Most of the medias energy and focus over the past few months has been on 2010s Affordable Care Act and its problematic roll-out, with its ensuing intended and unintended consequences. Flawed analysis led to flawed legislation and flawed outcomes for the health care industry and millions of Americans.
Another pillar of President Obamas first-term agenda was 2010s Dodd-Frank Act, which has not received the analogous broad-based attention that it deserves. Just as with the Affordable Care Act, a thorough analysis of this flawed financial legislation would fill volumes, but one case study of the failings of Dodd-Frank is how it has changed the landscape for insurance companies.
Making it easier for Americans to get affordable, high-quality medical care was a noble mission, but a legislative solution rooted in further displacing private markets and injecting more federal government involvement in health care has led us to where we are today: an industry in chaos and people suffering as a result. So too Dodd-Franks good intentions are running into the roadblock of reality and yielding equally unsatisfying results.
One admirable goal as expressed by President Obama as he signed Dodd-Frank into law was to put a stop to taxpayer bailouts once and for all. But, it is not the anti-too-big-to-fail elixir Americans were promised. Quite the oppositeit has further enshrined too-big-to-fail.
The framers of Dodd-Frank looked at the big failures and near failures of the crisis (AIG, Washington Mutual, Lehman Bros., Bear Stearns, etc.) and concluded, without marshalling convincing supporting evidence, that special regulation by the Federal Reserve of large, so-called systemic financial institutions was the solution. The appointed designator is the newly created Financial Stability Oversight Council (FSOC), which has ten voting members, most of whom are the heads of other federal financial regulators.
The criteria for designating non-bank financial institutions systemically important to the financial system arein characteristic Dodd-Frank styleimprecise. The FSOC may designate any company if it determines that material financial distress at the [company] or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the [company] could pose a threat to the financial stability of the United States.
In July, FSOC made its first two such designations: GE Capital and AIG. GE Capital, as a savings-and-loan holding company, was already regulated by the Fed, but FSOC wanted to be sure that the company had no escape from the Feds grip. FSOC likely felt obligated to designate AIG to reaffirm the governments seat-of-the-pants $182 billion decision that AIG could not be permitted to fail during the crisis.
Five years after AIGs implosion, the Fed still refuses to come clean about why it concluded that a massive bailout was the only solution. The Fed released more than 900 pages of internal emails through the Justice Department earlier this year on its decision to bail out AIG, but completely redacted all the details regarding the basis for this important decision. One of the key government decision-makers during 2008, Sheila Bair of the Federal Deposit Insurance Corp. (FDIC), in her book on the financial crisis, verified the lack of substantive analysis behind decisions like AIG: ..the lack of hard analysis showing the necessity of [the bailouts troubles] me to this day.The designation only makes permanent the governments demonstrated commitment to keep AIG and other failed entities alivein other words, it codifies too-big-to-fail.
Having developed a taste for insurance companies, FSOC designated Prudential Financial as systemic in September. It is openly eyeing MetLife as the next member of this exclusive club.
Prudentials designation engendered oppositioneven from within FSOC. Edward DeMarco, whose day job is overseeing Fannie Mae and Freddie Mac, raised concerns about the thoroughness of FSOCs analysis and its failure to consider how designating Prudential could distort market equilibrium and competition.
Two of the FSOCs insurance expertsone voting and one non-voting memberalso objected. S. Roy Woodall, Jr., the Councils independent member with insurance expertise, cast his dissenting vote based on FSOCs flawed analysis, including a false perception, contradicted by facts and experience, that policyholders value life insurance only or primarily as cash instrumentsthe way a bank depositor would view his bank account. John Huff, Missouris insurance commissioner and a nonvoting member, likewise expressed concern about FSOCs everything-is-like-a-bank approach, concluding that the rationale for Prudentials systemic designation was flawed, insufficient, and unsupportable. In other words, there is nothing inherent in the structure of insurance companies that would dictate the concern that they are regularly susceptible to bank-like runs that would give rise to an ensuing system-wide panic.
Prudential abandoned its initial talk of fighting the designation and reluctantly capitulated to its new overseer. MetLifethe insurance company on deckis continuing to push back.
Why the initial opposition? After all, being a too-big-to-fail entity comes with privileges. Because for nonbanks, such as insurance companies, there is a big catch: It is not at all clear that the Federal Reserve is well-positioned to regulate these non-banks. Federal Reserve governor and Obama Administration nominee for deputy treasury secretary, Sarah Bloom Raskin, made this point in recent testimony on her nomination: A one-size-fits-all approach is not going to work here. Insurance companies have a very different set of asset liability structures than do banks. And to regulate them in terms of a one-size-fits-all approach is not going to be an effective form of supervision or regulation in my experience.
The Federal Reserve makes noises about accommodating the unique features of insurance companies, but Dodd-Frank will let the Fed go only so far in doing so. For example, the Fed may be limited in the adjustments it can make to the so-called Collins Amendment, a capital requirements provision in Dodd-Frank intended for banks. In Chairman Ben Bernankes words, On the Collins Amendment, it does make it more difficult for us, because it imposes . . . bank-style capital requirements on insurance companies. There are some things we can do, but . . . this does pose some difficulty for our oversight. As Mr. Woodall warned with regard to the application of the Collins Amendment to insurers, the possible unintended negative consequences to consumers, the insurance marketplace, and the broader economy are not at all clear at this point.
The FSOCs designation has a direct impact on those large insurance companies designated as systemically important. But, it also has an indirect impact on smaller insurance firms that now have to compete against large insurers that will now have the explicit backing of the federal government. Dodd-Frank has exacerbated too-big-to-fail by making it a permanent fixture of the insurance industry.
The impact of Obamacare has clearly manifested itself over the past two months. The Dodd-Frank legislation is being implemented at a slower pace, but the result is the same. Its just a matter of time before bad legislation turns into market chaos.