Managing Systemic Risk: Restoring The Balance


A lot has been done to shore up financial regulations since the end of the crisis, mostly the result of Dodd-Frank, and some rules are still being developed (eg we just got new details about the liquidity coverage ratio rule this week). But as the memory of the crisis fades, the Bipartisan Policy Center (BPC) has reviewed the risk management regulations set out by Dodd-Frank and while it is supportive of the law in general it has identified five provisions that could prevent the government from effectively dealing with the next crisis.

“The Dodd-Frank Act and other reforms that have been passed and implemented in response to the crisis have attempted to address the various causes of the crisis and are likely to make the financial system much safer than it was prior to 2007,” write BPC Systemic Risk Task Force co-chairs John C. Dugan, Peter R. Fisher, and Cantwell F. Muckenfuss III. “There remain, however, important areas in which Dodd-Frank went too far and ended up taking away important tools that the Federal Reserve and the FDIC used to greatly mitigate the negative impacts of the crisis.”

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Systemic Risk lehman

Systemic Risk: Removing two Dodd-Frank restrictions on government action

The first recommendation is that “Congress should restore the ability of the Federal Reserve to make emergency loans to non-depository institutions,” like the ones it extended to AIG during the crisis. These individual loans (as opposed to broader programs available to multiple financial institutions) proved to be politically unpopular, but they were also paid back with interest and bought time until more permanent policies could be put into effect. Similarly, the BPC report wants Congress to get rid of the Dodd-Frank requirement that the FDIC get Congressional approval before giving emergency loans to depository institutions.

Systemic Risk repo market

In both of these cases, Dodd-Frank is supposed to make these remedies unnecessary with better macro-prudential risk management, but the BPC doesn’t see why they should be completely off the table in case our regulations fail us again.

Systemic Risk debt issuance

BPC: Expanding Fed and FSOC authority

The BPC’s third recommendation is for broker-dealers owned by regulated SIFIs to be given access to collateralized liquidity from the Federal Reserve just like depository institutions, as well as any broker-dealer with a large balance sheet susceptible to asset runs. Even if this recommendation would reduce the risk of an asset run, it seems like it would be hard to politically justify lending money from the Fed directly to broker-dealers. The BPC also recommends tailoring rules governing non-bank SIFIs to better suit those individual industries instead of expecting them to meet prudential standards (eg capital and liquidity requirements) designed with banks in mind.

Systemic Risk lending

Finally, the BPC report recommends that Congress give the Financial Stability Oversight Council (FSOC) the authority to write rules on behalf of its member agencies if those agencies have failed to do so within 180 days of the stated deadline (this isn’t nearly as rare as it should be) with a supermajority FSOC vote.

Systemic Risk government profit