SEC Commissioner Piwowar Comments on the FSOC

At the AEI Conference on Financial Stability, SEC Commissioner Michael S. Piwowar gave a speech in which he spoke very critically about the accountability and transparency of the Financial Stability Oversight Council (“FSOC,” or the “Council”).

Commissioner Piwowar stated that he is fully supportive of Congressman Garret’s bill, the FSOC Transparency and Accountability Act (H.R. 4387), which Commissioner Piwowar noted has already forced FSOC to begin to clarify its transparency policy. However, Commissioner Piwowar said, he still has many issues with FSOC’s lack of clarity. 

Referring to FSOC as the “Unaccountable Capital Markets Death Panel,” Commissioner Piwowar explained that he had “far too many concerns about the Council to touch on all of them” in his allotted time. He focused his concerns on (i) the role of prudential regulators, especially the Board of Governors of the Federal Reserve System (“FRB”), and (ii) FSOC’s “apparent disdain for non-banking subject matter expertise.”

According to Commissioner Piwowar, prudential regulators have four voting representatives on FSOC, whereas nonbank regulators each have one. Additionally, Commissioner Piwowar explained, the FRB has expanded the prudential regulators’ seats from four to six, and Governor Tarullo recently suggested broadening “the perimeter of prudential regulation” even further. Commissioner Piwowar stated that Governor Tarullo is asserting the FRB’s authority over capital market actors through FSOC and, subsequently, is overlooking the expertise and capability of the SEC’s rulemaking divisions. According to Commissioner Piwowar, “deference is not a word in the Council’s vocabulary.”

Commissioner Piwowar also explained that the SEC’s trading and market expertise is being marginalized by FSOC, since a review of equity market structure should be led by the SEC. He encouraged FSOC and the FRB to submit comment letters to the SEC on this topic. With FSOC and the FRB inserting themselves into the SEC’s jurisdiction, Commissioner Piwowar said, he worries that the SEC’s mission is being compromised. He explained that he is determined to “defend our jurisdiction from the prudential regulators’ Council-enabled turf war.”

Lofchie Comment: Given the intensity of Commissioner Piwowar’s criticism of FSOC, it seems useful to introduce an alternative view defending FSOC from the Commissioner’s withering critique. Matt Levine, a Bloomberg columnist and former investment banker offers one in his article: “Man Dislikes Unaccountable Capital Markets Death Panel.” Levine’s defense of FSOC is instructive in that it is, in part, based on common misunderstandings of the way that the regulations actually work.

The heart of the FSOC’s defense against the attacks by the SEC Commissioner is midway through the linked article, where there is a list of bullet points, among which is the assertion that “[one should] look at [the SEC’s] capital requirements, they’re a joke. Bear was 42 times levered.” The author’s misunderstanding of the SEC’s capital rules likely is unintentional, but it is significant. The SEC’s capital requirements are, in fact, extremely tough; they are far more restrictive in what they allow as good assets than are the rules imposed by the banking regulators. The 42x leverage ratio to which the author refers is that of the broker-dealer holding company, a kind of entity that the SEC did not – and does not have the authority to regulate. Implicit in the author’s outright mistake, however, is a greater mistake: the notion that the banking regulators take capital regulation seriously, and get it right, while the SEC does not on either score. Here is a link to the FSOC’s own 2011 annual report. It doesn’t support the notion that the banking regulators had it right. Rather, it supports the notion that modesty might be a beneficial attribute for everyone involved. 

More substantively, Levine’s FSOC defense goes on to state that, in its most recent financial reports, in response to capital requirements imposed by the banking regulators, Goldman Sachs had reduced its assets by $56 billion, with much of the reduction seeming to be the result of reducing its client financing activity. He says that most of this reduction in lending in response to regulatory pressure was likely a reduction in low-risk lending transactions. He then concludes by commenting: “You’ll need someone smarter than me to tell you why low-risk, low-return, client-financing businesses are the ones that the Fed wants to cut back on, but here we are. I guess it’s reasonable to say that super-leveraging mostly safe things is a big source of risk.” Unfortunately for Mr. Levine, his conclusion undermines the entire point of his FSOC defense because the key economic question is, in fact, “why low-risk, low-return, client-financing businesses are the ones the Fed wants to cut back on.” The author’s defense of the Fed’s position reflects his admitted lack of understanding of the economic substance: “I guess it’s reasonable. . . . “

The main point of SEC Commissioner Piwowar’s remarks is contained in the question: wouldn’t the decision-making process of FSOC be improved if its rules provided a greater opportunity for the expression of differing points of view, including those from regulators who have significant experience overseeing the customer financing markets in question? Questions of process and of jurisdiction are important; they ultimately affect the quality of decision-making. If the process is weak, or is structured in a way to avoid challenges or to exclude those with more expertise, it is less likely to lead to good outcomes. 

Leaving aside the tone of the arguments, and the questions of regulatory jurisdiction that Mr. Levine finds “like, meta-boring,” there is an economic point at issue here, and one that should be opened up for much broader discussion by regulators and economists: are the new banking regulator capital rules unduly harsh on “low-risk, low-return client financing businesses”? If they are, then it’s bad for the economy. 

See: Commissioner Piwowar’s Speech
Related news: House Financial Services Committee Schedules Markup of FSOC Bills (June 18, 2014); House Financial Services Committee Hearing: “Examining the Dangers of the FSOC’s Designation Process and Its Impact on the U.S. Financial System” (May 22, 2014); House Financial Services Committee Chairman Calls on FSOC to Cease and Desist (May 21, 2014); House Financial Services Subcommittee Chairmen Send Letter to FSB and FSOC Requesting Information on Methodologies Used to Designate G-SIFIs (May 12, 2014); House Financial Services Committee Chairman Hensarling Urges Secretary Lew to Cease Using “Too Big to Fail” Designations (May 9, 2014); Representative Garrett Questions the SIFI Designation Authority Granted to FSOC by Dodd-Frank (May 6, 2014); House Subcommittee Chair Garrett Delivers Opening Remarks at Oversight of SEC Hearing, Focuses on FSOC and NMS (April 30, 2014); House Financial Services Subcommittee Chairman Introduces Legislation to Reform FSOC (April 4, 2014).