You might have seen recent news that MetLife won a battle against being deemed “too big to fail,” and that other companies are looking at the situation as an opportunity.
But why would they want to avoid that label? Why does it matter to companies like AIG? What are the repercussions?
This is an incredibly important topic for insurance industry leaders, as well as the general public. MetLife has been able to circumvent federal precautions put in place by the government in response to the Great Recession, but is this good or bad? While MetLife will be able to grow much more as a company, it raises the bigger question of whether legislation that is currently in place is enough, or if we a country need to take alternative measure to ensure that our financial stability is safeguarded.
What is the case about?
Prior to Wednesday’s ruling, MetLife Inc. was going to be deemed “too big to fail,” officially called Systemically Important Financial Institution (SIFI) by the U.S. government’s Financial Stability Oversight Council (FSOC).
MetLife, America’s largest life insurer, fought against the title, as it would put them under much tighter government scrutiny and would force it to have a much larger financial reserve to guard against bankruptcy.
The company has won, but the judge, at least for now, is keeping the reasoning sealed. A public version will be published on April 6th.
The case is a big deal because it calls into question a major facet of the Dodd-Frank Act, which was put in place in July of 2010 to curtail and regulate the activities of Wall Street. By challenging this bill, it indicates that we could see further curtailing of the FSOC’s sway in Congress in coming months.
If the Act survives long term, the case still raises important questions about how the government should decide which companies are SIFI, and which aren’t.
Why do SIFI and the Dodd-Frank Act exist?
A huge contributing factor to the Great Recession in 2008 was “too big to fail” corporations defaulting on their commitments, specifically in the mortgage industry. The American public was required to bail them out.
In an effort to prevent this situation from occurring again, Dodd-Frank was enacted to ensure proper precautions and financial cushions were established for corporations deemed so integral to our economy that it could not go bankrupt without disaster.
The bill includes annual tests to ensure that if another recession were to hit, each company would be able to survive and fulfill their obligations.
What does it mean to be a SIFI, from a practical standpoint?
Once a company is designated as SIFI, they’re required to follow a significant amount of legislation set down by the Obama Administration in 2010, when Dodd-Frank was introduced after The Great Recession.
The main issues that MetLife – and many other companies – resent focus on the requirement to hold more money in reserve to guard against failure, and, more practically, allow them to pass the annual stress test. The tests are tweaked each year, but serve to see if the institution being examined would survive a severe recession.
These tests are a huge factor when determining the financial cushion that SIFIs must put aside – which means less bonuses for shareholders and executives. For example, last year, J.P. Morgan was required to put aside an extra $6 billion to ensure that they would not collapse if the economy did.
Overall, being deemed a SIFI is not a positive thing for corporations – the regulations are in place to protect shareholders and investors, but many corporations with the label believe that they’re too conservative and restrict growth.
What is the impact of MetLife winning this case?
There were a few nearly-immediate reactions to the win. For MetLife, the announcement came with a five percent jump in share prices in New York Trading, which the firm is taking as affirmation as to the importance of the case.
Other SIFIs reacted strongly, with General Electric already applying for the same change. The company has undertaken a massive restructuring over the past twelve months, including selling over financial assets to return to an industrial company. It would seem that losing SIFI designation would allow it to regain its former glory.
Even more boldly, American International Group Inc., or AIG, is making moves to shed its SIFI designation as well. AIG was one of the companies that prompted Dodd-Frank to come into being in the first place; however, the MetLife win has given new confidence to the company, and they’re angling to not only shed the designation for themselves, but fight against the entire Act.
AIG’s mortgage unit, United Guaranty Corp., filed for an initial public offering (IPO) on March 31st, in an obvious effort to break up the company to assist in the removal of SIFI designation. According to Abdul Wasay of Bidness:
“AIG CEO Peter Hancock has plans to gradually narrow down the business while implicitly adopting the idea of a smaller and simpler company, as demanded by the investors Carl Icahn and John Paulson. The company has undertaken various expense control measures, including plans to slash 242 jobs in New York City.”
Prudential has also challenged it’s SIFI designation, and there are more on the way. Overall, the insurance giants are all highly interested in wriggling out of the federal grip.
So what does this mean, long term?
It’s a really interesting time to be in insurance right now – the greats are, essentially, disbanding to avoid the SIFI designation. This means that they’re also shrinking and separating into many smaller companies, instead of giant behemoths. Whether or not they’ll still act like a single company remains to be said – it can be assumed they will – but it does mean that there will be a change in market dynamics.
From a shareholder standpoint, it’s important to know that while it is really nice right now to have stock in these companies, the original threat of recession driving these companies into the ground still looms. If another collapse on the level of the Great Recession were to occur, we would see the same catastrophe for those involved, and the same damage done to the general public’s economic well being.