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OpEdNews Op Eds    H3'ed 4/20/16

Too Big to Fail From the Eyes of a Specialist

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Sorkin's discussion of Judge Colyer's decision shows that she and he do not understand the statute or the concept of systemic risk. It is, of course, impossible for FSOC to "project" (a) the losses that MetLife will sustain over the next decade or (b) the losses that MetLife's failure would impose on other entities during some year over say the next decade. How can the FSOC know the counterparties that MetLife will have three weeks from now, much less a decade from now? Only a fool would believe that they could predict the mechanism three or ten years from now by which MetLife's failure would destabilize a particular market, particularly because MetLife may be a critical counterparty to an entity three years from now that does not even now. I am a strong critic of Dodd-Frank, but that does not mean that every (or even most) provisions of the Act were drafted by fools to be absurd. The Act does not require the impossibility that Judge Colyer demanded -- that FSOC quantify "the actual loss" that would result from MetLife's failure.

But Sorkin and the judge are also wrong (as are the FSOC officials who make the systemic risk determinations) in their reliance on statistics and probabilities -- and in the absurd belief that we ran, randomly into the equivalent of "a 100-year storm." The probability of a global crisis is increased enormously if (a) we continue to create and make worse the criminogenic environments that produce the increasingly severe fraud epidemics that drive our financial crises and (b) if we continue to allow systemically dangerous institutions to exist rather than shrinking them. The econometric techniques being relied on by FSOC (and demanded by judges) are based on statistically invalid assumptions of a fixed distribution of risk. When we create perverse financial incentives to engage in widespread fraud we create a vastly increased risk of systemic failure.

Sorkin and other readers should read Better Markets' analysis of the district court opinion. It would have allowed him to understand the issues and the district court's two other major errors in addition to its inventing a requirement that FSOC divine the future and quantify the "actual loss."

First, the court erroneously held that FSOC had to prove that MetLife was "vulnerable" to failure. The statute has no such requirement for a logical reason. If you could not designate a financial entity as systemically dangerous until it had a demonstrated, major problem that could lead to its failure it would be far too late to do the things that the statute is designed to do to reduce the risk of failure and the severity of the failure. The statute asks: if the entity fails "could" that failure pose a material risk of disrupting the economy?

Second, the court invented a requirement for a cost-benefit study. The statute has no such requirement, because doing so would require a farcical exercise.

The three central errors that the court made have nothing to do with her lacking specialized finance training. They are all easily understood errors of law and they all arise from extreme ideological hostility on the part of the judge against government regulation of the systemically dangerous financial institutions that will again blow up the global economy unless we shrink them to the point that they no longer create that danger. The issue is when the next systemically dangerous entity will fail -- not "if."

One of the reasons we, the Bank Whistleblowers United, proposed getting rid of the systemically dangerous institutions through the use of banking regulators' powers to set individual minimum capital requirements is that it allows vastly quicker remedial action than the cumbersome FSOC procedure that took over two years to designate MetLife as posing a systemic risk.

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William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)
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