CRS Examines Systemic Risk Reforms In Financial Regulation – Finance and Banking

In a new report, the Congressional Research Service
(“CRS”) analyzed the 2007 market crash and the
2020 pandemic crash, the steps that Congress took after each of
these crises, and the authorities that the regulators relied upon
to reduce systemic risk and avert market crashes.

The authors describe various post-Dodd-Frank measures and the
extent to which they have been implemented, and whether, or to what
extent, they succeeded. For example, the CRS provides a description
of the activities of FSOC, the various recommentations that it has
made and where FSOC was successful or not in obtaining the
implementation of those recommendations. CRS asserts that financial
stability-related reforms enacted after the crises were successful
in preventing the failure of large financial firms, which would
have otherwise required bailouts. The authors contend that the
responses were less successful overall in creating a more resilient
financial system that would withstand sudden shocks without
resorting to large-scale government intervention. CRS explained
that sectors that saw substantial reforms, such as banks and
derivatives, proved to be resilient during the onset of the
pandemic, while other reformed areas, such as money market funds,
repo markets and other short-term borrowing markets, broke down and
relied on federal emergency programs.

Further, CRS found that the restorative programs resulted in
financial stability and set off a large increase in asset values
after the spring of 2020. CRS concluded that this outcome raises
questions about whether government intervention was a success or
was unnecessary, since markets may have stabilized without
assistance. CRS concluded that the COVID-19 pandemic gave us a
real-life test of the systemic risk reforms and demonstrated that
financial regulators are facing several challenges, which stem from
political restraints, limits on regulatory powers, and innovation
in financial markets.

Commentary

While this report is well written, it reflects a political bias
towards over-reliance on regulatory authorities in times of
financial crises. With regard to the designation by FSOC
of firms as being “systemically significant,” the
authors complain that firms were de-designated after
reducing their systemic significance, as if downsizing of the
relevant firms were somehow an evasion of the regulation, or as if
FSOC ought to have continued to regulate the firms even after they
stopped being significant. Likewise, the authors suggest that
there should be an agency to approve new financial products (as
there is to approve new pharmaceuticals (page 42)). This may seem a
clever analogy, but it is not really one that works. Further, the
authors bemoan the fact that the regulators are slow to adopt
new regulations, as in the area of digital assets. However,
they say nothing of the fact that the regulators are also slow
to modify their regulations to permit new product innovations, as
in the area of digital assets. The report tends overmuch to
advocacy. Though an interesting read, one may reasonably disagree
with many of the implications.

Primary Sources

1. CRS Report: Financial Regulation – Systemic
   Risk

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