Regulators Worry Next Financial Crisis Won't Be Caused by Banks

"Non-bank financial firms" sounds like a non sequitur. And according to federal regulators, the idea of letting these kinds of financial "gray area" firms -- also known as NBFFs -- continue to endanger the global economic system is fast becoming a non-starter.

Earlier this week, the government's Financial Stability Oversight Council, and members Treasury Secretary Jacob Lew and Federal Reserve Chairman Ben Bernanke, proposed tightening oversight of NBFFs. If passed, the regulations would name specific NBFFs as "systemically important" to the financial system, and subject them to heightened regulation. Specifically, the move would:
  • Place such firms under Federal Reserve oversight;
  • Require them to hold more capital in reserve against potential losses;
  • Require them to undergo financial stress tests such as those that already apply to America's biggest banks;
  • Obligate each regulated NBFF to prepare a "living will" explaining how it will safely wind itself down in the event it becomes insolvent, or otherwise too weak to go on living.
But none of this answers consumers' two main questions about the NBFFs:

What are these things, anyway?

And how would heightened regulation of them affect us?

NBFFs: What they are
Generally speaking, NBFFs include such entities as hedge funds (aka mutual funds for the rich) and private-equity funds (firms that invest in other firms... for the rich), and also more familiar businesses such as insurers and run-of-the-mill mutual funds.

Probably the prime example of an NBFF would be AIG, the insurance giant whose ill-considered decision to insure billions upon billions worth of junky subprime mortgage bonds brought it to the brink of extinction during the financial crisis and necessitated a taxpayer-funded $182 billion bailout.

Both AIG and fellow insurer Prudential (PRU), along with General Electric's (GE) GE Capital unit and MetLife (MET), are currently in the process of being labeled systemically important.

NBFFs: What they mean to you
"Systemically important" -- that sounds like a compliment, and certainly doesn't carry the baggage of the terms we've all become more familiar with these past few years: "too big to fail" and "too big to jail."

But don't expect AIG or Prudential, or any of the other NBFFs that get tagged with the label, to be sending the Council any thank-you notes for the honor.

Consumers may rue the day NBFFs are named too big to fail, too. In arguing against the Council's move, MetLife CEO Steve Kandarian warned that requiring systemically important NBFFs to hold higher "capital reserves" means they'll have less money to lend to consumers.

That means fewer loans, and it means more competition for the loan money that is out there -- which could increase the interest rates consumers have to pay to get access to it.

Kandarian also grumbled about how labeling his insurance company systemically important might hobble his ability to compete with smaller, less "important" insurers: Imposing higher capital requirements will "shift market share to smaller competitors who are not similarly regulated."

Shedding a tear for those poor, big NBFFs
Of course, from a consumer's perspective, our response to Kandarian's comment has to be: "So? What's the downside?" Because, to be perfectly honest, the CEO of MetLife appears to be saying that the only real "bad" effects of labeling too-big-to-fail NBFFs "systemically important" are that:
  • Too-big non-banks' costs will rise;
  • The prices they charge will rise;
  • As a consequence, consumers will shift their business to smaller institutions that can still charge us less anyway.
That sounds like a recipe for getting exactly what we want: smaller banks, which please consumers and reward investors better, and don't need $182 billion bailouts from the taxpayers every 10 years or so.

Motley Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and General Electric and has the following options: Long January 2014 $25 Calls on American International Group.
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