There's some criticism around the idea that the list of large financial institutions that will be subject to heightened regulatory requirements under new systemic risk regulation should be kept secret. I wrote about this feature during my eight-part series on the new systemic risk draft proposal being mulled over by the House Financial Services Committee. At first, I said that there were some legitimate reasons for secrecy. Upon greater reflection, however I'm not sure I even see the point, given the purpose of the list.
Before examining the list's secrecy, let me note a few things. First, as mentioned before, I highly doubt such a list will be kept secret successfully anyway. When I first wrote about it, I said:
Of course, these firms are going to have substantially different regulatory requirements from their peers. So I find it hard to believe that just by reading annual reports and other filings, savvy investors and creditors couldn't figure out who these firms are.
I still think that's true. Any investor who really wants to determine which firms are on the list can probably back into the list through some analysis. But just for argument's sake, let's assume this wasn't possible and that the list really could be kept secret.
Second, it's kind of the status quo to allow firms who seek emergency assistance through the Fed to remain secret. And remember, the Fed is essentially the systemic risk regulator under the new plan. As it turns out, this current precedent is being challenged right now in the courts. I wrote about it back in August. At that time I lamented the fact that the Fed is able to keep this information from the public and investors. But I also understand the challenge it could pose for those firms if this information is released -- financial panic and mayhem may ensue. Public perception can create a new reality contrary to the Fed's stabilization goals.
But from the standpoint of a systemic risk regulator, I think things are a little different. If I understand the purpose of the list as proposed, it's to subject those firms to greater regulation -- not to protect them from failure. As a result, being on the list doesn't mean these firms will be saved. Indeed, I understand it to mean quite the opposite. The firms on that list will be resolved by the FDIC if the Fed decides they aren't up to the stability standards set forth. So firms on this secret list would be required to hold more capital, potentially pay fees to ensure that the government can afford to resolve them if they get into trouble and subject them to other additional regulation.
As you can probably see, there isn't really a scary perception issue that might occur if the public or investment community were to learn who is on this list. There are, instead, some pros and cons to consider. The good news is that the government is requiring more cushion for these firms in case bad things happen. That will make them safer than the average firm. The bad news is that additional capital cushion will result in a smaller return on capital for these firms than some of their smaller competitors can achieve with less stringent regulatory requirements.
I think the more important question is not whether a bank is subject to heightened regulation -- it's if the judgment that the Fed bestows on each of these firms should be public. It categorizes them based on their stability. Investors might be much more interested to hear about those opinions of the Fed. But this question, I think, is moot. Investors should already be doing their own analysis of firms' stability, and should not need to rely on the Fed -- or anyone else -- to do their due diligence for them.
The above analysis, of course, all assumes that these firms will actually be allowed fail if that's the fate they deserve. If we're talking about a situation where this list becomes the firms that that the government will bail out at essentially any cost, then that's a game-changer. Then, these firms should be regulated more like utilities than banks, because they'd essentially be eternal wards of the state. I hate this idea. That's why I think that if a firm cannot be resolved without taking down the financial system with it, then it should be split up into parts with less systemic risk than the whole.
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