Presenting FSOC's annual report, Mnuchin is questioned on GSE reform, SIFI designations, cybersecurity risks, Russia sanctions, tax reform bill, CFIUS, debt limit

The Senate Banking Committee on January 30, 2018, held a hearing to receive "The Financial Stability Oversight Council Annual Report to Congress." The only witness was Treasury Secretary Steven Mnuchin, who chairs the FSOC. Testimony from the hearing is available here.

In opening statements, Chairman Mike Crapo (R-ID) noted that the FSOC's latest annual report urged Congress to "reform the housing finance system and boost the role of private capital in mortgage finance." Crapo said such reform is one of his key priorities. He noted the bipartisan Corker-Warner and Johnson-Crapo GSE reform efforts in 2013, saying there is "an opportunity now to build on that effort and create a broader coalition of Republicans and Democrats to pass a bill into law." Crapo cited the growing incidence of data breaches and other cyber-crimes, noting that the FSOC report focused on cybersecurity as an area requiring more attention due to the increasing sophistication of cyber-criminals. The 2017 report also highlights the fact that FSOC rescinded the "SIFI" designations of two non-bank financial firms since the 2016 report was issued, he said. Crapo said FSOC's process for such designations in the past has lacked "transparency and analytic rigor" and said any future designations should have "clearly outlined criteria when such designations are appropriate."

In his statement, Ranking Member Sherrod Brown (D-OH) said the personal savings rate now stand at only 2.4%, the lowest since September 2005, while household debt continues to climb; job growth in 2017 was below the levels of job growth in the six previous years; and "3 million Americans have lost their health insurance since this president took office." Brown said the booming stock market "helps the top fifth of Americans," while only a third of workers are making contributions to a 401(k) or a similar retirement plan. He said the recently enacted tax reform bill raises health care premiums and keeps in place an "idiotic" tax break that corporations get for shuttering plants and moving overseas. Brown acknowledged the corporations that have announced they will boost their workers' wages, but noted that Wells Fargo last week had also said it will buy back more than $22 billion of its own stock this year, "dwarfing" what it passed on to workers. He was critical of the series of reports Treasury issued last year on regulations, which proposed "hundreds of changes to our consumer protection and financial stability rules that will make the risk and severity of the next crisis much greater … While past members of FSOC were eager to do the hard work of keeping Wall Street honest, this new team would rather join them for schnapps at a Swiss ski resort." Brown agreed with the FSOC report's warning that many multi-employer plans are in "tough shape," and urged passage of the Butch Lewis Pension Act he has sponsored (S. 2147).

In his own statement, Treasury Secretary Mnuchin said the growth rate of the economy over the past year was higher than the average over the prior 20 years, and included two straight quarters of 3% or higher GDP growth. "Because of tax reform, over 3 million Americans have received special bonuses or other benefits, and over 250 companies have announced investments in their workforces," he said. "Companies are announcing higher wages and increased benefits." Mnuchin noted that the FSOC report recommends that its member agencies "address regulatory overlap and duplication, modernize outdated regulations, and tailor regulations based on the size and complexity of financial institutions." He emphasized the need for "sustained attention to cybersecurity risks," noting that the report's recommendations in this area include creating a council of senior financial-sector executives to collaborate with regulators in order to mitigate cybersecurity threats.

Turning to "specific priorities for this new year," Mnuchin praised the bipartisan regulatory relief bill recently approved by the Banking Committee (S. 2155), saying it reflected "many of Treasury's recommendations from our Executive Order reports released last year." He said he had notified Congress in December that a "debt issuance suspension period" (DISP) would last until January 31, but because Congress has not yet suspended or increased the debt limit, he is extending the period into February and urged Congress to act. Mnuchin said he supports efforts to modernize the Committee on Foreign Investment in the United States (CFIUS), specifically legislation offered by Sens. Cornyn, Feinstein and Burr (S. 2098) and Reps. Pittenger and Heck. He said Treasury will "continue to take frequent and ongoing actions to combat threats from malicious actors" such as terror groups, weapons proliferators, human rights abusers, cyber criminals and rogue regimes. Mnuchin said the current housing finance system's "indefinite conservatorship" of Fannie Mae and Freddie Mac "is neither a sustainable nor a lasting solution," and he looks forward to working with Congress to reform the system in a way that helps consumers while protecting taxpayers.

Questions

GSE reform. In his questions, Chairman Crapo said housing finance reform is "currently my highest priority in the committee" and asked Mnuchin why it is important for private capital to play a larger role in any new system. Mnuchin said he believes in the "fundamental importance" of the 30-year mortgage and was open to many types of reform ideas, cautioning that "we do need to have substantial private capital and risk in front of any type of government guarantee." Crapo asked if Mnuchin believes it is important for any private guarantors to be subject to "GSIB-like capital requirements" to protect taxpayers, referring to the capital regime for global systemically important banks (GSIBs). Mnuchin repeated that GSE reform should involve "substantial" private capital.

Later in the hearing, Bob Corker (R-TN) said that "if we have a new model of housing finance reform … if we have a government guarantee in the future, would it not be your preference that that be at the actual security level, and not at the entity level? Mnuchin agreed. Corker continued, "Whereas last time, taxpayers had to bail out the entities with hundreds of billions of dollars, what we really care about is the individual borrowers and that their securities are guaranteed. Is that correct?" Mnuchin agreed, saying that would create a sustained liquid market. Corker said, "I assume that if we were able to pass something here, you would want significant private capital in advance of an explicit guarantee where … these entities are actually paying for those, so the government is getting something for the eagle stamp which is causing that 30-year mortgage to be guaranteed … We would [also] want to do what we could to end the too-big-to-fail situation that we have today." Corker then asked what the administration might do on its own to "revise" Fannie and Freddie, short of new legislation, and mentioned the possibility of placing them in receivership and "moving forward with a clean slate." Mnuchin told him, "There are certain administrative options that we have. These entities are very complicated … I don't really want to go through, in this format, publicly, all the different alternatives … I just want to be careful, given that they do have different market impacts." Corker said Congress and the administration have "an opportunity … to really deal with all of the interests in a manner that is fair, but also move our nation ahead in a manner that we don't have these two behemoths that, basically, are 100% backed by the federal government right now. And I hope we'll get there."

SIFI designations. Chairman Crapo asked how an "activities-based" approach for FSOC's designation of non-bank firms as SIFIs, as recommended by Treasury's reports last year, world work. Mnuchin said, "To the extent that we look at risky activities across an industry or within a sector, we can look at proper regulation that deals with those issues." Crapo then asked where FSOC sees "gaps or shortfalls" in cybersecurity protections today, and how they can be addressed. Mnuchin said, "I don't see any specific gaps today," though he mentioned problems with "chips" and software. "We need to be working in public-private partnerships. We need to have ways of sharing intelligence when it's appropriate."

Later, when Jon Tester (D-MT) asked about the FSOC's actions to remove the SIFI designations of non-bank financial firms, Mnuchin said, "The only company that we de-designated as a result of them not being financially systemic was AIG, where they had de-levered and cut their risk significantly … That's the only company [where] we made that judgment … The decision on MetLife had nothing to do with the risk of MetLife. The decision was there was a recommendation as it relates to a legal case that had nothing to do with its riskiness, and MetLife could indeed be subject to designation in the future. So the issue was more around a legal issue." When Tester asked if the FSOC is "still functioning and actively looking at companies, financial products, and assessing their risk to the financial system," Mnuchin said, "Absolutely."

$50 billion SIFI threshold. In his questions, Ranking Member Brown noted that the FSOC uses a $50 billion asset threshold as "an initial factor" when gauging risks posed by shadow banks. He asked if the FSOC would change that standard if Congress passes a bipartisan regulatory relief bill (S. 2155) recently approved by the committee. Mnuchin said "I think that is correct. And I think there is a general consensus from the regulatory community that the threshold should be raised," while noting that FSOC "could always make certain exceptions." Brown warned that would mean the FSOC "would be very unlikely to designate a large, leveraged hedge fund like Long-Term Capital Management," which was rescued in 1998 while holding just $129 billion in assets and more than $1 trillion in derivatives exposure. Brown then noted that one of Treasury's reports on financial regulation had said that "if we raised the $50 billion threshold for U.S. banks, we should do the same for foreign megabanks, based on their domestic assets. So … foreign banks with up to $250 billion in U.S. assets are going to be deregulated, akin to U.S. regional banks." Brown then said the same report also called for raising the $50 billion threshold for CCAR stress tests for domestic and foreign banks. "So, to be clear, the chairman's bill, with your acquiescence, will deregulate banks like Santander that repeatedly fails its stress test, and Deutsche Bank … ," Brown said.

Russia sanctions. Ranking Member Brown said President Trump on Monday night had chosen not to impose any sanctions upon Russia under the authorities granted by the sanctions law Congress passed last year, despite a list of offenses committed by Russia that Brown recited. He asked how sanctions could be effective if they "sit on the shelf, unused." Mnuchin said Treasury had done "an enormous amount of work" in preparing the report delivered Monday night. "There is a substantial amount of work that was done. I look forward to you reviewing the classified report," he said. "And … based upon that, we will be looking at taking appropriate action." Later, in questions from Sen. Menendez, Mnuchin said, "The intent was not to have sanctions by the delivery of the report last night. The intent was to do an extremely thorough analysis. It's hundreds of pages. And there will be sanctions that come out of this … "

Property taxes. In his questions, Robert Menendez (D-NJ) focused on the IRS's advisory warning taxpayers that they could not deduct property taxes prepaid in 2017, which he called "confusing, frustrating, and … plain wrong," because the tax reform bill "specifically prohibited the deduction of prepaid state income taxes, but it made no similar prohibition against prepaid property taxes … The advisory clearly contradicts the law and is nothing more than a back-door attempt to get these people who should be able to deduct their property taxes when they paid it." He asked if Mnuchin would commit to "fixing" the flawed advisory. Mnuchin told him, "Actually, I don't think it was confusing … What the IRS advisory did is it deferred it to the legal position of the state … The intent was that it wouldn't allow taxpayers to abuse the system. And again, it was intended for clarification." Menendez said, "I hope that you can get to a point … that you can help us on this, because it'll be bad enough that, in the next years, they won't have that deduction, [so] they certainly should get the deduction for the year in which they paid."

Online sales tax. Sen. Tester asked if the president supports the Marketplace Fairness Act (S. 976), which would allow states to collect sales tax from online retailers outside their states. Mnuchin said the president "fundamentally supports the idea of some type of sales tax across the board … there are aspects of that that he likes a lot, and he looks forward to working with you and others on it." Tester asked if Mnuchin would direct Treasury to conduct a study "on what I believe would be burdensome costs on small businesses in non-sales-tax states." Mnuchin said he would work with Tester and "we think there's ways of dealing with that."

If you have questions, or need additional information, please feel free to contact Will Heyniger or Bob Schellhas at Washington Council Ernst & Young at (202) 293-7474.

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