Earlier this week, the Financial Stability Oversight Council (FSOC) removed GE Capital from its list of systemically important financial institutions (or SIFIs). How big a deal is this? Big. And not so big. And a little bit scary. Let’s back up a bit to see why.
FSOC is a new entity created by Dodd-Frank. Its members are the heads of the federal financial agencies, with the Secretary of the Treasury serving as Chair. In comparison to other similar bodies, which only advise the president, FSOC has broad authority to act. Chief among its tools is the ability to designate an entity as a SIFI, and to impose stringent oversight and regulatory requirements on it thereafter.
The SIFI designation and attendant oversight have been promoted as a means to end Too Big to Fail. Many people, myself among them, have questioned how labeling entities as systemically important and putting them under greater oversight can possibly end Too Big to Fail. Isn’t a SIFI designation essentially the same as slapping a big “TBTF” label on the thing? Well, here’s where GE Capital’s story gets scary.
Aside from concerns about having a SIFI designation at all, the greatest critique of the designation has been the process itself. Dubbed the “modern day Star Chamber” by SEC Commissioner Michael Piwowar, its deliberations and the criteria it uses to decide if an entity is a SIFI have been notoriously opaque. FSOC has defended its processes by asserting that “much of the discussion in a designation process involves reviewing internal information.” FSOC has issued some guidance on how it makes its decisions, but it has had difficulty even sticking to those very minimal guidelines. The insurance company MetLife was designated a SIFI in 2014 and filed suit to challenge the designation. It won at the trial court level, garnering a scathing opinion from District Court judge Rosemary Collyer who found that FSOC “focused exclusively on the presumed benefits of [MetLife’s] designation and ignored the attendant costs.” Until GE Capital’s de-designation this week, MetLife was the only company to have escaped SIFI status.
This is unsurprising. Because entities don’t know why they have been designated SIFIs, it’s been very hard for them to get de-designated. There is no roadmap for a company to follow. As others have pointed out, this makes no sense if we want to end Too Big to Fail. The TBTF concept assumes that there are companies that are so big that their demise could bring down the whole economy because they are, in short, systemically important. If you want to end TBTF, don’t you want to help companies understand how to become less systemically important? To help them get de-designated as SIFIs?
Apparently, this is not what FSOC wants. And so companies like GE Capital who want to shed the SIFI label have had to cast about and find by trial and error what will satisfy FSOC. This is what is scary. Instead of providing companies with a clear plan for how to eliminate just those things that make them SIFIs, retaining everything else, including any efficiencies gained by being a large company, it encourages them to shed everything. GE Capital shed about $260 billion of assets since 2014, including $160 billion in commercial loans and a $26.5 billion portfolio of commercial real estate investments, as part of a massive downsizing project it has named “Project Hubble.” And now it has been de-designated as a SIFI.
Does this mean that other companies can simply follow GE Capital’s lead? is this now a roadmap? No. First, GE Capital is unlike many other companies in that it has GE itself standing behind it. Most other companies with SIFI status do not have such a wealthy and powerful parent to act as backstop. Second, and most important, GE Capital had strong business-based incentives to shed these assets. According to Wharton Professor of Management Emeritus, Lawrence Hrebiniak, GE CEO Jeff Immelt is “betting on the future of industrials with greater margins and greater returns. This will increase the valuation of the company.” GE Capital was fortunate in that what was good for business was also good for SIFI de-designation. For other companies, such downsizing would not be advantageous.
It’s important that at least one company has achieved de-designation. This shows that designation is not a life sentence and that, under certain circumstances, FSOC is willing to remove a company from the list. That’s all to the good. But because GE Capital downsized so substantially, it is impossible to tell which of its actions convinced FSOC to de-designate it. There is no roadmap. The only thing we know is that, when it comes to SIFI designation, smaller is better. But there is no reason to think that this is universally true for our economy as a whole. There are in many cases great efficiencies to be gained from consolidation and increased size. Unfortunately, FSOC’s current tack simply encourages downsizing for the sake of downsizing without any consideration for what such downsizing may do to productivity and growth.