MetLife (NYSE:MET) has just won a court case against the insurer's designation as a systemically important financial institution under the regulations stemming from Dodd Frank., This is quite obviously the correct decision as the original designation flowed from a basic mistake in Dodd Frank itself and the subsequent regulations. That there are systemically important financial institutions is true, that there are some which are that and also risky enough that we'd want enhanced regulation is also true. But an insurer doesn't meet both tests. Only a bank (and using the proper description of a bank too, not just the legal one) can manage that.
The news itself:
MetLife Inc. beat back a U.S. attempt to label it too big to fail, which would've put America's biggest life insurer under tougher government scrutiny and could have forced it to put more money in reserves. A federal judge in Washington struck down the designation on Wednesday in a decision that could shake up the financial regulatory reform implemented following the 2008 recession. The ruling might give ammunition to Republican lawmakers who've argued that regulators have abused their authority under the Dodd-Frank Act. "One of the centerpieces of the Dodd-Frank Act has been called into question," Isaac Boltansky, an analyst with Compass Point Research & Trading in Washington, said in a phone interview. "Depending on what the court's reasoning was, I think it's fair to believe that there could be a more aggressive push to curtail the FSOC's authority in the next Congress depending on the election outcome in November." U.S. District Judge Rosemary Collyer rejected the Financial Stability Oversight Council's rationale for classifying MetLife as a systemically important financial institution.
To understand the background to this we've got to understand two rather different economic points.
Firstly, there's the risk of large financial institutions turning turtle and damaging the wider economy. This is where too big to fail comes in: just as (wrongly in my opinion but so what) GM (NYSE:GM) was considered too important to be allowed to fail there's financial institutions which we would rescue just because they are so large. MetLife would certainly meet this definition. If it was about to collapse into disorderly bankruptcy taking millions of insurance policies with it then the government would indeed do something. Just as we would do something about Boeing (NYSE:BA) doing to same, or did do with GM.
But we've also got to consider the risk of a large financial institution turning turtle. In this other sense: is that business model inherently risky or not? And the answer for banks is that yes it is. This is true of banks which are designated in regulation as banks and it is also true of organisations which do banking but are not so regulated: so called "non-bank banks".
As the economist Brad Delong has long pointed out, if you borrow short and lend long then you are a bank. If you don't then you're not. And by borrowing short we mean that deposits are typically much shorter term than the loans which the organisation then finances with them. We have savings in the bank which we can rock up and get back any day we like. Those are used by the bank to finance 30 year mortgages. The bank can't get the money back any day so if we all do rock up then the bank goes bust. As in the crucial scene in Wonderful Life.
The fractional reserve banking is an inherently risky undertaking: it always depends upon the confidence of the depositors. The Crash itself was the loss of this confidence. All too many banks had portions of those MBS and CDO, financed with those short term deposits, and those portions were falling in value. No one knew who had what, who was bankrupt and who was not, so confidence in the entire system was shot. It was, in essence, a bank run: but a wholesale one, one bank not trusting another, not a retail one where howling mobs assemble to demand their money back.
It's entirely right that government should attempt to regulate organisations which meet both of these tests: government, the taxpayer, is going to be called upon to pay for it all if failure does happen after all.
But it must be those organisations which meet both tests: both that they are large enough that we would rescue them and also those which are engaged in the risky business of being a bank. It's that second which MetLife does not meet: and thus MetLife should not be designated as an organisation which must have the higher capital buffers and so on that such a designation leads to.
This is obviously good for MetLife but it's also good for the financial system in general. It would have been better if Dodd Frank had been written properly in the first place but then when politicians are involved we can't have everything. What we are seeing though is the unpicking of the mistakes in that law by the courts. this is the expensive and slow way to do it but better that than it not being done at all.
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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.