The news itself:
MetLife Inc. won a legal battle over federal regulators seeking to brand the insurer a threat to the financial system and to ramp up government oversight of the company and its operations.
The Obama administration criticized the ruling and could still appeal. But for now, the decision means MetLife, the largest U.S. life insurer by assets, has shaken off potential higher capital requirements and other restrictions that came with its December 2014 designation as a "systemically important financial institution," or SIFI. Regulators apply the label to financial giants whose failure they believe would threaten the economy, and it submits them to much tougher rules on capital and use of borrowed money to reduce their risks.
The reason for the original designation:
The label meant regulators deemed MetLife to be so big and entwined with the financial system that, if it collapsed, it could threaten the economy.
And the decision:
Insurance giant MetLife has won its battle with the government to shed its “too big to fail” designation.
A federal judge in Washington on Wednesday rescinded the government’s designation of MetLife as a “systemically important financial institution,” a label that the insurer has been fighting to remove since 2014 because of the extra regulatory scrutiny it brings. The government can appeal the decision.
And now a little step back to explain the background. There are indeed financial institutions out there which if they fall over will leave a large, smouldering and smoking, crater where a significant part of the US economy used to be. Citigroup and JPMorgan come to mind as instances. It's also true that there are financial institutions out there which are inherently risky: we call them banks. Of which obviously Citi and Morgan are examples. For the entire point and purpose of banking is to borrow short and lend long. We call this fractional reserve banking. Deposits into a bank are typically short term, loans out of a bank are typically longer term than the deposits. So, if everyone turns up asking for their money back at the same time the bank is bust. Thus we have the central bank's job of providing liquidity to a bank suffering from a run.
When we've got a small bank that gets into such trouble we can deal with it: provide liquidity, merge it with another institution, perhaps even let it go bust and let that be a lesson to bankers. An institution which is too big to fail we cannot do that with. We need not to just provide the liquidity but add capital to stop that collapse into a hole in the ground of significant portions of the general economy.
And it's worth pointing out that the financial crash really was a run on those major banks. Not retail depositors but wholesale ones. Every bank and financial institution was trying to get its money back from every other one, all at the same time, and no one could possibly settle all of those demands.
Thus, yes, we have both systemically important, too big to fail, institutions which are inherently fragile and regulation of them is a darn good idea.
However, what happened when Dodd Frank was written, and in the subsequent drafting of the regulations, was that large was equated with inherently fragile. This is not so, this is the flaw in the MetLife designation. Yes, it's large. Yes, failure would be a bad idea. It can even be considered to be systemically important, it is large enough. But it is not inherently fragile: because it's not a bank and isn't borrowing short to lend long. Thus it shouldn't be included in the regulatory system that is required for institutions which meet both of these tests, size and also fragility.
Just to give an example here. If all of those AAA tranches of the MBS and CDOs had ended up in the portfolios of the unleveraged insurers and pensions funds like MetLife then there would have been no general crash of the banking system. It was exactly because it was the banks holding those bonds as leveraged investments (ie, financing long term holdings with short term deposits) that we got the wholesale bank run. Dodd Frank errs here again of course, because it now insists that banks must hold portions of syndications that they organise. When in fact the correct solution is to insist that they hold none of them.
This refusal to designate MetLife as a SIFI is thus the correct solution. Because while it may be large and even possibly systemically important it isn't inherently fragile in the manner that banks are. Thus it shouldn't be covered by the same regulatory regime that large banks should be covered by.
Perhaps the most interesting public policy point about this is that we should craft financial regulation rather better than we did Dodd Frank. You know, rather than having to use the courts to unpick the mistakes in subsequent years?
