Roosevelt Institute | Cornell University

Take the Money and Run

By Hunter BossonPublished October 24, 2014

After years of relative unresponsiveness by financial regulatory institutions, progress is finally being made. Firms that claimed exemption from regulatory standards and inspections are finally coming within the regulatory framework in an increasingly global movement. The financial industry and the world economy is becoming a safer place because of it.

By Hunter Bosson, 10/24/14

The year 2008 was not the best year for American homeowners. While an under-regulated and overleveraged financial sector was bailed out to prevent a total systemic financial meltdown, taxpayers footed the bill and homeowners were left out to dry. In the spirit of actually learning from our mistakes, Congress passed the Dodd-Frank Act, meant to prevent the financial volatility and speculative culture that precipitated the financial crisis. Six years from that historic piece of legislation, regulators are still haggling over the details. However, though briefly doubted, it now appears that regulatory institutions are finishing the job and cracking down on the dangerously large banks and shockingly under-regulated firms responsible for the crisis.

Most comforting has been the willingness of institutions created by the Dodd-Frank Act to identify and address systemically vulnerable institutions. This was shown recently when the Financial Stability Oversight Council (FSOC), composed of the representatives from major regulatory agencies and departments, designated Metlife insurance as a systematically important financial institution (SIFI). The SIFI designation has its origins in the Dodd-Frank Act and is given to firms that "threaten the stability of the U.S. financial system," requiring it to hold more capital and allows it to be regulated as a bank-like institution by the Federal Reserve. Although some, including Peter Wallison of the Wall Street Journal, complain that the FSOC lacks a compelling reason to designate Metlife as an SIFI, its sheer size as the nation's largest life insurance provider puts it at risk of falling into a de facto status of "too big to fail," much like with the insurance giant AIG, which required government intervention to survive the 2008 crisis. Even better, this move has signaled that the regulatory zeal of the FSOC is not waning, and it may yet go after the final systemically threatening institutions: shadow banks.

The largest and most dangerous loophole in financial regulation is that surrounding "shadow banks," those that operate like banks but operate outside of the regulatory framework and do not have access to emergency credit through the Federal Reserve. These firms are largely financed through short-term money market funds that they use to make long-term investments, giving them an inclination towards overleveraging. The Financial Stability Board (a collection of central bankers and regulators) made a significant move on January 8 by releasing guidelines for assessing and identifying shadow banks for SIFI designation. Although some claim that regulations reduce firms' access to credit, American regulators may yet put to good use. Rightfully placing what, in the words of Laura Kodres from the IMF, "looks like a bank and acts like a bank" but is not a bank hardly seems unreasonable. Nor is the standard: suggesting that shadow banks, unregulated financial institutions without a secure line of emergency credit, with total assets over $100 billion receive SIFI designation. Most promisingly though is that the regulatory movement is increasingly international.

Foreign and global regulatory institutions have been implementing more and more sensible and stable regulatory measures. Chief among these would be the Financial Stability Board itself, created by the G20 and from which many regulatory policies are derived in the United States. More impressive has been the crafting of the most recent international financial regulation agreement, called Basel III. The Federal Reserve spent much of 2013 working to adopt Basel III's framework, particularly in raising and refining liquidity regulations. Pushing for greater capital and leverage levels in banks across the world, this agreement, though unpopular for most financial firms, will continue to keep the world of money and the world economy safer.

Nationally and internationally, financial regulation is finally keeping up with the financial industry. The increasing complexity of financial institutions, transactions, and products has the potential to do wonders for the global economy, but only so long as their volatility does not threaten the markets and people it espouses to serve. The regulation of nonbank entities, and shift towards shadow banks is an excellent start, but there is still much to do.