You can check out any time you like,
but you can never leave."
Should MetLife (NYSE:MET) be ruled systemically important? Columnist and Nobel Prize Winner Paul Krugman says "Yes." He weighs in against the decision of Federal Court Judge Collyer, made recently. Judge Collyer found for MetLife and against the government regulators' designation of MetLife as a systemically important financial institution (SIFI).
The Krugman article is particularly useful because he makes an argument for the government's position. The government itself has not responded to the Collyer decision, so Krugman's article is the best case for the government's position we have at the moment.
Krugman titles his article " Snoopy the Destroyer." (Snoopy is MetLife's mascot. Krugman objects to MetLife's use of Snoopy, leaving the impression that Darth Vader would be more suitable.)
MetLife celebrates the court's decision.
Krugman's Nobel Prize winning work had titles that were less pejorative than this one. But writing for public consumption is hand-to-hand combat. I use different titles for academic work too.
In a recent article "The State Of Systemically Important Things: Dealer Bank And Exchange Wars," I take the other side of the argument, that Judge Collyer had good reason for her ruling.
Here is Judge Collyer's objection to the SIFI designation:
- The government failed to consider the economic costs to MetLife of the SIFI classification.
- The government failed to explain what risks to the financial system failure of MetLife would create.
Krugman's response is nothing short of fascinating. He refutes both contentions.
His first argument is that government should not be required to consider the economic costs of SIFI classification.
Krugman states: "Judge Collyer repeatedly complained that the regulators had failed to do a cost-benefit analysis, which the law doesn't say they should do, and for good reason. Financial crises are, after all, rare but drastic events; it's unreasonable to expect regulators to game out in advance just how likely the next crisis is, or how it might play out, before imposing prudential standards."
On this point, Krugman seems to be on solid legal ground but questionable economic ground. The law, indeed, does not require regulators to measure the costs or benefits of the SIFI designation.
But can it truly be a good idea to ask regulators not to form opinions about the likely source and size of the next economic crisis? Of course not. On the contrary, regulators can, do, and must form judgments about the sources of coming crises. I grant that the regulatory track record is less than stellar. But that observation is no criticism of regulators.
Indeed, there are sufficiently few good forecasters of economic crises that it is reasonable to put the correct forecasts down to luck.
But. If we were to use the Dodd Frank forecast - watch the SIFIs - how many of the globe's financial crises would we have prevented? At the very most, one. That is not a forecast. That is a back-cast.
There will be another financial crisis. That statement is like predicting a sunrise. There has never been a decade without a financial crisis.
But I will venture further speculation. The next crisis will actually have something to do with the SIFIs. But in a twisted way. As the SIFIs are gradually seized up by the constantly increasing restrictions on their permissible activities, financial markets and the economy as a whole do not go to sleep.
Traders still find a way to position themselves to profit from their beliefs. Corporations still take risk in pursuit of profit.
John M. Mason in his recent SA article, " What's Going On In The Banking Sector? Nothing Very Good" provides a description of a vulnerable spot in the current financial system. Ultimately, it could be one possible source of a crisis. Commercial real estate. Such a crisis would be due to collapse of numerous smaller banks, and would spread to the foreign banks. The SIFI banks are not direct participants in this market, perhaps because of the market's risk profile and the bad experience with real estate in the crisis. And as Mason points out, the banking system in general is unhealthy in the United States.
But back to Krugman's article. Second, Krugman argues that the government should not be required to defend its SIFI designations:
In Krugman's words: "What determines whether a firm is systemically important? There aren't any cut-and-dried rules - there can't be, because if there were, corporate lawyers would find ways to evade them. Instead, it's a judgment call. But financial giants that don't like being regulated are trying to use litigation to question those judgments."
The government, according to Krugman, cannot be held to any legal standard in determining systemic importance. If there were a standard for determining SIFI designation, corporate lawyers would find a way around the rules. In other words, government must be permitted to designate any company SIFI, regardless of that company's characteristics, because lawyers can change corporate characteristics and remove the SIFI designation.
Those sneaky corporate lawyers are now going to the courts to consider the issue of the legality of the regulator's designation. In Krugman's opinion, it is not a legal issue. Government regulators must have carte blanche. Otherwise corporations, by changing their behavior, could avoid SIFI.
This opinion, if held by regulators, is GE's (NYSE:GE) worst fear. By simply ridding itself of its financial dimension, GE cannot remove the SIFI label, by this reasoning. Because that would be allowing the law to interfere with regulatory judgment. That would be allowing lawyers to manipulate GE's business to avoid SIFI designation. Welcome to the Hotel California.
Actually Krugman does not treat GE as harshly as he treats MetLife. He favors GE because it asked for regulatory relief from SIFI, rather than going to court as did MetLife (although GE asked for this regulatory relief days after the MetLife decision.)
In other words, what Krugman's objection is to interference of the law in politics.
Krugman ends his article by warning the reader that it is not enough to simply depend on politicians to protect the economy from the next financial deluge. Republicans, he tells us, won't. We need a Democratic President to protect us.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.