OPINION: Regulators Create Perverse Incentives

Terry Flanagan

Generally, it’s good to be important. If you are important, it means you are significant, powerful, and influential to some degree. Many of those (people, companies, sports franchises, nations, etc.) who are unimportant, aspire to be important.

But apparently there are exceptions. When is it not good to be important? For one, when the Financial Stability Oversight Council deems you a systemically important financial institution.

MetLife was the most recent recipient of the dreaded SIFI designation, which carries with it tougher new capital requirements that are meant as insurance against a failure at an institution that is considered too big to fail. MetLife indicated it would contest the ruling, which if finalized would make the company safer but less profitable.

It certainly makes sense to closely monitor the largest and most influential financial institutions, but at the same time, this SIFI ringer kind of feels like regulators are fighting the last war. Yes, Lehman Brothers failed in the global financial crisis of 5-6 years ago and AIG needed rescue, but presumably lessons were learned and other checks and balances have since been implemented as guardrails.

The SIFI designation seems to be so dreaded that companies have at least some incentive to make themselves less systemically important. The way to become less systemically important is to be smaller, which is contrary to the growth and profit that companies should aspire to in a free-market economy.

Is that a perverse incentive?

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