May 12 2011

Shelby: More Details Needed from FSOC

U.S. Senator Richard Shelby, ranking Republican on the Senate Committee on Banking, Housing and Urban Affairs, today submitted for the record the following statement at a hearing on the Oversight of Dodd-Frank Implementation: Monitoring Systemic Risk and Promoting Financial Stability.

Excerpts of Shelby’s statement are immediately below in bold, followed by the full text of his prepared remarks:

“Dodd-Frank established the Financial Stability Oversight Council and charged it with monitoring risk in the U.S. financial system…Unfortunately, Dodd-Frank provides little guidance on exactly which firms should be designated for systemic risk regulation and what that regulation should involve.  Instead, these decisions were left to the discretion of the regulators through broad delegations of authority.

“So far, regulators appear to be divided on what the final rules should look like and what entities should be designated as systemically significant financial institutions.  It is not surprising that regulators are having difficulty determining how to regulate firms for systemic risk.

“…there is a great deal of confusion about how the Council will proceed with its rulemaking.  This has created uncertainty in our markets as firms are unsure which types of activities will cause them to be subject to systemic risk regulation. 

“I want to hear more details from our witnesses about how they envision systemic risk regulation will function in practice.  I am particularly interested in hearing how they will address the potentially adverse consequences that could arise.  Most importantly, how will regulators ensure that selecting a handful of firms for enhanced regulation will not increase moral hazard if markets believe that regulators will never allow a designated firm to fail?  

“The last thing our fragile economy needs is a far-reaching government experiment that destabilizes the financial system it is intended to protect.”

 

STATEMENT OF SENATOR RICHARD C. SHELBY

Committee on Banking, Housing and Urban Affairs

May 12, 2011

“Thank you, Mr. Chairman. 

“Today’s hearing will examine the difficult task of defining and regulating systemic risk.  Dodd-Frank established the Financial Stability Oversight Council and charged it with monitoring risk in the U.S. financial system.  The Council is also responsible for designating firms for special, systemic risk regulation by the Federal Reserve.

“Unfortunately, Dodd-Frank provides little guidance on exactly which firms should be designated for systemic risk regulation and what that regulation should involve.  Instead, these decisions were left to the discretion of the regulators through broad delegations of authority.  Accordingly, before regulators move forward, they will need to devise a well-considered and transparent regulatory scheme that limits adverse consequences.

“So far, regulators appear to be divided on what the final rules should look like and what entities should be designated as systemically significant financial institutions.  It is not surprising that regulators are having difficulty determining how to regulate firms for systemic risk.  Many commentators have questioned whether it is even possible to make such a determination with any degree of accuracy.  Indeed, Secretary Geithner recently told the Special Inspector General for TARP:  ‘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.’ 

“Despite the divergent views of its members, the Council is moving forward with its framework for designating nonbank financial entities for extra regulatory scrutiny.  Unfortunately, the Council has not yet released for public comment the detailed rules on how they will designate firms.   Instead, the Council has issued proposed rules that merely restate the broad statutory parameters.  As a result, there is a great deal of confusion about how the Council will proceed with its rulemaking.  This has created uncertainty in our markets as firms are unsure which types of activities will cause them to be subject to systemic risk regulation. 

“Accordingly, I want to hear more details from our witnesses about how they envision systemic risk regulation will function in practice.  I am particularly interested in hearing how they will address the potentially adverse consequences that could arise.  Most importantly, how will regulators ensure that selecting a handful of firms for enhanced regulation will not increase moral hazard if markets believe that regulators will never allow a designated firm to fail?  

“As we saw during the recent financial crisis, regulators may go to great lengths to rescue a firm in order to cover up their mistakes.  In other words, does the Council’s designation responsibility threaten to undermine one of the Council’s other responsibilities -- the promotion of market discipline by eliminating expectations that the government will bail out financial institutions if there is a crisis?

“In addition, I am interested in hearing how regulators believe designating firms will impact the competitiveness of our markets.  In the lead up to the financial crisis, our regulators failed on a grand scale to monitor the activities of individual institutions.  There is good reason to doubt whether our regulators can effectively monitor the risks posed system-wide.  

“Thus, the burden is on our regulators to demonstrate that they know exactly what they are doing before they begin to implement this new form of regulation.  The last thing our fragile economy needs is a far-reaching government experiment that destabilizes the financial system it is intended to protect.

“Thank you.”