The 2013 FSOC (Financial Stability Oversight Council) Annual Report was developed collaboratively by the members of the Council and their agencies and staff. Under Dodd-Frank, FSOC must make recommendations to promote market discipline, maintain investor confidence, and enhance the integrity, efficiency, competitiveness, and stability of U.S. financial markets.
In its third annual report, the Council’s findings and recommendations are organized around seven themes:
- The vulnerability to runs in wholesale funding markets that can lead to destabilizing fire sales;
- The housing finance system that continues to rely heavily on government and agency guarantees, while private mortgage activity remains muted;
- Operational risks that can cause major disruptions to the financial system;
- The reliance on reference interest rates, which recent investigations have demonstrated were manipulated, particularly in the case of the London Interbank Offered Rate (LIBOR);
- The need for financial institutions and market participants to be resilient to interest rate risk;
- Long-term fiscal imbalances, as the absence of bipartisan agreement on U.S. fiscal adjustment has raised questions about whether long-term fiscal problems may be resolved smoothly; and
- The United States’ sensitivity to possible adverse developments in foreign economies.
In the report, the Council’s recommendations address the following topics:
- Reforms to address structural vulnerabilities;
- Reforms of wholesale funding markets (money market funds, tri-party repo);
- Housing finance reform;
- Reforms relating to reference rates;
- Heightened risk management and supervisory attention;
- Operational risk (cybersecurity, infrastructure);
- Risk of prolonged period of low interest rates;
- Capital, liquidity, resolution; and
- Progress on financial reform.
Lofchie Comment: As a lawyer, the parts of the report that I thought most interesting were the non-lawyerly sections of the report (sections 4 and 5) that talk primarily about the big-picture state of the financial markets. It’s pretty depressing stuff.
In terms of its analysis of risk, most interesting was the discussion of interest rate risk. The report seemed to say that the government was holding rates down but at some point the rates were going to pop up, and that could be a shock to the system. It was not so clear how market participants should deal with a risk that was more political than market-driven. The report also takes a very ambivalent view of the trade-off between risk and stimulating the economy. On the one hand, the report seemed to praise banks for cutting back on risk and on the other, to criticize them for not making high-risk subprime loans.
The discussion of regulatory issues is primarily in part 6 and to a lesser extent in part 7. (The main points of these parts are listed in the descriptive part of this story.) Reading these parts may be useful in terms of understanding the direction that the regulators will go. That said, these sections feel more like (moderately low-key) political statements, than they do the disinterested studies such as a GAO report. For example, these sections talk about all the Dodd-Frank “milestones” that have been achieved, without mentioning the raft of no-action letters to deal with unworkable rules and likewise without mentioning that earlier sections of the report discuss the risks imposed on the system by central clearing corporations; and the report boasts of the government’s improvements in requiring information, without mentioning that the government has no way to store and use much of it. (Somewhat coincidentally, today’s news also includes a speech by CFTC Commissioner O’Malia that is primarily focused on all of the problems with the CFTC’s reporting regime: see Commissioner O’Malia Speech Criticizing the CFTC’s Implementation of Dodd-Frank )
The report does not say much about the designation of systemically important financial institutions, other than that it is coming. Presumably, litigation will follow, particularly in light of the GAO’s fairly critical study on FSOC (cited below).
See: 2013 FSOC Annual Report; FSOC Charts in PDF or Excel.
See also: Remarks by Treasury Secretary Jacob J. Lew.
See also: GAO Finds FSOC and OFR to Be Well-Intentioned.
See also: 2011 FSOC Annual Report; 2012 FSOC Annual Report.