Rethinking the Financial Stability Oversight Council

ABSTRACT:

New major existential challenges are threatening the U.S. financial system. Climate change, cyber risk, the evolving role of digital assets, and vulnerabilities in nonbank financial intermediation call for prompt collective responses by financial regulators. However, the existing U.S. financial macroprudential regulatory architecture seems not to be up to the task because of “architectural vulnerabilities” that undermine its proper functioning.

The Financial Stability Oversight Council (FSOC) is a multiagency authority created by the Dodd-Frank Act to mitigate systemic risk by coordinating the actions of U.S.financial regulators. It was envisioned as a macroprudential authority to stabilize the financial system. FSOC was given the power to designate systemically important entities and activities and to trigger a novel back-up regulatory and supervisory authority of the Federal Reserve (Fed), what l call the Regulator of Last Resort (ROLR) function.

This Article shows that FSOC, in its current structure, is not up to the challenges facing the U.S. financial system. Offering a novel political economy account to its operations and structure, the Article shows that architectural vulnerabilities in the FSOC design exposes it to political cyclicality—which undermines its operations, deprives the markets of a critical watchdog, and compromises the operation of the Fed as ROLR.

This Article proposes incrementalistic and marginal policy solutions to this problem. Congress should fix the architectural vulnerabilities of the FSOC by adopting a different leadership structure. Building on the comparative experience of the U.K. and the E.U., the Article proposes two alternative options: upgrading the current leadership of the Council to a Co-Chair role of the Fed Chair and the Treasury Secretary; or alternatively, creating a new Systemic Risk Council within the Fed as a novel macroprudential authority.