FSOC | Delisting AIG

FSOC Delisted AIG, One of Only Two Nonbank SIFIs

The following is a belated posting of an interesting report by Dana Chasin (Update 209) on the FSOC’s De-Designation Decision, posted here by permission:

The Update takes its own “tax holiday” to look at last Friday's Financial Stability Oversight Council (FSOC) under-the-radar vote to de-designate AIG as a Systemically Important Financial Institution (SIFI) and the rationales provided by seven of the ten FSOC members. 

The Council’s 68-page report – the most comprehensive snapshot of the current financial regulatory leadership and administration’s thinking on systemic risk – attributes the decision to material changes in the company’s size, complexity, and risk profile since its designation. Now only one non-bank financial company, Prudential Financial, maintains its SIFI designation. 

Was this decision merely the operation of law or is it the result of a clear Trump agenda to diminish or eliminate FSOC’s impact? What does the vote breakdown tell us? More below.

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The Votes

The Council voted 6-3 to rescind its 2013 designation of AIG as a SIFI. All four Trump appointees on the FSOC voted in favor of delisting, while the Obama-era appointees were split. SEC chairman Jay Clayton recused himself from Friday’s vote in order to avoid a conflict of interests, raising a key legal question about the vote. Fed Chair Janet Yellen voted in favor. 

•  All Those In Favor

–Keith A. Noreika, Acting Comptroller of the Currency: Noreika, an Obama-era appointee, voted in favor of rescission. He does not believe non-bank financial institutions should be regulated as SIFIs.

–J. Mark McWatters, Chairman of the National Credit Union Administration: McWatters voted in favor of rescission on the grounds that AIG today is a far different company than in 2009 when he examined the company as part of the Congressional TARP Oversight Committee. Notably, he fails to acknowledge that AIG’s baseline SIFI designation occurred in 2013, not 2009.    

–J. Christopher Giancarlo, Chairman of the Commodities Futures Trading Commission: Giancarlo explained that AIG’s decreased derivatives liabilities, lending liabilities, capital markets downsizing, and ceasing of swaps activity led to his decision to vote yes.

–S. Roy Woodall, Jr., the Independent Member Having Insurance Expertise: Woodall, an Obama appointee, criticized FSOC’s rescission document as confusing and deviant from the statutory test to determine whether the company poses a risk to financial stability. On the grounds of this statutory test, however, he does not believe AIG to be a SIFI, writing that it is half the size it was during the crisis. 

–Janet Yellen, Chair of the Federal Reserve: Fed Chair Janet Yellen, the most prominent Obama-era appointee on the Council, voted in favor of rescission on the grounds that AIG’s downsizing efforts render is no longer too big to fail.

Steven Mnuchin, Treasury Secretary: Mnuchin praised FSOC’s decision of rescind AIG’s designation, claiming that it showed the Council’s commitment to removing companies that are no longer systemically risky. (The Council is housed in the Treasury.)

•  The Dissenters

–Richard Cordray, Director of the Bureau of Consumer Financial Protection: As a member of the 2013 Council, Cordray does not believe AIG has made true reduction changes based on planning but has shrunk due to a failed business model and weakened financial market.

–Martin J. Gruenberg, Chairman of the Federal Deposit Insurance Corporation: Dissented for three reasons – an increase of liabilities/assets in other areas of AIG like life insurance and annuities, an inconsistent determination of the Council, and continued irresolvability due to AIG’s size and operations.

–Melvin L. Watt, Director of the Federal Housing Finance Agency:  the two legal standards for FSOC designation were not given independent reviews. If FSOC reviewed AIG under the other standard (size, scope, etc.,) then the Council would have found AIG is still in need of enhanced supervision.

AIG’s Material Changes

Many see FSOC’s decision as a manifestation of Trump’s deregulatory agenda. The FSOC here was fulfilling its legal obligation to re-evaluate its designations annually. At the time of designation, the FSOC concluded that AIG posed significant systemic risk primarily because of its exposure to financial intermediaries, its inability to conduct an orderly liquidation of its assets, the company’s “financial contagion” risk in insurance markets, and its general complexity.

Friday’s announcement comes after more than a year of interaction between AIG and FSOC and an official request for de-designation on July 7, 2017. FSOC’s re-evaluation focused on “material changes” since the Council’s previous review. 

Since 2012, AIG has:

• decreased its debt by 58 percent since 2012
• decreased its asset size from $547 to $498 bn
• divested billions including $30 billion with divestiture of ILFC assets
• sold non-core operations and businesses including ILFC, AIG Advisor Group, and United Guaranty Corporation

FSOC’s Determination

FSOC based its determination of designation of AIG in 2013 on three transmission channels of negative effects on the financial market:

• Exposure: material impact on creditors, counterparties, investors, etc.
• Asset liquidation: liquidation in such a way that asset prices and markets are affected.
• Critical function/service: entity no longer provides services that are relied upon.

At that time, AIG produced negative risk most frequently and powerfully through excessive exposure and asset liquidation. The decision to rescind the company’s designation was due to the reconstruction and reduction of various high-risk practices.

Capital market/institutional exposures lead to a cascading effect if a non-bank experiences distress later on. Therefore, AIG reduced its total assets, total debt outstanding, short-term debt, and securities lending from their 2012 levels. Also, the complexity of AIG rendered it irresolvable in 2013. The Council considered that the company has simplified its total assets, multi-jurisdictional operations, and global financial impact in order to address this. Yet, it maintained that the entity is still complex and requires further efforts.

State of Play

•  One Last Shadow Banking SIFI 

After Friday, Prudential Financial is only nonbank financial company to bear a SIFI designation. The institution is the largest nonbank by by asset size at $784 billion – over $285 billion larger than AIG. As FSOC must re-evaluate all designations each year, we could soon see the announcement of its de-designation.

•  Trump Decision on MetLife Appeal Expected

Metlife challenged its SIFI designation and won de-designation in court. President Obama’s justice department appealed the decision. The Trump could announce that it will not move forward with the appeal at any point.

•  Two-Thirds Requirement Satisfied? 

Clayton’s recusal might be legally significant. Section 113(d) of DFA requires two thirds of serving FSOC members to vote yes for a SIFI rescission. If Clayton is considered to be a serving voting member FSOC, then FSOC has ten serving members. Six of ten is not a two thirds majority. This would open up a question about the legal standing of AIG’s de-designation.

TREASURY | Mnuchin Testimony, Senate Banking Committee

President Trump and Treasury Secretary
Steven Mnuchin

The Senate Banking Committee heard Treasury Secretary Mnuchin on Thursday, May 18. The following report on Mnuchin's testimony is from Dana Chasin, reposted by permission:

The Senate Banking Committee hearing with Treasury Secretary Mnuchin exhibited a coordinated effort among the Democrats on the panel to press the administration on all the priority issues for the minority. One by one, Democratic members challenged Sec. Mnuchin about promises made by the Trump administration for supporting the middle class:

The CHOICE Act —seems to renege on promises to the middle class and actually sacrifices the middle class for tax cuts.

The "Mnuchin Rule" — while he was Secretary-Designate, Mnuchin told reporters immediately after his nomination that the Trump tax plan would not net the wealthy a tax cut. Mnuchin continues to stand by it.

Passthroughs — Sen. Warren appears to have exacted a promise from Sec. Mnuchin that the S-corp passthrough will only be available to small and medium-sized business owners.

Foreclosures — Sen. Cortez Masto grilled Sec. Mnuchin about why his leadership team has no one advocating for borrowers or homeowners.

Export-Import Bank — the Secretary heard appeals for full Bank reauthorization from both sides of the aisle.

Orderly Liquidation Authority — Sen. Warner advocated preserving the authority extended to the FDIC to resolve non-banks.

Here are more detailed highlights:

Warren's Passthrough Reform Bid
Sen. Shelby called on Sec. Mnuchin on the S-corp pass-throughs and how Mnuchin had promised to not give a tax cut to the wealthy. Mnuchin responded that "we are committed to make sure that rich people do not use pass-throughs as a loophole to pay lower rates. … So we do want small and medium sized businesses to have the benefit of lower taxes."
How about big law, for example? Mnuchin: "... we will make sure that not every single accountant, lawyer, and doctor who should be paying higher personal rates sets up an LLC or a pass-through to get around the system.”
This point was brought up again later by Sen. Warren, in the most productive exchange in the hearing. Mnuchin enumerated the key elements of the administration's new passthrough policy: "specifically, people who are making lots of money will not be able to use pass throughs. There will be criteria as to whether you're eligible for the business tax if you're pass through. It will not be available to everyone.”

OLA: Backstop against Bailouts
Sen. Reed said giving up the Orderly Liquidation Authority would deprive the system of its main defense against bailouts and sought assurance that taxpayers wouldn't bear losses under OLA.
In a critical exchange, Sen. Warner asked Sec. Mnuchin,
“If we have a large, trillion-dollar-plus SIFI institution headquartered in the United States and operating across the world with multiple subsidiaries, if it runs into a credit crunch and the rest of the financial industry stops doing business with this SIFI and it therefore fails, in order to have an orderly failure and wind in Congress this week-down, would you agree that shareholders need to be wiped out in that SIFI institution?”
Mnuchin concurred that something drastic would be necessary in such a situation. Sen Warner reiterated that the OLA is necessary as a backstop for this sort of systemic risk, and Mnuchin demurred again.

EXIM Bank: Two Takes
EXIM came up several times, with Sen. Heitkamp arguing for protection of it and Senator Shelby supportive but asking for reform. Mnuchin made no promises, but it does seem to be understood that the Bank is not on the chopping block anymore -- now that the president knows it “makes us a lot of money.”

Events Next Week
The following events are scheduled:
Tuesday
House Ways and Means Committee: Hearing entitled, "Increasing U.S Competitiveness and Preventing American Jobs from Moving Overseas," focused on the border-adjustment tax, 10 a.m.
The American Enterprise Institute event on the CHOICE Act with House Financial Services Committee Chairman Jeb Hensarling, 11 a.m. The bill is Hensarling's overhaul of Dodd-Frank.
Wednesday
House Budget Committee: Hearing on the White House fiscal 2018 budget with OMB Director Mick Mulvaney, 9:45 a.m.
House Ways and Means Committee: Hearing on the White House fiscal 2018 budget, with Treasury Secretary Steven Mnuchin, 10 a.m.
Thursday
Senate Budget Committee: Hearing on the White House fiscal 2018 budget proposal with OMB Director Mulvaney, 9:45 a.m.
Senate Finance Committee: Hearing entitled "Fiscal Year 2018 Budget Proposals for the Department of Treasury and Tax Reform", witness is Treasury Secretary Steven Mnuchin, 10 a.m.

Other Takes on the Testimony: Sen. Warren on Reinstating Glass-Steagall . Video of Exchange with Sen. Warren . Video of testimony (CNBC)