptions regarding the mechanics of designated firms' financial distress 

typically mirror those of a classic bank run even though designated companies are insurance 

companies without a preponderance of deposit-like liabilities. The institution's financial distress 

is then assumed to cause distress for other important financial market participants because the 

firms are alleged to be "highly interconnected." How the FSOC concludes that the firms' are 

highly interconnected is unknown as other financial firms' net exposures to the FSOC-designated 

firms are never explicitly calculated. Indeed, such conclusions are almost certainly speculative 

as the necessary exposures information cannot be calculated based on information the FSOC 

might acquire from the designated firm alone 3 

In its recent report (GA0-15-51 ), the General Accountability office found (p. 39) that, "the 

FSOC did not develop a process or additional guidance for identifying detailed and specific 

analytical methods or prescriptive criteria for applying the analytical framework in evaluating 

companies." Until the Subcommittee on Oversight and Investigation released its recent report, 

' https ://www. treasu rv .gov /in itiatives/fsoc/ designations/Pages/ defau it. as px 

3 The FSOC has the power to require any information it deems necessary to make its assessment from the institution 

that is a candidate for designation, and yet this information would not be adequate to determine counterparties' 

exposures to the candidate for designation. For example, counterparties to the designated finn could offset (or 

acquire) exposure in swap markets without the knowledge of the designated firm. To accurately determine the 

exposure of other financial firms to the designated fim1 would require that the FSOC receive detailed exposure 

reports rrom any finn exposed to the designated finn. To the best of my knowledge, this level of analysis is beyond 

the capabilities of the FSOC. 

4 
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27251.012

.. The Arbitrary and Inconsistent FSOC Nonbank Designation Process," there was no way to 

know how this identified FSOC shortcoming impacted FSOC designation decisions. 

Unfortunately, the new information provided in the subcommittee's report shows that the FSOC 

designation decisions are the outcome of a completely ad hoc evaluation process. 

The inconsistency in the FSOC's designation processes becomes strikingly apparent when one 

compares the FSOC's reasoning in public designation cases to the discussion that appears in 

documentation acquired by the subcommittee on the FSOC's so-called stage-two designation 

decisions. 

In a stage-two assessment, firms are evaluated by the FSOC staff. The staff either recommends 

that the FSOC elevate the firm to a stage-stage three investigation, or the staff recommends that 

the FSOC end its investigation. Failure to elevate a firm to a stage-three evaluation is effectively 

a decision to decline to designate the firm. So the FSOC reasoning behind non-designation 

decisions reveals important information about the FSOC's evaluation process. Before the 

subcommittee released its report, the details surrounding stage-two assessments were completely 

confidential-to the public, to Congress, and to the firms that were reviewed for designation by 

the FSOC. 

The comparison of stage-two FSOC documents with public FSOC designation documents 

reveals that, in many stage-two assessments where the FSOC evaluated a firm but declined to 

designate it, FSOC staff did make an assessment about the potential that the firm being evaluated 

might face financial distress. But even in these cases, the documents reveal that the FSOC did 

not follow its own guidance regarding this matter, and the FSOC staff did not use the same 

criterion to assess the probability of financial distress in every case. 

According to its own guidelines, the FSOC is supposed to evaluate the potential for an institution 

to experience financial distress in the midst of overall stress in the financial services industry and 

a weak macroeconomic environment. Yet in a number of cases, the FSOC failed to designate a 

tirm on the basis of the staff judgment regarding the potential that the institution's failure in 

isolation (without regard to the health of the financial services sector or the state of the macro 

economy) might pose a threat to US financial market stability. 

Apparently some companies are evaluated by the FSOC based on a subjective judgement about 

the financial stability impact of the firm's failure in a normal market, whereas other institutions 

are judged according to the impact their failure may have when financial markets and the 

economy are in turmoil. The documents clearly show that the FSOC has not evaluated all firms it 

has examined under a common standard or using uniform assessment criteria. 

Another nonstandard practice revealed in the subcommittee's examination of stage-two 

documents is the manner in which the FSOC staff evaluates the implications of collateral 

associated with sizable repurchase agreement and securities lending programs. In some 

instances, the collateral associated with repo and securities lending is characterized as a strength 

for the firm being evaluated, while for other firms with exposures of similar size and character, 

collateral was deemed to be a potential threat for financial market stability. Clearly the FSOC has 

not developed a standardized approach for evaluating the stability impact of these activities. 

5 
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27251.013

The findings reported in the subcommittee report are disturbing, but they are not shocking. One 

reason that the FSOC has had difficulty in establishing uniform methodologies and processes to 

identify SIF!s is that no such processes exists. There is no scientific way to identifY the 

'·systemic risk" that is created by an individual financial institution.4 To date, all SIFI 

designations represent little more than the judgements of empowered regulators who back up 

their designations using hypothetical stories of the consequences of firm financial distress but 

without any solid evidence to support these claims. 

In many ways, systemic risk has become the financial equivalent of a "boogie-man" who is 

hiding out of sight- under the bed or in the closet-in places that only regulators can see. Thank 

goodness the Dodd-Frank Act requires regulators to protect us from this specter. 

4 This issue is analyzed in detail in Kupiec, Paul and Leven! Gilntay (2016). "Testing for Systemic Risk Using 

Stock Returns," Journal of Financial Services Research (49), pp. 203-227. 

6 
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27251.014

Testimony of Alex J. Pollock 

Distinguished Senior Fellow 

R Street Institute 

Washington, DC 

To the Subcommittee on Oversight and Investigations 

Committee on Financial Services 

United States House of Representatives 

Hearing on "The Arbitrary and Inconsistent Non-Bank SIFI Designation Process" 

March 28, 2017 

A Flawed Process Generated by a Flawed Structure 

Madam Chairman, Ranking Member Green, and Members of the Subcommittee, thank you for the 

opportunity to be here today. I am Alex Pollock, a senior fellow at the R Street Institute, and these are 

my personal views. I spent 35 years in banking, including twelve years a President and CEO of the 

Federal Home Loan Bank of Chicago, and then eleven years as a fellow of the American Enterprise 

Institute, before joining R Street last year. I have both experienced and studied numerous financial 

crises and financial cycles, including the political contributions to creating them and the political 

reactions afterward, and my work includes the issues of banking systems, central banking, risk and 

uncertainty in finance, housing finance and government-sponsored credit, and extensive study of 

financial history. 

To begin with, let me compliment the committee staff for their detailed, specific paper on the FSOC's 

non-bank designation process. The paper embodies a very good analytical idea: it "compares the FSOC's 

evaluation memoranda [of various companies] against one another to measure the consistency of the 

FSOC's analysis." This comparison, as documented in the paper, results in the conclusions that the 

treatment of different companies is not consistent, that FSOC did not follow its own formal guidance, 

and in summary, that the evaluations upon which companies either were or were not designated as 

systemically risky (as "SIFis") "have been characterized by multiple inconsistencies and anomalies on key 

issues." 

The paper says that "These examples cast doubt on the fairness of the FSOC's designation process." 

They do, but in my opinion, the more important point than fairness, is that the observations cast doubt 

on the objectivity of the FSOC's work. Were these evaluations impartial analyses looking for 

disinterested conclusions, or were they rationalizations for conclusions already reached in political 

fashion? 
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2 

As we all know, federal District Judge Rosemary Collyer, in her decision on the lawsuit Metlife brought 

against FSOC, found for Metlife and ruled that FSOC's action was "arbitrary and capricious." I want to 

focus on one of the reasons stressed by the Judge: the assumptions FSOC made to arrive at its proposed 

designation. 

Considering hypothetical losses resulting from Metlife, Judge Collyer's Opinion pointedly observes that 

"FSOC assumed that any such losses would affect the market in a manner that 'would be sufficiently 

severe to inflict significant damage on the broader economy.' ... These kinds of assumptions pervade the 

analysis; every possible effect of Metllfe's imminent insolvency was summarily deemed grave enough to 

damage the economy" [my italics]. "But," the Judge continued, "FSOC never projected what the losses 

would be, which financial institutions would have to actively manage their balance sheets, or how the 

market would destabilize as a result" [original italics]. Further, "FSOC was content ... to stop short of 

projecting what could actually happen if Metlife were to suffer material financial distress." FSOC's work 

appears pretty pathetic in this light, doesn't it. FSOC "hardly adhered to any standard when it came to 

assessing Metlife's threat to U.S. financial stability," the Judge found. 

This sound and sensible judicial decision was appealed by the previous administration. I believe the 

current Treasury Department should immediately request the Department of Justice to withdraw the 

appeal, and that the Department of Justice should do so as soon as possible. 

Recall that the point of designation of insurance companies as SIFis is to give significant regulatory 

jurisdiction over them to the Federal Reserve Board, an institution with little or no experience in 

insurance regulation and which certainly cannot be considered expert in it. The Independent Member 

of FSOC Having Insurance Expertise, Roy Woodall, who indubitably is a true expert in the insurance 

business and its regulation, voted against the SIFI designation of Metlife. Coming again to FSOC's 

assumptions, he objected: "The analysis relies on implausible, contrived scenarios" [my italics], which 

moreover, include "failures to appreciate fundamental aspects of insurance and annuity products." 

Mr. Woodall continued that "the central foundation for this designation" is the assumption of "a sudden 

and unforeseen insolvency of unprecedented scale [and] of unexplained causation." He reasonably 

added, "I simply cannot agree with such a premise." Can anybody? 

Voting against the earlier designation of Prudential Financial as a SIFI, Mr. Woodall similarly pointed out 

that "Key aspects of [FSOC's] analysis are not supported by the record or actual experience," that it 

presumes "an unfathomable and inexplicable simultaneous insolvency and liquidation of all insurance 

companies" among its ,misplaced assumptions." 

Ed DeMarco, a distinguished financial regulator who was at the time the Acting Director of the Federal 

Housing Finance Agency and thus the Conservator of Fannie Mae and Freddie Mac, joined the dissent on 

Prudential and also observed the lack of evidence presented in the FSOC's evaluation. FSOC proceeded 

"despite the acknowledgment that no institution has as disproportionally large exposure to Prudential"; 

it "does not fully take account of the stability of Prudential's liabilities"; it assumes that "withdrawals at 

Prudential could lead to runs at other insurance companies without providing supporting evidence." 

Once again, FSOC was operating on assumptions. 
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3 

Of course, Messrs. Woodall and DeMarco were in the minority. But did the majority address their 

serious and substantial objections? Was there a meaningful, substantive exchange among the members 

of FSOC about the conceptual issues and the relevant evidence, as would be appropriate, before voting 

the proposal in? I am told that there was not. 

Why not? The whole point of the existence of FSOC is supposed to be the combined substantive 

deliberation and development of insights by this committee of the heads of financial regulatory 

agencies. But it doesn't seem to happen. So the designation process does not work well not only at the 

staff level, but also at the level of the FSOC as a corporate body. 

I directly asked one former, senior FSOC insider from the previous administration if the meetings of the 

FSOC members had ever provided a new insight into financial issues. After thinking a moment, he gave 

me a candid answer: "No." 

Why is this? The Milken Institute, in a recent paper, proposed idealistically that although FSOC is 

currently nothing like this, "policy makers should convert the FSOC into a truly cooperative working 

group of regulators focused on risks." To anyone familiar with the ways of Washington, this will seem 

an unlikely outcome. 

The underlying problem, it seems to me, is the structure of FSOC itself. The shortcomings of the 

designation process reflect the underlying problems with the fundamental design. To begin with, FSOC 

is primarily a group of individuals each representing a regulatory agency, with turf to protect from 

intrusions by the others, and a regulatory record to defend from criticism, as principal bureaucratic 

concerns. 

It is a big group, with 15 official members, but in addition they all bring along helpers and allies. At the 

FSOC meeting of December 18, 2014 which approved the Metlife SIFI designation, there were according 

to its minutes, 46 people present. It's pretty hard, indeed impossible, to imagine a real, open, give-andtake, "truly cooperative" discussion with 46 people. 

Moreover, FSOC is chaired by the Secretary of the Treasury, a necessarily very political, powerful senior 

government actor with major partisan and institutional interests always in play. No company can be 

taken up for systemic risk study by the SIFI staff without the approval of the Secretary. Does this 

suggest a disinterested analytical process? 

The Federal Reserve is a special case in the structural design of FSOC, because it stands to expand its 

power every time FSOC makes a SIFI designation. Does the Federal Reserve like power? Would it like to 

acquire a big new jurisdiction? Of course, and it is a party at interest in every SIFI discussion. I think it is 

not unreasonable to suggest that given the Fed's major conflict of interest, it should recuse itself from 

any SIFI votes. 

With this context, it is easier to see why the FSOC's SIFI evaluations had to rely on big assumptions and 

tended to make inconsistent analyses of different companies. It was because the decisions being made 
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were inherently judgmental, with inherently subjective elements, made amidst competing intereststhat is to say, unavoidably political. 

The shortcomings of the FSOC evaluations appear at least consistent with the theory that the 

evaluations were meant to rationalize decisions already made. Where might the pressure for such 

decisions have come from? 

One publicly debated possibility is that commitments were already made in the setting of the 

international Financial Stability Board, in which two of the FSOC members, it is sometimes suspected, 

made deals with foreign central bankers and regulators about which companies were "Global 

Systemically Important Insurers." There is dispute about whether the FSB discussions were really 

agreements, and whether they were thought to be binding. But there is no dispute that the 

international discussions and the naming of "Global Slls" preceded the Prudential and Metlife 

designations of the FSOC. Roy Woodall reflected, "While the FSB's action should have no influence, I 

have come to be concerned that the international and domestic processes may not be entirely 

separate." A related question is whether the Treasury and Federal Reserve FSOC members felt 

personally committed by their international discussions. If they did, it seems that they should have 

disclosed that and recused themselves from the FSOC decisions. Did they feel committed to follow the 

FSB? Only they know. 

4 

During their research for the study of the FSOC designations process, the committee staff asked the 

Executive Director of the FSOC, Patrick Pinschmidt, what "significant damage on the broader economy" 

meant in their assessments. Mr. Pinschmidt replied, "It's up to each voting member of the Council to 

decide for him or herself what constitutes a significant threshold." That sounds like depending on 

subjective judgments to me. 

I agree that it is a naturally good idea for financial regulatory agencies to get together and share 

information, ideas and experiences (to the extent that they will really share). But what is a committee 

of heads of regulatory agencies, who are acting as individuals and not even on behalf of the relevant 

boards or commissions, doing making political decisions? If Congress wants to have the Federal Reserve 

Board regulate big insurance companies, it can make it so in statute, using whatever subjective 

judgments it wants. In my view, FSOC is a distinctly inappropriate body to act as a little legislature. 

The staff paper of FSOC's evaluations of possible SIFis, those recommended for designation and those 

not, details the inconsistencies in treatment. But these differences pale beside the huge discrepancy of 

those companies chosen for evaluation and those companies not evaluated at all, because the previous 

Treasury Secretary did not approve their being studied. So the FSOC staff did not even analyze them 

because of some higher, prior, political judgment. I think this could fairly be characterized as 

desperately wanting to "see no evil" when it comes to the systemic financial risk of some entities. 

The most egregious cases are Fannie Mae and Freddie Mac, which are obviously systemically important 

and without question systemically very risky. To document that is simple, starting with their combined 

$5 trillion in credit risk, virtually zero capital, and ubiquitous interconnectedness throughout the country 
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and world. Two of the biggest causes of systemic risk are leveraged real estate and the moral hazard 

created by the government-Fannie and Freddie are both of these combined and to the max. 

The Dodd-Frank Act gives a key assignment to FSOC: "To promote market discipline, by eliminating 

expectations on the part of shareholders, creditors, and counterparties that the Government will shield 

them from losses in the event of failure." Fannie and Freddie are pure cases of "the Government 

shielding creditors and counterparties from losses," not only as a hypothetical, but as a vast/act. They 

operate entirely on the government's credit. They represent the very essence of the problem that FSOC 

was supposedly created to address. But FSOC doesn't even study them-instead, the staff was ordered 

not to study them. 

That is an inconsistency raised to the nth power-- in my view, a bankruptcy of FSOC's intellectual 

credibility as run by the previous administration. 

A recent article claims that "the next financial crisis that rocks America ... will be driven by pension funds 

that cannot pay what they promised." Whether or not it triggers the next crisis, there is no doubt that 

this is a looming huge risk. 

In the very center of this risk is an insurance company absent from FSOC's evaluation as a SIFI: the 

Pension Benefit Guaranty Corporation. The PBGC is not only on the hook as guarantor of unpayable 

pensions nationwide, but is already insolvent itself, with according to its own books, a deficit net worth 

of $76 billion. Might PBGC represent a systemic risk? Yes. Do the creditors of the PBGC think "the 

Government will shield them from losses"? Yes. Does the FSOC staff evaluate the PBGC? Nope. 

In sum, it appears that the flawed process of FSOC's SIFI designations is generated by the flawed 

structure of FSOC itself. 

In my opinion, structural reform of FSOC is needed as part of larger the Dodd-Frank reform legislation. 

But here are a few recommendations for improvements which could be implemented by the new 

administration in the short run: 

-FSOC should have regular meetings of principals only with substantive discussions of major issues 

and explorations of disagreements. No helpers, no staff. 

-The Secretary of the Treasury should immediately instruct the FSOC staff to undertake systemic risk 

evaluations of Fannie Mae and Freddie Mac. 

-The Secretary of the Treasury should immediately instruct the FSOC staff to undertake a systemic 

risk evaluation of the Pension Benefit Guarantee Corporation. 

-The Treasury Department should immediately request the Department of Justice to withdraw the 

government's appeal in the Met life v. FSOC suit and the Department of Justice should immediately do 

so. 

-The FSOC staff should be encouraged to come up with new ideas on evolving risks for discussion 

among the FSOC principals. 

5 
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-Any SIFI evaluation should strictly follow the rules and guidance approved by FSOC, with analysis 

performed in a strictly consistent manner. 

-Assumptions about macro reactions and assumptions of implausible and contrived scenarios should 

be clearly identified as judgments and guesses. 

-International discussions and actual decisions of FSOC should be kept strictly separate. Any 

international agreements, even if informal, made by FSOC members, should be fully disclosed. 

Again, my appreciation to the committee staff for their productive study of the inconsistent FSOC 

designations process and the very important issues it raises. 

And thank you very much for the chance to share these views. 

6 
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27251.020

TESTIMONY OF DAVID ZARING 

Associate Professor of Legal Studies and Business Ethics, The Wharton School 

to the 

United States House of Representatives 

Committee on Financial Services 

Oversight and Investigations Subcommittee 

Hearing on "The Arbitrary and Inconsistent Non-Bank SIFI Designation Process." 

March 28, 2017 

I am an associate professor of legal studies and business ethics at the Wharton School. 

study financial regulation and, have written an article on the administrative procedure of the 

Financial Stability Oversight Council (FSOC or "the council") with Daniel Schwarcz, professor 

of law at the University of Minnesota, that is forthcoming in the University of Chicago Law 

Review, and that may be found here. 1 FSOC has already transformed the way that banks and 

capital markets are regulated, and has become, through its nonbank designation program, 

influential for insurance and other financial companies as well. 

I. Overview 

In my testimony on the procedures followed by the Financial Stability Oversight Council 

(FSOC or "the council") today, I would like to focus on three points. 

1 Schwarcz, Daniel and Zaring, David T., Regulation by Threat: Dodd-Frank and the Non-Bank Problem. 

(November 7, 2016). University of Chicago Law Review, Vol. 84, 2017, Forthcoming; Minnesota Legal Studies 

Research Paper No. 16-42. Available at SSRN: https://ssrn.com/abstract~2865958 
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First, the report prepared by the Republican staff of the Committee on Financial Services 

subjects the council to a degree of after-the-fact review that is inconsistent with the flexibility 

Congress gave the council in the Dodd Frank Wall Street Reform Act. 

In that statute, Congress charged the council with designating non-bank financial 

companies as systemically significant on the basis of, among other things, a ten-factor test. It did 

not specify how those factors should be weighed and emphasized that the council should apply 

"any other risk related factors that the council deems appropriate" to its designation decisions, in 

addition to those identified in the statute. 

The Republican staff report identifies portions of the written memoranda of the council 

where it emphasized some safety and soundness factors more heavily than other factors. It also 

identifies cases where the council considered the riskiness of a financial institution as a general 

matter as indicative of the risk the institution would pose when the economy was stressed. There 

is nothing arbitrary about emphasizing some factors more than others in such circumstances. Nor 

is it arbitrary to presume that a non-bank risky in normal conditions would definitely be risky 

when times are difficult. 

Second, the report, while a real contribution into how the council makes decisions, 

attempts to isolate particular aspects of the council's analysis and make arguments about 

inconsistency based on these aspects. But the designation decision is meant to be a holistic one, 

utilizing a number of different factors in a way that enables the council to consider a full picture 

of any particular nonbank's position. 

Third, the council itself has been given the responsibility for taking a broad view of the 

safety of the financial system, and is the only part of the federal government with the power and 

the capability to do so. It has chosen to make designations in a manner that makes it possible to 

2 
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re-visit those designations. Only the three largest American insurance companies have been 

designated by it as systemically significant, as well as one large financing company, but it is 

important that the council retain its flexibility to adjust its assessments of risk in the future. 

Second-guessing small portions of large decisions is inconsistent with the necessary flexibility 

that Congress gave to the council. 

II. The Report Prepared By the Republican Staff of the Committee on Financial Services 

I congratulate the Republican staff of the Committee on Financial Services for preparing 

a careful report on FSOC's designation practices so far. The report tells us some things that we 

have not known about the council's practices. It will help observers and interested institutions 

make more sense out of the designation process. But the report's conclusions are misguided. 

The report subjects FSOC to a degree of technical second guessing that is simply 

unsustainable if the authority given to the council by Congress is to be exercised at all. 

Congress constrained the council's discretion in a number of ways, but it also afforded 

the council with plenty of flexibility to assess systemic riskiness in response to changing 

conditions. It declined to impose a cost-benefit analysis requirement on the council's 

designation decisions, for example. 2 It did not establish a particular set of procedures that the 

2 Although one court has suggested that the council should be required to do a cost-benefit analysis, nothing in 

the text of Dodd-Frank requires, or even hints that this should be necessary. Metlife, Inc. v. Fin. Stability Oversight 

Council, 177 F. Supp. 3d 219 (D.D.C. 2016). That case is on appeal, at any rate. Moreover, a quantified cost benefit 

analysis requirement imposed on a financial regulator assessing the possibility of a catastrophic collapse would 

make no sense. The failure of a major, systemically important, financial institution is almost by definition a low 

probability event that, turns on a number essentially unquantifiable assumptions. As one court has observed, "the 

law does not require agencies to measure the immeasurable." lnv. Co. Ins!. v. Commodity Futures Trading 

3 
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council was obligated to follow in making those decisions. Finally, il instructed the council to, 

among other things, consider in any designation decision "any other risk-related factors that the 

Council deems appropriate," a provision that fairly exudes an intention to ensure that the council 

exercises plenty of discretion in making designation determinations, rather than holding it to a 

hard and fast formula. 3 

As for the constraints, Congress required FSOC to designate firms under one of two 

standards: FSOC must find that the firm "could pose a threat to the financial stability of the 

United States" either (i) in the event of its "material financial distress," or (ii) due to "the nature, 

scope, size, scale, concentration, interconnectedness, or mix of [its) activities."4 It enumerated 

nine other factors, that FSOC shall consider in deciding whether a firm meets one of these two 

designation standards. 5 It limited designation to firms "predominantly engaged in financial 

activities."6 Additionally, it provided that designated firms are to be subject to annual reviews to 

determine whether the designation is still appropriate. 7 

FSOC has carefully elaborated a three stage process for designation in light of this 

congressional instruction. Firms that pass through a Stage 1 quantitative screen are then subject 

to a Stage 2 evaluation, during which the council "prioritizes" its analysis of them. In doing so, 

the council relies on "a wide range of quantitative and qualitative information" that it extracts 

from publicly available and regulatory sources. Firms that pass the first two stages proceed to 

Comm'n, 720 F.3d 370,372-75 (D.C. Cir. 2013). 3 Dodd-Frank Act§ 113(a)(2)(K). 4 Dodd-Frank Act§ 1 J 3. 5 Dodd-Frank Act§ 113. 6 Dodd-Frank Act§§ 102(a), 113. Such firms must derive 85 percent or more of their consolidated annual gross 

revenues from financial activities, or have 85 percent or more of their assets related to activities that are "financial in 

nature." !d. § l02(a). 7 ld. § 113(d). 

4 
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Stage 3, at which point they are informed that they are being considered for FSOC designation 

and invited to meet with council staff and submit relevant materials to the council. The council 

issues a preliminary decision, takes comment and a meeting from the designated finn if 

requested to do so, and then issues a final decision, which requires a supennajority vote of7 of 

the II voting members of the organization. 

The report's overly intense after-the-fact review misapprehends the underlying goal of 

FSOC's designation decisions. Those decisions are not meant to be, and nor can they be, hyperspecific rules promulgated in advance that work with machine-like precision to establish 

conclusively which non-bank financial institutions pose risk to the system and which do not. If 

we knew the answer to those questions, systemic financial regulation would be easy. But it isn't; 

instead, it is very hard. 

Accordingly, the portions of the decisions that the report characterizes as arbitrary really 

just involve the application of broader standards to particular aspects of particular nonbank 

balance sheets and places within the financial ecosystem. In some cases, the discretion given the 

council by Congress has pointed to weighing some often factors articulated in Dodd-Frank 

particularly heavily. In other cases, other factors will carry more weight. But in all cases, it does 

not make sense to scrutinize a sentence or paragraph of a designation decision in isolation from 

the rest of the decision, or to worry about the council's analysis of one particular factor in a 

decision when it is supposed to balance ten of them. 

5 
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In particular, the report made much of the idea that FSOC occasionally deemed some 

institutions to be systemically risky in unstressed times while evaluating others in the contexts of 

stress tests. But rather than being inconsistent, designating institutions that pose risks whether 

the economy or financial system is unstressed obviously means that they will pose risks in 

stressed periods as welL The council by observing that some institutions were risky no matter 

what the state of the economy or the potential for some other kind of shock was acting entirely 

consistently with its stated goal of figuring out which institutions would be the most likely to run 

into trouble during those unfortunate periods. 

The report worries that the council has focused on the "material financial distress" 

inquiry in its designations at the second stage of the designation process, even though it concedes 

elsewhere that occasionally, such as when assessing the interconnectedness of nonbanks, it 

considered "the nature, scope, size, scale, concentration, interconnectedness, or mix of the 

activities" of a company. 

I saw in the report's characterization of the stage 2 memoranda consideration of both 

inquiries, and would be untroubled by a focus on material financial distress at any rate. Size and 

interconnectedness, after all can threaten systemic stability, and arc especially likely to do so 

when such companies are experience material financial distress. Moreover, in some cases 

enormous non banks alone will create problems for the economy even if they themselves could 

survive a financial shock- it: for example, firms generating risky products like mortgage backed 

securities survive a shock to the housing market, but the firms that consumed the mortgage 

backed securities they generated do not. In such case, it makes sense to prioritize the size 

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inquiry. In other case, prioritizing the stress inquiry will be more sensible. In neither case would 

an emphasis on one factor over the other be arbitrary. Moreover, in the four final designations 

that the council has made, both size and stress are considered and it is the stress to the system 

and interconnectedness of the institution that are emphasized. 

The report then posits that FSOC was focusing on "systemic" risk instead of"systematic" 

risk, though the difference between these two concepts appears to be marginal, and not one that 

FSOC has made use of, as far as I know. FSOC's procedures reflect the importance of the 

inquiry into systemic riskiness, and, rather than being an arbitrary focus, FSOC's the reliance on 

the term is an example of consistency. Systematic risks, as the report defines them, are risks of 

size that do not necessarily reflect interconnectedness; the report alleges that FSOC has failed to 

make this distinction. But big firms can pose systemic risks because, as size increases, the 

number and variety ofcounterparties may increase as well. At any rate, none of the designation 

decisions that I have read only focus on the size of the institution without considering their 

interconnectedness. 

FSOC had made findings about the effect that distress would have on the broader 

financial marketplace in each case. In the designation of Prudential, the council noted that 

"Prudential is one of the largest financial services companies in the United States" and that it "is 

interconnected with global systemically important banks, nonbank financial companies, large 

insurance companies, and other companies of all sizes through its broad mix of institutional 

customers, debt holders, and other counterparties." It is difficult to know what more the council 

should do in this regard. 

7 
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Moreover, it is unfair to suggest that the council failed to distinguish "whether 

interconnections between companies are likely to 'impair financial intermediation or financial 

market functioning,' or instead prevent that impairment," as the report does on page 15. 

Financial intermediation depends on interconnections- it is a transactional activity. The 

question for FSOC is how interconnected a nonbank is, and, whether, if its financing suddenly 

dried up or if it was subjected to some other shock, the nature of its interconnectedness would 

imperil the market as a whole. 

The report also attempts to make something of the fact that in some cases the council 

worried about the use of collateral in certain financial transactions as a mitigating factor against 

designation and in other cases did not. Again, this is a narrow critique of what is necessarily a 

broader inquiry; at any rate, it is unclear what the problem is with the distinctions that the council 

has drawn. 

The report singles out the council's concern regarding its treatment of collateral in the 

context of securities lending and repurchase agreements, which are agreements that insurance 

companies often engage in and that do create risks of bank runs. The report complains that 

FSOC did not explain why it treated some companies that had securities lending programs 

differently than others. Congress required the council, in this regard, to consider the 

interconnectedness of nonbanks, and their importance to the financial system, and "the amount 

8 
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and types of the liabilities of the company, including the degree of reliance on short-term 

funding." 8 

But the council's conduct does not in any way suggest that there has been some 

inconsistency in its treatment of collateral. Some companies that rely for financing on their 

securities lending programs would face risks if demand for the securities they lend out dried up. 

Other companies that rely to a lesser degree on the securities lending programs for 

financing are less likely to run into trouble if those programs run into trouble. The staff has more 

access to information than the rest of us do. But it certainly looked to me like the council was 

assessing the riskiness of these programs in the context of the entire balance sheet of each 

company engaged in securities lending. It is eminently possible that companies that engage in 

more securities lending than their near-peers would nonetheless be less dependent for financing 

overall on securities lending programs. The report does not address that possibility. 

It is clear in assessing systemic stability that the council cares about the counterparties 

with which non-banks are engaged in financing transactions, but while the report suggests that it 

had not engaged in this inquiry consistently. Yet we see the council explicitly conducting the 

inquiry in three of the four company memos quoted in the report. In the case of the fourth it may 

have concluded that the inquiry was unnecessary in wake of the other reasons discussed. 

The report has access to information that I cannot see on the designation process but there 

is nothing in the apparent smoking guns that it has analyzed that suggests to me that the council 

8 Dodd-Frank Act§ 113. 

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has made arbitrary distinctions between the companies it has designated and the companies it did 

not. 

Emphasizing that the council assessed, for example, the vulnerability to financial distress 

of all of the companies that it investigated for systemic risk differently does nothing to suggest 

that making distinctions between these vulnerabilities was inappropriate or that the companies 

had not taken different steps to approach the material financial distress problem. 

The flexibility that FSOC has retained for itself ensures that it can respond to new risks 

posed by non-banks rather than being straightjacketed to an extremely specified set of 

procedures that, likely as not, would make evasion easy, and thereby encourage, rather than 

discourage, risk-taking in this sector. It is also worth remembering that, like any standards based 

regime, or our great common law courts, we will know more about how the designation system 

will work the more experience we get with it. The right time to insist precision is not shortly 

after agencies have been asked to implement a neW'program designed by Congress, informed by 

a ten factor test. With four designations and (apparently) nine stage 2 memos, we are seeing a 

process that does not strike me as arbitrary in any way. As it continues to evolve, it will only 

become more predictable. 

III. The Council's Role In Financial Regulation 

FSOC is uniquely tasked with taking the broadest possible view of the safety and 

soundness of our financial system and acting to protect that system from the risky conduct of 

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financial institutions. After years of academic research, we still do not know what, precisely, 

predicts financial crises and from what part of the financial infrastructure crises are likely to 

come. Sometimes crises have been created by unwise investments by banks, as was the case in 

the Latin American debt crisis of the 1990s. In other cases they come from shadow banks, as the 

collapse of Long Term Capital Management, a hedge fund, demonstrated. In the last financial 

crisis, the collapse of the insurance company AIG was a regrettable contributor to the worst days 

of the period. 

This lack of certainty about what risks in the future will jeopardize the economy, 

potentially threatening businesses with large losses, and workers with job cuts, makes the 

council's job challenging. But even more alarmingly, the consequence of a mistake in 

designation could be enormous for the financial system and the broader economy as a whole. 

In those kinds of circumstances, a precautionary approach to regulation is better than one 

with elaborate and narrowly tailored procedures spelled out in advance. Where the nature of the 

risk is uncertain, and the downside enonnous, deference to regulatory discretion is appropriate. 

FSOC must be afforded the flexibility to address new risks that they identify, and to 

encourage all companies engaged in financial transactions to act safely in as cost-effective a way 

as possible. FSOC's non-bank insurance designation process does this. The council has spelled 

out the procedures for designation and has created a relatively elaborate three-stage architecture 

that it applies to every designation decision. But it has always retained for itself the flexibility to 

identify and respond to new potential sources of risk in the financial system based on the 

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collective wisdom of the leaders of the financial regulators in the federal government, all of 

whom are members of the council. 

FSOC's nonbank designations have been restrained. Currently, three companies are 

designated (with one of those in litigation), while the council has lifted the prior designation of a 

fourth. These institutions are subject to extra supervision by the Federal Reserve on account of 

their systemic riskiness. The three designated companies are the three largest insurers in the 

United States, and include AIG, which collapsed so spectacularly during the last financial crisis. 

In assessing whether a regulatory regime ought to prioritize process before making 

decisions, or flexibility about how those decisions are made, it is critical to focus on what the 

regime is supposed to do. Sometimes process is important. Presumably this is one reason why 

administrative adjudications at the Securities and Exchange Commission come with elaborate 

procedures that are designed to balance the agency's need to protect against securities fraud, 

against defendants' need to make their case before being subjected to sanctions. 

But sometimes flexibility is critical. The council is the only institution in the government 

with the duty to assess risk across the entire financial system and to look for systemically 

significant sources of that risk and make sure that those sources are adequately regulated. All of 

its members have specific and limited authority and no other institution in the government has 

responsibility for governing the risks posed by all financial institutions not just banks. Reducing 

FSOC's authority to make designations in a way where its discretion is outlined but not entirely 

curtailed by its rules in advance would eliminate the country's early warning system and make 

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the likelihood of expensive bailouts in the future more real. The process it has created includes 

an elaborate three stage evaluative approach, and a multi factor analysis of the systemic risk of 

nonbanks. Any multi-factor test creates ambiguities. But Congress instructed it to weigh these 

factors- the council cannot say no. 

Moreover, an important purpose behind these designations is deterrence across an entire 

industry. Bright line rules that rule in some institutions as systemically significant, but that rule 

out others would not deter the "ruled outs" from taking on risk once they get their free pass. 

Finally, the costs of designation are real, but they are easy to overstate. While GE 

Capital transformed itself in an effort to move away from designation, it is clear that there were 

business reasons to restructure the company anyway. And as the CEO of AIG has observed, 

designation "just simply isn't a binding constraint on our capital returns and our objectives. So, 

we don't spend too much time worrying about it." For that insurance company, designation has 

not been a burden, but rather a regulatory requirement that has not imperiled its business or 

ability to make plans for the future. 

13 
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ffACL/ 

Fmanua! Security., .for Lde. 

Statement for the Record 

Subcommittee on Oversight & Investigation 

House Committee on Financial Services 

U.S. House of Representatives 

Hearing titled "The Arbitrary and Inconsistent Non-Bank SIFI Designation Process" 

March 28,2017 

Chairman Wagner, Ranking Member Green, the American Council of Life Insurers (ACLI) is 

pleased to submit this statement for the hearing record expressing the views of member life 

insurance companies regarding the non-bank Systemically Important Financial Institution 

(SIFI) designation process. We agree with the Committee's majority staff report that the nonbank SIFI designation process has been arbitrary, inconsistent, and highly problematic. The 

insurer designations have led to duplicative supervision and regulation of insurers, produced 

excessive and unnecessary regulatory costs and burdens, and harmed competition in the 

insurance market without actually reducing systemic risk. We strongly support provisions in 

Chairman Jeb Hensarling's Financial CHOICE Act from the previous Congress (H.R. 5983) that 

would reform the authorities of the Financial Stability Oversight Council (FSOC) to repeal its 

ability to designate life insurance companies as SIFis. 

The American Council of Life Insurers is a Washington, D.C.-based trade association with 

approximately 290 member companies operating in the United States and abroad. ACLI 

advocates in state, federal, and international forums for public policy that supports the 

industry marketplace and the 75 million American families that rely on life insurers' products 

for financial and retirement security. ACLI members offer life insurance, annuities, retirement 

plans, long-term care and disability income insurance, and reinsurance, representing 94 

percent of industry assets, 93 percent of life insurance premiums, and 97 percent of annuity 

considerations in the United States. Learn more at www.acli.com. 

The FSOC Designation Process is Fatally Flawed 

As clearly identified in the Committee's majority staff report, the FSOC process for systemic 

designations of non-banks has been materially unfair and uneven. The experience of life 

insurance companies that have been designated by FSOC confirms the findings of the staff 

American Council of Life fnsuretS 

101 Constitution Avenue, NW, Washington, DC 20001-2133 

www.ac/f.com 
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2 

report. In the view of ACLI, the FSOC process has not met basic standards of accountability, 

transparency, and good governance. 

A significant issue with the FSOC process has been the extremely inconsistent use of its broad 

authorities as applied to different sectors of the financial services industry. This problem is 

best illustrated by the very different approaches taken towards the insurance industry, which 

has been subject to designation of individual firms, as compared to the asset management 

industry. In the case of asset managers, FSOC has focused on recommendations for new or 

heightened standards for specific practices that may pose significant risk rather than singling 

out firms for designation. 

Even in the insurance sector itself, there is no evidence of a uniform, consistent or 

transparent methodology being applied to each individual company under review. Life 

insurance companies that have gone through the designation process have not received 

adequate information or explanation of FSOC analysis and decisions. Documents provided by 

FSOC to insurance companies provide little insight into the basis for designation decisions. 

These documents typically offer only conclusory statements, predictions, and speculations 

that are unsupported by factual and economic analysis. FSOC has not provided companies 

with enough information that would allow them to take positive steps to avoid designation, or 

be de-designated through appropriate action. 

One of the most significant problems with the FSOC process for non-bank systemic 

designations of insurers has been its failure to appropriately consider the role of existing 

primary financial regulators leading to a lack of understanding and recognition of the strong 

insurance regulatory framework in place through the state-based system. The state-based 

insurance regime has a long and successful track record of insurance regulation. 

One of the explicit statutory requirements the FSOC must consider is the "degree to which the 

company is already regulated by one or more primary financial regulatory agencies." Contrary 

to this statutory requirement, the FSOC has not appropriately considered in its designation of 

insurers the authority and tools available under the state-based insurance regime, including 

numerous and substantial reforms policymakers have implemented since the financial crisis. 

FSOC lacks State Insurance Regulator Voting Representation 

The lack of consideration given to primary financial regulators of insurance has been 

exacerbated by the lack of insurance expertise and representation on the panel. Of the 10 

FSOC voting members, at least seven are primarily banking industry regulators. When either 

the FSOC Independent Member with Insurance Expertise or the nonvoting state insurance 

regulator offered dissenting views, they were disregarded and overruled. FSOC also dismissed 

concerns registered by the then primary insurance regulator in New York state, Benjamin 

Lawsky, Superintendent of the New York Department of Financial Services, in a letter to 

Treasury Secretary Jacob Lew in July of 2014. 

Amerlcan Council of Ufe Insurers 

101. Constitution Avenue, NW, Washington, DC 20001-2133 

www.acll.com 
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3 

Clearly, the designations of insurers were largely dependent on banking expertise, not 

insurance expertise. FSOC's decisions with regard to insurers were bank-centric and not 

grounded in an accurate understanding of the business of insurance. Life insurers are 

fundamentally different from banks. FSOC's reliance on an inappropriate and unrealistic 

bank-like "run" scenario on insurance products as the trigger of an insurer's financial distress 

or cause of systemic risk illustrates its bank-centric mindset for considering insurance firm 

designations. 

The structure of FSOC should be changed to add state insurance regulators as voting 

members. Right now, no state insurance commissioner is a voting FSOC member. The history 

of FSOC, now dominated by bank regulators, shows that it discounts the opinions of the single 

insurance expert voting member, resulting in erroneous and harmful decisions for insurance 

markets. Structural change must also ensure that any FSOC recommendations that would 

affect insurers must be developed with direct input from state insurance regulators, and that 

any implementation of such recommendations is solely within the province and authority of 

those regulators. 

FSOC Has Misused Its Existing Authority 

FSOC's narrow focus on a few individual entities in certain sectors has diverted attention and 

resources away from its more important role as a broad-sighted macro-prudential overseer of 

the economy that can identify potential systemic risk in a timely fashion. The enormous 

resources and time devoted by FSOC to duplicative oversight of a few individual insurance 

companies has significantly depleted the attention that could be focused on insufficiently 

regulated or unregulated sectors of the financial economy, where the next crisis is much more 

likely to arise. For any such entity that by virtue of its activities poses a threat to the financial 

stability of the United States, FSOC should act as an early warning system and ensure that 

adequate regulation can be put in place. 

FSOC's primary responsibility should be assessing macro-prudential risks to U.S. financial 

stability. It should be made clear that its principal role is making advisory recommendations 

to primary financial regulatory agencies, which for insurance are the state commissioners, on 

applying new or heightened safeguards for financial activities that could increase risks to the 

U.S. financial markets. 

There is no evidence that the current structure and approach of FSOC has facilitated the 

reduction of systemic risk, nor has it effectively demonstrated that life insurance activities 

present a systemic risk. The resulting erroneous FSOC systemic designations of insurance 

companies have imposed unnecessary costs on insurers and distorted the competitive 

landscape in the insurance industry. 

American Council of Ufe lnsuretS 

101 Constitution Avenue, NW, Washington, DC 20001-2133 

www.acll.com 
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4 

Life Insurers Do Not Represent a Systemic Risk 

There is no compelling evidence that any life insurer represents a systemic risk to the 

financial services system. The exact opposite is true. Life insurers have historically been a 

source of stability in the U.S. financial system, providing families with financial protection and 

providing businesses with long-term capital for economic growth and job creation. Life 

insurance companies hold assets for the long-term to match up with product guarantees that 

are made for the long-term. The average maturity of the bonds purchased by life insurance 

companies is more than 18.5 years on a dollar weighted basis. 

Life insurers are not subject to a "run on the bank" as depository institutions are. The longterm nature of our products and promises discourage such behavior. Policyholders cannot 

accelerate benefits or periodic payments. Indeed, during the greatest stress-test in more than 

70 years- the financial crisis of 2008- extraordinary redemptions from life insurance or 

annuity policies did not occur. Given the improbability of this occurrence, insurers would not 

be forced into a mass liquidation of assets. 

Insurance companies have experienced prudential regulators that have greatly increased the 

tools available to oversee and effectively regulate the industry. In the last decade, state 

insurance holding company laws and group supervision practices have been strengthened 

and expanded to enable state regulators to be vigilant in identifying and aggressive in 

addressing issues of concern that might jeopardize the corporation as a whole. For example, 

insurance companies or groups are now required to submit their own risk and solvency 

assessments to state insurance regulators, who routinely review them with the group's 

management in cooperation with other regulators. Prudential oversight of insurance 

companies through the state-based system continues to be demonstrably strong and effective 

as it evolves to meet ongoing challenges. 

ACLI Supports Provisions in the Financial CHOICE Act to Eliminate Non-Bank Designation 

Authority 

ACLI would like to reiterate its strong support for provisions in the Financial CHOICE Act that 

address the clear failures of the existing FSOC non-bank designation authority. Elimination of 

the non-bank designation authority for life insurance companies is an essential reform that 

will refocus systemic oversight on insufficiently or unregulated sectors or those that actually 

present systemic risk, while maintaining its authority for identifying and assessing macroprudential risks to U.S. financial stability. By rebalancing the FSOC approach, and removing 

the impact of arbitrary and misdirected FSOC designations, insurance regulators, insurance 

markets, and insurance consumers can expect better outcomes. 

Conclusion 

The American Council of Life Insurers (ACLI) thanks the Committee for convening this 

important hearing and for its comprehensive oversight over the non-bank systemic 

American Council of Ufe Insurers 

101 Constitution Avenue, NW, Washington, DC 20001-2133 

www.acll.com 
68 


27251.037

5 

designation process. We strongly support the Committee's efforts to examine the failures of 

FSOC to conduct a fair, transparent, and accountable process. We look forward to working 

with the Committee to eliminate FSOC designation authority of life insurance companies. 

American Council of Ufe Insurers 

101 Constitution Avenue, NW, Washington, DC 20001-2133 

www.acll.com 
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•••• 

Pel .~~~ . ...• ...• ..... Property Casualty Insurers 

Association of America 

Advocacy. Leadership. Results. 

Testimony 

Property Casualty Insurers Association of America (PCI) 

The Arbitrary and Inconsistent Non-Bank SIFI Designation Process 

House Committee on Financial Services 

March 28, 2017 

444 Nonh Capitol Street NW, Suite 801, Washington. DC 20001 Telephone 202·639·0490 facsimile 202-639·0<94 www.pdaa.net 
70 


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The Property Casualty Insurers Association of America (PCI) is pleased to offer testimony on the Arbitrary 

and Inconsistent Non-Bank SIFI Designation Process. PCI is composed of nearly 1,000 member companies, 

representing the broadest cross section of insurers of any national trade association. PCI members write 

$202 billion in annual premium, 35 percent of the nation's property casualty insurance. Member companies 

write 42 percent of the U.S. automobile insurance market, 27 percent of the homeowners market; 33 

percent of the commercial property and liability market and 34 percent of the private workers 

compensation market. 

Congress created the Financial Stability Oversight Council (FSOC) to identify and reduce systemic risk. FSOC 

has selectively targeted large state regulated insurers for designations to vastly expand federal regulatory 

involvement in insurance in violation of its own rules and due process. PCI strongly supports proposals 

adopted by the House Financial Service Committee to terminate FSOC's authority to designate nonbanks as 

systemically important financial institutions (SIFis). Instead of imposing ill-targeted federal bank regulations 

on large insurers to duplicate state insurance supervision, FSOC should work with state insurance regulators 

and other financial regulators to identify and mitigate and reduce systemically risk activities. 

Flaws in the Non-Bank Designation Process 

FSOC Rationale for Designations Unclear and Inconsistent. The non-bank systemic risk designation decisions 

handed down by FSOC have failed to state clearly the rationale for the decision based on activities in which 

the firms engage. For example, a Federal District Court ruling overturning a nonbank designation found that 

the FSOC's Final Determination "hardly adhered to any standard when it came to assessing [the] threat to 

U.S. financial stability."' Not only does this call the integrity of the designation decision into question, but it 

has left all companies in the dark about what activities the FSOC considers systemically risky and thus 

provides no clear direction to companies on how to reduce systemic risk. Thus, FSOC has failed to achieve 

the primary objective of Dodd-Frank, which was to identify and reduce systemic risk. 

A report released in February by the Committee's majority staff concluded that FSOC's non-bank designation 

process is "arbitrary and inconsistent," and that FSOC failed to follow its own rules and guidance. The report 

concluded that "FSOC is not fulfilling its statutory mandate of actually analyzing where companies are 

systemically risky."' 

1 Met Life v. Financial Stability Oversight Council, 177 F.Supp.3d, 219 at 237 (2016). 2 Report Prepared by the Republican Staff of the Committee on Financial Services, U.S. House of Representatives, The 

Arbitrary and Inconsistent FSOC Nonbank Designation Process (February 28, 2017). 

2 
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The Government Accountability Office (GAO), in a report released on November 20, 2014, identified several 

of the flaws in the FSOC's process3 Specifically, the GAO noted that "FSOC's public documents have not 

always fully disclosed the rationale for its determination decisions" and that "the lack of full transparency 

has resulted in questions about the process and may hinder accountability and public and market 

confidence in the process." 4 GAO also criticized FSOC for "using only one of two statutory determination 

standards (a company's financial distress, not its activities)" and noted that "FSOC may not be able to 

comprehensively ensure that it had identified and designated all companies that may pose a threat to U.S. 

financial stability."5 

PC! believes there is ample evidence in the Federal court decision, the Committee Staff Report, the GAO 

report, and elsewhere to support the conclusion that the current nonbank systemic risk designation process 

has not worked to identify systemic risk correctly and consistently or to eliminate it where FSOC believes it 

exists. 

FSOC Insurance Experts Disregarded. When FSOC designated two insurers as systemically important, the 

Independent Member Having Insurance Expertise, Roy Woodall, filed strong dissents arguing that the FSOC 

had failed to appreciate differences between the banking and insurance industries and saw systemic risk in 

the insurance industry that does not exist. For example, in his dissent from an insurer designation, Mr. 

Woodall said the FSOC's analysis "relies on implausible, contrived scenarios as well as failure to appreciate 

fundamental aspects of insurance and annuity products, and, importantly, State insurance regulation and 

the framework of the McCarran Ferguson Act."' These views were echoed by FSOC's non-voting State 

Insurance Commissioner Representative, Adam Hamm, who noted his statement disagreeing with an insurer 

designation that the FSOC "fails to fully consider the range of mechanisms insurance regulators use to 

identify and address problems ... " He noted that, in addition to preventing solvency concerns, these tools 

"also minimize the impact of any material financial distress on policyholders, other counterparties and the 

system." He said in disregarding the full scope of state insurance regulatory authorities, FSOC had 

misapplied Section 113 of the Dodd-Frank Act, which requires that "the Council appropriately take into 

account the degree to which the company is already regulated when making a determination that a 

'Government Accountability Office, Financial Stability Oversight Council: Further Actions Could Improve the Nonbank 

Designation Process, GAO Highlights Page, (November, 2014). 

'!d. 

'!d. 

6 Basis for the Financial Stability Oversight Council's Final Determination Regarding Metlife, Inc., Views of the Council's 

Independent Member Having Insurance Expertise. 

3 
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company could pose a threat to the financial stability of the United States."' PCI agrees with Mr. Hamm's 

views. 

It is alarming that non-insurance regulators on the FSOC would so cavalierly ignore the advice of the 

insurance experts Congress provided to it in considering questions of systemic risk. What is even more 

alarming is that, following these designations, the FSOC failed to provide clear direction on how these 

insurers could reduce the perceived risk. 

A primary purpose of the Dodd-Frank Act was to mitigate systemic risk to avoid a repeat of the 2008 

financial crisis. It should follow that the Financial Stability Oversight Council (FSOC) would place a high 

priority on providing sufficiently detailed and credible information to companies it designates. This 

information would allow a company's management to make decisions to reduce the company's exposure to 

systemic risk and to be delisted as a systemically important financial institution. FSOC's refusal to do this 

suggests that its members may be more interested in preserving the enhanced supervisory authority they 

obtain as a result of a systemic risk designation than in reducing systemic risks posed to the economy. As 

Mr. Woodall said in his dissent from an insurer designation, "[w)hile the Council's approach to designation 

triggers supervisory jurisdiction by the Board of Governors of the Federal Reserve System ... it does little 

else to promote real financial system reform." This is not at all consistent with the goal of Congress in 

enacting Dodd-Frank. 

Inappropriate Pre-Designations with Foreign Governments. There is substantial evidence that, before FSOC 

considered designation of some companies, members of the FSOC agreed with foreign regulators 

participating in deliberations of the Financial Stability Board (FSB) that certain of these firms would be 

designated as Global Systemically Important Institutions (G-SIIs). Thus, a subset of members of the FSOC 

who participated at the FSB committed the United States to a position before the full FSOC (including FSOC's 

chair) had even considered the question. Mr. Woodall was highly critical of this in his dissent from an insurer 

designation, stating "[a]n FSB meeting with only a few Council members' agencies participating should not 

decide that certain firms are systemically important; or conversely, that any firms are not systemically 

important, before the Council as a whole has decided those questions." He urged his fellow FSOC members 

"to not again allow the FSB to 'front-run' or pressure decisions that must be made first by the Council as a 

whole." He further charged that to do otherwise is "to undermine confidence in the Council itself; to be 

7 Basis for the Financial Stability Oversight Council's Final Determination Regarding Met life, Inc., Views of Adam Hamm, 

the State Insurance Commissioner Representative. 

4 
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inconsistent with the intent of Congress; and to be patently unfair to those nonbank financial companies 

under review that must be afforded due process and fair dealing under U.S. law and procedures."' PCI 

agrees with Mr. Woodall's assessment. Ceding systemic risk designation authority to foreign governments is 

not in the best interests of the United States, and there is no hint of any such intent in Dodd-Frank. 

Insurance is Not Systemically Risky. There was widespread recognition during the legislative process that led 

up to the passage of Dodd-Frank that traditional insurance activities simply are not systemically risky. 

Property casualty insurers, in particular, have low leverage, are not interconnected with other financial 

firms, do not pose a "run-on-the-bank" threat, are highly competitive with low market concentration, have 

low failure rates, and have their own effective and self-financed resolution system. These points were 

reiterated by Mr. Woodall in his dissents from the designations of several insurance companies. They have 

also been noted by U.S. and foreign insurance regulators. The International Association of Insurance 

Supervisors (IAIS) said in a 2011 report that "traditional insurance is unlikely to become a source of systemic 

risk."' In addition, Dr. Mary Weiss, a Distinguished Scholar with the Center for Insurance Policy and 

Research at the National Association of Insurance Commissioners found in a 2010 report that "insurers are 

not instigators or the cause of systemic risk" and that "they do not require systemic risk regulation- any 

direct systemic risk regulation of insurers is unlikely to stem future systemic risk crises." 10 Nevertheless, the 

FSOC designated insurance companies as systemically risky and then refused to provide a coherent rationale 

for the decision or any meaningful direction on how to eliminate the perceived risk. 

'Basis for the Financial Stability Oversight Council's Final Determination Regarding Met life, Views of the Independent 

Member Having Insurance Expertise. 9 International Association of Insurance Supervisors, Insurance and Financial Stability, pg. 6, (November, 2011) 10 Mary A. Weiss, Ph.D, Distinguished Scholar, Center for Insurance Policy and Research of the National Association of 

Insurance Commissioners, Systemic Risk and the Insurance Sector, (February 23, 2010). 

5 
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Conclusion 

By failing to achieve the primary goal assigned to it by Congress, FSOC has failed to protect taxpayers form 

the risk of future financial crises while imposing unwarranted burdens and costs on companies that do not, 

in fact, pose systemic risk. Not only does this create additional costs for consumers, but it also fails to 

protect them from the negative economic implications of the next crisis. Because the FSOC has not utilized 

its nonbank systemic risk designation authority wisely and, in particular, has declined to focus its activities 

on reducing perceived systemic risk, the FSOC's authority to designate nonbanks as systemically important 

should be eliminated. Federal and state financial regulators could still consider whether nonbank financial 

institutions pose systemic risk, but should not be burdened with the FSOC's current conflict of interest under 

which providing clear rationales on how to identify and eliminate systemic risk requires them to relinquish 

their enhanced supervisory authority. 

6 
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COMMENTARY 

Blame Congress for the arbitrary nature of the 'systemically important' label under DoddFrank. 

PHOTO: GETTY IMAGESIJSTOCKPHOTO 

By ADAM J. WHITE 

March 29, 2017 7:05 p.m. ET 

When President the Dodd-Frank Act in20l0, he said it would cure the 

problem of too-big-to-fail banks by setting "new rules to make clear that no firm is 

somehow protected" from failure. "In the end," he said, "our financial system only 

works-our market is only free-when there are clear rules and basic safeguards that 

prevent abuse, that check excess, that ensure that it is more to play by the 

rules than to game the system. 

Seven years later, those reforms have achieved far less than he promised. That's 

especially true ofthe framework for designating insurance companies and other nonbanks as "systemically important financial institutions," or SIF!s. 

The Financial Stability Oversight Council bas pnt the SIFllabel on four companies so 

far, but its approach has proved wildly arbitrary. After a two-year investigation into the 

FSOC's operations, the House Financial Services Committee last month released a staff 

report highlighting the problems. The report says that the FSOC has failed to honor its 

own procedural rules and apply its standards and methodologies consistently. 
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"The FSOC treats certain companies differently than other companies," the report says. 

"The reason for this disparate treatment is unclear. It could be because the FSOC has no 

internal procedural controls ... or it could be the case that the FSOC deliberately 

circumvented its procedures and expected that this deviation would never be 

discovered." 

This confirms what a federal district court found last year after the insurance company 

MetLife sued over its SIFI designation. Judge Rosemary Collyer struck down that 

designation, concluding that the FSOC "hardly adhered to any standard when it carne to 

assessing MetLife's threat to U.S. financial stability." Federal regulators didn't analyze 

whether MetLife actually posed a substantial systemic risk. Instead they simply 

assumed the worst at every turn. The FSOC has appealed and the case remains pending. 

But during oral argument in October at the U.S. Court of Appeals for the District of 

Columbia Circuit, the judges expressed similar concerns. 

Moreover, the House committee's new report reiterates the criticism leveled at the 

FSOC by its own "independent member with insurance expertise," S. Roy Woodall. 

When the FSOC labeled MetLife and the insurer Prudential as SIFis, Mr. Woodall voted 

against the designations. He wrote in a dissent that the majority's approach "would 

inevitably lead to a conclusion that any nonbank financial company above a certain size 

is a threat-contradicting pronouncements that 'size alone' is not the test for 

determination." In other words, the FSOC's designation of some large companies but 

not others is arbitrary. 

To be fair to the FSOC, its blunt approach is not exclusively the fault of the regulators. 

Much blame lies with Congress, which created and empowered it in the first place. 

As former Treasury Secretary Timothy Geithner once explained, it is impossible to set 

effective, purely objective criteria for evaluating systemic risk: "What size and mix of 

business do you classify as systemic? ... It depends too much on the state of the world at 

the time. You won't be able to make a judgment about what's systemic and what's not 

until you know the nature of the shock" the economy is undergoing. 

The recipient of that warning was the special inspector general for the Troubled Asset 

Relief Program, who drew an ominous conclusion. "If the Secretary is correct," he wrote 

in a 2011 report, "then systemic risk judgments in future crises will again be subject to 

concerns about consistency and fairness, not to mention accuracy." This was prescient, 

as Mr. Woodall, Judge Collyer and now the House Financial Services Committee have 

confirmed. 

Given the problems inherent with the FSOC's designations, Congress should consider 

whether the overarching policy is misguided and excessively ambitious-an example of 

Hayek's "fatal conceit." At the very least, lawmakers should end Dodd-Frank's approach 

of granting open-ended power to regulatory agencies, hoping that the administrative 

state will solve the problem. 

Congress did not meaningfully define the standards for the FSOC to use in discerning 

"systemic importance." Instead lawmakers authorized nearly a dozen broad 

considerations, ending with the catchall of"anyother risk-related factors that the 

Council deems appropriate." Such grants oflirnitless discretion not only invite arbitrary 

bureaucratic action, they also stretch the bounds of constitutional government. 
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If Congress believes in reducing systemic risk through regulation, then it should do the 

hard work oflegislating the precise, substantive standards that it believes will best 

guard the financial system. If the FSOC has expertise, then it can advise lawmakers in 

writing the law. 

But the FSOC should not make up the law, let alone make up the law as it goes along. As 

President Obama said, we need "clear rules and basic safeguards that prevent abuse"-

not least abuse by the regulators themselves. 

Mr. White is a research fellow at the Hoover Institution. 

Appeared in the Mar. 30, 2017, print edition. 

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