How devastating would it be to today’s economy if one of the nation’s largest financial institutions collapsed, the way Lehman Brothers did in 2008 under the weight of more than $600 billion in debt? No one knows for sure, and no one wants to repeat that scary chapter in history. That’s why “too big to fail” safeguards aimed at heading off such a catastrophe were put in place following the global economic implosion eight years ago. Under 2010’s Dodd-Frank Act, regulators were given new powers to keep tabs on banks and other firms deemed “systematically important,” such as requiring them to have more cash on hand and to pull back on investments considered too risky.
But a recent ruling by a federal judge in a case involving MetLife Inc. threatens to erode some of the legislation’s key protections and raises troubling questions about whether more people are starting to view the hard lessons of 2008 through a soft-focus lens. MetLife had sued over being labeled too big to fail by the Financial Stability Oversight Council, which includes Federal Reserve Chair Janet Yellen and Treasury Secretary Jack Lew. US District Court Judge Rosemary M. Collyer found that regulators were “arbitrary and capricious” in deciding to lump the country’s top life insurer with companies like Citigroup, Goldman Sachs, and Morgan Stanley. Most problematic, Collyer imposed a requirement on regulators that is not built into Dodd-Frank. She said they didn’t conduct a rigorous cost-benefit analysis to quantify the chances of a MetLife meltdown and show that the company’s demise would create serious fractures throughout the entire financial system.
In doing so, Collyer glossed over an important point: Dodd-Frank is intended to help prevent a terrible thing from ever taking place. In effect, Collyer is calling for the Oversight Council to prove something whose repercussions can’t be known in advance. That’s perplexing to former Massachusetts congressman Barney Frank, who championed the landmark oversight legislation with former Connecticut senator Christopher Dodd. “How do you decide what the cost is, and what the benefits are of avoiding a tremendous crisis?” Frank asks. “I believe we have the right to err on the side of safety.”
There appears to be more than enough evidence of MetLife’s importance to warrant special scrutiny from regulators. It sells a wide and complex range of insurance products globally, holds about $900 billion in assets, and has millions of customers worldwide. Remember, it was another giant insurer, American International Group, that nearly brought down the economy in September 2008. It took an $85 billion loan and government takeover to keep AIG from bankruptcy.
If that's not enough to set off alarms, consider this: Not long after the MetLife ruling, the Federal Reserve and the Federal Deposit Insurance Corporation — which are charged with overseeing the nation's banking giants — sent what were essentially warning letters to five of the nation's largest banks. Regulators said the banks' plans for dealing with disaster were "not credible or would not facilitate an orderly resolution under the US Bankruptcy Code." In other words, any one of these institutions would still put the economy at risk if it were to fail.
By making "too big to fail" more difficult to establish — or keep in place — the court ruling could encourage other companies that are listed as systematically important to challenge their standing, and it is likely to embolden them to take more chances with investors' money in an effort to drive higher profits and satisfy stockholders. Mark T. Williams, a Boston University finance lecturer and former Federal Reserve bank examiner, calls the outcome "a further dismantling of the guardrail that was supposed to be put in place to protect us against the next financial crisis." He also worries that it sends the wrong message to global banking markets. "It's almost as if our memories are too short," says Williams.
The Treasury Department plans a vigorous appeal of the District Court decision. Let's hope it prevails, or that the definition of "too big to fail" is at least clarified. Today the nation's economy is stable, if stubbornly sluggish. There are no signs of impending calamity on Wall Street. But as Treasury Secretary Lew noted in his response to the MetLife finding, "the financial crisis demonstrated that even the strongest firms can collapse quickly and with little warning."