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FSOC: Our Early Warning System to Detect Threats to the Financial System

With a title like “The Arbitrary and Inconsistent Non-Bank SIFI Designation Process,” one can be reasonably sure that the House Financial Services Subcommittee on Oversight and Investigation hearing today will not be singing the praises of the Financial Stability Oversight Council (FSOC).

But they should be.

FSOC is the country’s only early warning system for detecting systemic threats to our financial system. The mission of the FSOC is to keep a watchful eye on all financial markets, to mitigate the accumulation of systemic risk in our financial system, and to reduce the likelihood of another catastrophic crash by identifying systemically significant nonbank financial firms and activities that might otherwise escape oversight or regulation.

Congress established the Financial Oversight Council (FSOC) in the wake of the worst financial and economic crisis since the Great Depression. Enacted as part of the Dodd-Frank Wall Street Reform Act, the creation of FSOC was widely supported by financial industry stakeholders such as the Financial Services Forum, the American Bankers Association, the Securities Industry and Financial Markets Association, and the Investment Company Institute.  And it is clear that FSOC has been thorough, thoughtful, and measured in the use of its designation authority to date, exercising it only four times in almost seven years.

Unfortunately, it is equally clear that Congress and the Administration have put FSOC in the cross-hairs, and as a result, the safety and stability of the financial system is under threat. The unique role FSOC plays cannot be overemphasized.  It is only entity in the government with the legal authority and duty to assess risk across the entire financial system and to evaluate systemically significant nonbanks for increased regulation.  

Every other regulator has specific and limited authority and no one else has responsibility for systemically significant nonbanks, i.e., the shadow banking system. Eliminating or gutting FSOC would get rid of the only early warning system that the U.S. has for emerging risks that don't fall neatly into the silo of an existing regulatory agency.

Disabling this critical agency is a great idea for all those who loved the $185 million bailout of AIG, the $3.7 trillion backstop of the entire money market fund industry, and so many of the other bailouts and backstops – all made with taxpayer money – during the financial crisis of 2008. Killing or gutting FSOC guarantees that this will happen again in the future.

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