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A Major Test for Dodd-Frank: Can GE Check Out of the SIFI Hotel (California)?

By Aaron Klein, Justin Schardin

Monday, April 13, 2015

Friday’s announcement by General Electric Co. (GE) that it plans to sell or divest the majority of GE Capital’s assets is a seminal test for whether the Financial Stability Oversight Council (FSOC) can implement the Dodd-Frank Act as Congress intended. FSOC, which designated GE Capital as one of the first systemically important financial institutions, or SIFIs, will for the first time be faced with deciding whether a firm that drastically changes its business model can shed its SIFI status. How FSOC responds will tell us much about how well Dodd-Frank is working for “de-designating” SIFIs. Put another way, is SIFI designation a Hotel California, where institutions are checked in but then can never leave? Or, is it a two-way street?

Dodd-Frank created the SIFI designation process to allow regulators to bring systemically important nonbank financial institutions under the umbrella of meaningful federal regulation. This was meant to solve the problem exposed during past financial crises in which the failure of some non- or lightly-federally regulated firms threatened the stability of the financial system. Dodd-Frank also envisioned a de-designation process to implicitly allow companies that changed their business models so that they are no longer systemically important to be treated as such. The law requires FSOC to annually review all SIFIs and determine whether each one still meets the criteria necessary for designation. If a firm does not, then FSOC is supposed to rescind the company’s SIFI status.

However, the formal review process has been opaque and given little attention. So far, just two companies, GE Capital and the American International Group, have had their SIFI status reevaluated. FSOC’s decision not to rescind their designations merited a paragraph in the council’s July 31, 2014 minutes that gave no insight into its reasoning. FSOC has a lot more work to do to create a robust de-designation process. Among the questions that need to be answered:

  • How much of the de-designation process will focus on principles that apply generally to any SIFI versus applying case-by-case to each individual SIFI?
  • Who will be in charge of administering the annual reviews? Should the FSOC staff managing the de-designation process for an institution be the same as the ones that managed its designation process?
  • What will be the role of the Federal Reserve, which is now the primary federal regulator of SIFIs?
  • Ultimately, what does a SIFI need to do to be de-designated?

FSOC itself may not know the answers to these questions at this stage. But to its credit, FSOC has been taking steps to address them. In November 2014, FSOC conducted a series of outreach meetings, including with the Bipartisan Policy Center (BPC), on ways to improve its designation and de-designation processes. In February, FSOC approved a series of changes to these processes, including allowing a SIFI to meet with FSOC staff prior to the SIFI’s annual review, allowing a SIFI an opportunity for an oral hearing before the full council once every five years and providing a more detailed explanation of any decision made to not de-designate a SIFI.

GE’s decision, though, means that FSOC is now on the clock to come up with a strong and meaningful de-designation process. In the meantime, BPC has begun developing a white paper offering new policy solutions to this topic. We hope that our ideas for improving the de-designation process, which we are targeting to release this fall, can provide FSOC and policymakers with the insights they need to improve this important component of the Dodd-Frank Act.

KEYWORDS: AIG, DODD-FRANK ACT, FEDERAL RESERVE, FINANCIAL STABILITY OVERSIGHT COUNCIL (FSOC), GENERAL ELECTRIC, SIFIS