Includes: MET
by: John Cochrane

What does "systemically important" mean? How can an institution, per se, be "systemically important?" The WSJ coverage of Judge Rosemary Collyer's decision rescinding MetLife's (NYSE:MET) designation as a "systemically important financial institution" gives an interesting clue to how our regulators' thinking is evolving on this issue:

The [Financial Stability Oversight] council argued - bromide alert - that "contagion can result when relatively modest direct, individual losses cause financial institutions with widely dispersed exposures to actively manage their balance sheets in a way that destabilizes markets."

It's not a bromide. It is a revealing capsule of how the FSOC, headed by Treasury, thinks about this issue.

"Actively manage balance sheets" is a fancy word for "sell assets." So there you have it. "Systemically important" now just means that an institution might sell assets, because selling assets might lower asset prices. "Contagion" and "systemically important" are no longer about runs - you see one bank in trouble and go take your money out of a different one. "Contagion" and "systemically important" are no longer the (false, but plausible) domino theory - that if I default and owe you money, you default.

Policy is no longer just about stopping runs. Policy is not just about stopping any large bank from failing, or even just losing money. Policy is about stopping asset prices from falling, and stopping even the small marginal additional fall in prices that might accompany one large institution's sales. (Except that leverage and capital ratios now force institutions to sell even if they don't want to - a delicious case of contradictory regulatory commands.)

Owen Lamont's classic characterization of policymakers' attitude toward selling short now applies to selling at all:

Policymakers and the general public seem to have an instinctive reaction that short selling is morally wrong. Short selling has been characterized as inhuman, un-American, and against God

The journal nails the basic problem:

For eight years, federal regulators have failed to define precisely the "systemic risks" they claim they can identify across the financial landscape.

But no definition makes it easy to endlessly expand the word's meaning.