• <div class="header-image" style="background-image: url(/live/image/gid/4/2801_V6N8_Header.rev.1537380633.jpg);">​</div><div class="header-background-color"/>

An Eye on the Big Picture: Five Key Takeaways from FSOC’s Annual Report to Congress

June 28, 2015

July 21 marks the five-year anniversary of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the establishment of the Federal Stability Oversight Council, or FSOC. This new body, a who’s who of the financial regulatory community, was created as a forum for regulators to keep an eye on the big picture of the U.S. financial system, identify potential risks, and address those threats before they materialize in a new global financial crisis.

By Yana Kaplun, C’18, W’18

On June 17, Treasury Secretary Jack Lew (also the chair of FSOC) delivered the Annual FSOC Report in a hearing before the House Committee on Financial Services.[1] The report, largely overlooked by the media, sheds light on the collective views of the regulatory community regarding potential risks to our financial system. While complex, the document and Secretary Lew’s testimony should not be ignored. Below are five forward-looking takeaways from FSOC’s 2015 report.

1. Market structure is evolving and regulations are not keeping up.

Technology, competition, and regulations have contributed to a quickly evolving financial market structure in the U.S. As regulations have tightened in recent years, there has been a migration of financial activity from more regulated to less regulated areas of the market. For example, trades of volatility products, or derivatives specifically tied to the volatility of a reference asset, have moved from regulated exchanges to over the counter (OTC) operations, whose risk is difficult to measure and even harder to regulate.[2] Meanwhile, regulations placed on loan quality have caused a rise in risky lending by nonbank mortgage servicers. These institutions are not subject to the same capital and liquidity standards as banks, and thus pose a risk of collapse in the event of an economic downturn.[3] 

2. The low yield environment incentivizes financial institutions to conduct risky business.

Incredibly low interest rates are making it difficult for investors to make a profit. As a result, banks, insurance companies, hedge funds, and pension funds across the financial system are taking on a disproportionate amount of risk to boost yields. If interest rates increase, demand for credit assets and the ability for creditors to pay back their loans could decrease, and the effect would be magnified across the financial industry. Losses by highly leveraged institutions could cause a massive sell-off of assets, putting our economy at risk of another dip.[4]

3. Cybersecurity breaches pose a real threat to the financial services industry.

Cybersecurity has been on the minds of many Americans given the devastating attacks on both government and retail institutions in the past year. The financial services sector is not immune to cyber-attacks. High levels of data confidentiality, integrity, and availability are crucial for the safe completion of all financial transactions. Given that the financial markets rely on relatively few core systems, an attack on any of these systems could spell disaster for a multitude of financial institutions and pose a risk to the financial system as a whole.[5] Regulators are releasing tools to help banks assess their own vulnerabilities to cyber attacks, but the FSOC and other federal regulators urge financial institutions to stay vigilant as hacking attempts become more frequent and severe.[6]

4. Regulation of central counterparties could have a destabilizing effect on financial markets.

Following the crisis, regulators mandated that a greater proportion of financial transactions be cleared through central counterparties, or CCPs. These measures were intended to provide transparency and liquidity to the markets, but there are now concerns that CCPs could be a new source of systemic risk. In other words, CCPs are so closely connected to many systemically important financial institutions that their failures could reverberate through the entire financial system in the event of an economic downturn. The FSOC has not yet rolled out a concrete set of recommendations to address these risks, but has indicated that more stringent regulations could be necessary.[7]

5. Housing finance reform is the missing piece in the economic recovery puzzle. 

During the subprime mortgage crisis of 2008, the government took over Fannie Mae and Freddie Mac in an effort to stabilize the housing industry. Seven years later, our housing finance infrastructure remains virtually unchanged. Fannie and Freddie remain under the control of the federal government and over 70% of mortgages in America are backed by the U.S. government.[8] This puts taxpayers at enormous risk in the event of another economic collapse.  There is broad agreement in Washington on the importance of reform and on the need for Fannie and Freddie to hand off their mortgage credit risk to the private markets. However, there is disagreement about the most responsible way to approach this reform. The lack of clarity on the future of housing finance has caused uncertainty in the mortgage market, contributing to tight credit and the anemic recovery of the housing market since the crash. The FSOC report urges lawmakers to act decisively on housing finance reform.                                                                                        

Why should we care?

The FSOC report is 150 pages long and full of regulatory jargon that is easy to dismiss. Yet, the information it contains is relevant to current and future business leaders, not just policymakers.  Like it or not, the aspiring investment bankers and hedge fund managers among us will be entering a new financial and regulatory landscape. Cybersecurity threats, changing market structure, and stringent regulations by the federal government are just a few of the challenges we will face in the financial sector in the coming years. Publications like the FSOC annual report provide a rare big-picture view of our financial system and allow us to assess and mitigate risks to our businesses. Very simply, the FSOC report is a glimpse into the future of financial markets that none of us can afford to overlook. 

Bibliography

Ackerman, Andrew. “Regulators Sound Alarm on High-Frequency Trading Firms.” Wall Street

Journal, April 30, 2015. http://www.wsj.com/articles/regulators-sound-alarm-on-high-

frequency-trading-firms-1430414889?KEYWORDS=high+frequency+trading.

Financial Stability Oversight Council. “2015 Annual Report: Financial Stability Oversight Council.” FSOC. Accessed June 25, 2015. http://www.treasury.gov/initiatives/fsoc/studies-reports/Documents/2015%20FSOC%20Annual%20Report.pdf.

Ian, McKendry. “Cyber Threats Pose Systemic Concerns, OCC’s Curry Says.” American Banker. Accessed June 25, 2015. http://www.americanbanker.com/news/law-regulation/cyber-threats-pose-systemic-concerns-occs-curry-says-1074680-1.html.

Nocera, Joe. “The End of Fannie and Freddie?” The New York Times, June 26, 2013.

http://www.nytimes.com/2013/06/27/opinion/nocera-the-end-of-fannie-and-freddie.html.

The Annual Report of the Financial Stability Oversight Council. Washington, D.C., 2015. http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=384888.

Tracy, Ryan. “Regulators Point to Risks From Rapid-Fire Trading, Clearing.” Wall Street Journal, May 19, 2015, sec. Markets. http://www.wsj.com/articles/regulators-point-to-risks-from-rapid-fire-trading-clearing-1432064436?KEYWORDS=central+counterparties.


  [1] The Annual Report of the Financial Stability Oversight Council.

  [2] Ackerman, “Regulators Sound Alarm on High-Frequency Trading Firms.”

  [3] “2015 Annual Report: Financial Stability Oversight Council,” 113.

  [4] Ibid., 106.

  [5] Ian, “Cyber Threats Pose Systemic Concerns, OCC’s Curry Says.”

  [6] “2015 Annual Report: Financial Stability Oversight Council,” 105.

  [7] Tracy, “Regulators Point to Risks From Rapid-Fire Trading, Clearing.”

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

PENN WHARTON PPI
RESOURCE SPOTLIGHT:

  • <h3>Federal Aviation Administration: Accident & Incident Data</h3><p><img width="100" height="100" alt="" src="/live/image/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg" class="lw_image lw_image80 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg 2x, /live/image/scale/3x/gid/4/width/100/height/100/80_faa-logo.rev.1402681347.jpg 3x" data-max-w="550" data-max-h="550"/>The NTSB issues an accident report following each investigation. These reports are available online for reports issued since 1996, with older reports coming online soon. The reports listing is sortable by the event date, report date, city, and state.</p><p> Quick link: <a href="http://www.faa.gov/data_research/accident_incident/" target="_blank">http://www.faa.gov/data_research/accident_incident/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>The Penn World Table</h3><p> The Penn World Table provides purchasing power parity and national income accounts converted to international prices for 189 countries/territories for some or all of the years 1950-2010.</p><p><a href="https://pwt.sas.upenn.edu/php_site/pwt71/pwt71_form.php" target="_blank">Quick link.</a> </p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Bureau of Economic Research (Public Use Data Archive)</h3><p><img width="180" height="43" alt="" src="/live/image/gid/4/width/180/height/43/478_nber.rev.1407530465.jpg" class="lw_image lw_image478 lw_align_right" data-max-w="329" data-max-h="79"/>Founded in 1920, the <strong>National Bureau of Economic Research</strong> is a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works. The NBER is committed to undertaking and disseminating unbiased economic research among public policymakers, business professionals, and the academic community.</p><p> Quick Link to <strong>Public Use Data Archive</strong>: <a href="http://www.nber.org/data/" target="_blank">http://www.nber.org/data/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>National Center for Education Statistics</h3><p><strong><img width="400" height="80" alt="" src="/live/image/gid/4/width/400/height/80/479_nces.rev.1407787656.jpg" class="lw_image lw_image479 lw_align_right" data-max-w="400" data-max-h="80"/>The National Center for Education Statistics (NCES) is the primary federal entity for collecting and analyzing data related to education in the U.S. and other nations.</strong> NCES is located within the U.S. Department of Education and the Institute of Education Sciences. NCES has an extensive Statistical Standards Program that consults and advises on methodological and statistical aspects involved in the design, collection, and analysis of data collections in the Center. To learn more about the NCES, <a href="http://nces.ed.gov/about/" target="_blank">click here</a>.</p><p> Quick link to NCES Data Tools: <a href="http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4" target="_blank">http://nces.ed.gov/datatools/index.asp?DataToolSectionID=4</a></p><p> Quick link to Quick Tables and Figures: <a href="http://nces.ed.gov/quicktables/" target="_blank">http://nces.ed.gov/quicktables/</a></p><p> Quick link to NCES Fast Facts (Note: The primary purpose of the Fast Facts website is to provide users with concise information on a range of educational issues, from early childhood to adult learning.): <a href="http://nces.ed.gov/fastfacts/" target="_blank">http://nces.ed.gov/fastfacts/#</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Internal Revenue Service: Tax Statistics</h3><p><img width="155" height="200" alt="" src="/live/image/gid/4/width/155/height/200/486_irs_logo.rev.1407789424.jpg" class="lw_image lw_image486 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/155/height/200/486_irs_logo.rev.1407789424.jpg 2x" data-max-w="463" data-max-h="596"/>Find statistics on business tax, individual tax, charitable and exempt organizations, IRS operations and budget, and income (SOI), as well as statistics by form, products, publications, papers, and other IRS data.</p><p> Quick link to <strong>Tax Statistics, where you will find a wide range of tables, articles, and data</strong> that describe and measure elements of the U.S. tax system: <a href="http://www.irs.gov/uac/Tax-Stats-2" target="_blank">http://www.irs.gov/uac/Tax-Stats-2</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>MapStats</h3><p> A feature of FedStats, MapStats allows users to search for <strong>state, county, city, congressional district, or Federal judicial district data</strong> (demographic, economic, and geographic).</p><p> Quick link: <a href="http://www.fedstats.gov/mapstats/" target="_blank">http://www.fedstats.gov/mapstats/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>USDA Nutrition Assistance Data</h3><p><img width="180" height="124" alt="" src="/live/image/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg" class="lw_image lw_image485 lw_align_right" srcset="/live/image/scale/2x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 2x, /live/image/scale/3x/gid/4/width/180/height/124/485_usda_logo.rev.1407789238.jpg 3x" data-max-w="1233" data-max-h="850"/>Data and research regarding the following <strong>USDA Nutrition Assistance</strong> programs are available through this site:</p><ul><li>Supplemental Nutrition Assistance Program (SNAP) </li><li>Food Distribution Programs </li><li>School Meals </li><li>Women, Infants and Children </li></ul><p> Quick link: <a href="http://www.fns.usda.gov/data-and-statistics" target="_blank">http://www.fns.usda.gov/data-and-statistics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>HUD State of the Cities Data Systems</h3><p><strong><img width="200" height="200" alt="" src="/live/image/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg" class="lw_image lw_image482 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg 2x, /live/image/scale/3x/gid/4/width/200/height/200/482_hud_logo.rev.1407788472.jpg 3x" data-max-w="612" data-max-h="613"/>The SOCDS provides data for individual Metropolitan Areas, Central Cities, and Suburbs.</strong> It is a portal for non-national data made available through a number of outside institutions (e.g. Census, BLS, FBI and others).</p><p> Quick link: <a href="http://www.huduser.org/portal/datasets/socds.html" target="_blank">http://www.huduser.org/portal/datasets/socds.html</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>The World Bank Data (U.S.)</h3><p><img width="130" height="118" alt="" src="/live/image/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg" class="lw_image lw_image484 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg 2x, /live/image/scale/3x/gid/4/width/130/height/118/484_world-bank-logo.rev.1407788945.jpg 3x" data-max-w="1406" data-max-h="1275"/>The <strong>World Bank</strong> provides World Development Indicators, Surveys, and data on Finances and Climate Change.</p><p> Quick link: <a href="http://data.worldbank.org/country/united-states" target="_blank">http://data.worldbank.org/country/united-states</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Federal Reserve Economic Data (FRED®)</h3><p><strong><img width="180" height="79" alt="" src="/live/image/gid/4/width/180/height/79/481_fred-logo.rev.1407788243.jpg" class="lw_image lw_image481 lw_align_right" data-max-w="222" data-max-h="97"/>An online database consisting of more than 72,000 economic data time series from 54 national, international, public, and private sources.</strong> FRED®, created and maintained by Research Department at the Federal Reserve Bank of St. Louis, goes far beyond simply providing data: It combines data with a powerful mix of tools that help the user understand, interact with, display, and disseminate the data.</p><p> Quick link to data page: <a href="http://research.stlouisfed.org/fred2/tags/series" target="_blank">http://research.stlouisfed.org/fred2/tags/series</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>NOAA National Climatic Data Center</h3><p><img width="200" height="198" alt="" src="/live/image/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg" class="lw_image lw_image483 lw_align_left" srcset="/live/image/scale/2x/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg 2x, /live/image/scale/3x/gid/4/width/200/height/198/483_noaa_logo.rev.1407788692.jpg 3x" data-max-w="954" data-max-h="945"/>NOAA’s National Climatic Data Center (NCDC) is responsible for preserving, monitoring, assessing, and providing public access to the Nation’s treasure of <strong>climate and historical weather data and information</strong>.</p><p> Quick link to home page: <a href="http://www.ncdc.noaa.gov/" target="_blank">http://www.ncdc.noaa.gov/</a></p><p> Quick link to NCDC’s climate and weather datasets, products, and various web pages and resources: <a href="http://www.ncdc.noaa.gov/data-access/quick-links" target="_blank">http://www.ncdc.noaa.gov/data-access/quick-links</a></p><p> Quick link to Text & Map Search: <a href="http://www.ncdc.noaa.gov/cdo-web/" target="_blank">http://www.ncdc.noaa.gov/cdo-web/</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>
  • <h3>Congressional Budget Office</h3><p><img width="180" height="180" alt="" src="/live/image/gid/4/width/180/height/180/380_cbo-logo.rev.1406822035.jpg" class="lw_image lw_image380 lw_align_right" data-max-w="180" data-max-h="180"/>Since its founding in 1974, the Congressional Budget Office (CBO) has produced independent analyses of budgetary and economic issues to support the Congressional budget process.</p><p> The agency is strictly nonpartisan and conducts objective, impartial analysis, which is evident in each of the dozens of reports and hundreds of cost estimates that its economists and policy analysts produce each year. CBO does not make policy recommendations, and each report and cost estimate discloses the agency’s assumptions and methodologies. <strong>CBO provides budgetary and economic information in a variety of ways and at various points in the legislative process.</strong> Products include baseline budget projections and economic forecasts, analysis of the President’s budget, cost estimates, analysis of federal mandates, working papers, and more.</p><p> Quick link to Products page: <a href="http://www.cbo.gov/about/our-products" target="_blank">http://www.cbo.gov/about/our-products</a></p><p> Quick link to Topics: <a href="http://www.cbo.gov/topics" target="_blank">http://www.cbo.gov/topics</a></p><p>See all <a href="/data-resources/">data and resources</a> »</p>