Nearly four years after the financial crisis began, regulators on April 3 finally agreed to the criteria they will use to decide which parts of the shadow banking system to regulate. But they still haven’t imposed tougher standards on a single insurer, hedge fund, private equity shop, or money-market mutual fund. Failure to do so exposes the U.S. economy to unnecessary dangers.
American International Group (AIG) is a prime example. The giant insurer required a $182 billion bailout in 2008. Its near-collapse helped propel the Dodd-Frank financial regulatory overhaul. Many lawmakers and policy makers agree that large, complex companies such as AIG had fallen through the regulatory cracks.
The Dodd-Frank law addressed this by creating a special panel of top financial regulators, the Financial Stability Oversight Council, to supervise large companies whose unraveling could threaten the economy. Those deemed “systemically important financial institutions,” or SIFIs, would face stricter supervision and tougher capital and liquidity requirements.
The stability council spent 18 months debating the criteria it would use to name SIFIs. With that chore out of the way, the council should move quickly—next month wouldn’t be too soon—to begin naming the actual institutions.
The final criteria are an improvement over an earlier proposal, but holes remain. For one thing, many potentially risky companies probably won’t make the list. A Bloomberg Government analysis identified 15 that would meet or exceed the thresholds and 10 more that might. Among the companies that probably will make the cut are AIG, GE Capital (GE), and 10 government-sponsored enterprises, including mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC). Not a single hedge fund, private equity shop, or money-market mutual fund made the list.
Many of the criteria make sense, including a company’s debt relative to the capital it holds, reliance on short-term funding, importance as a source of credit, and amount of derivatives outstanding. Yet the rule will apply mostly to companies with at least $50 billion in assets, the same threshold Dodd-Frank set for banks. It’s unclear whether any hedge funds or private equity shops would meet that or the other tests. The council said it lacks data on such firms and may have to adjust its criteria once it has more information.
Hedge funds and private equity firms have been lobbying regulators not to pull them into the dragnet. Many of these companies are closely held, and their financial data are not available to the public. The council should do whatever it takes to properly assess these firms’ risks.
The panel also delayed a decision on whether to designate money-market mutual funds as systemically important. That’s surprising, given the tumult the Reserve Primary Fund caused in fall 2008 when it “broke the buck,” meaning its net asset value fell below the $1-a-share level that money-market funds are expected to maintain. BlackRock (BLK), the giant money-management firm with more than $3.5 trillion in assets, is also worth a close look. The company might not trigger any thresholds beyond size, but it’s hard to imagine why regulators wouldn’t want to supervise such a sprawling complex closely, regardless of how well it’s managed. Erring on the side of tagging too many shadow banks as systemically risky, and making adjustments later, seems the wisest course.