The Financial stability Oversight Council, (FSOC or Council), formed as part of the Dodd-Frank, is charged with three main responsibilities:

1. To identify risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies, or that could arise outside the financial services marketplace.
2. To promote market discipline, by eliminating expectations on the part of shareholders, creditors, and counterparties of such companies that the U.S. government will shield them from losses in the event of failure.
3. To respond to emerging threats to the stability of the U.S. financial system.

The FSOC recently issued a report discussing the financial crisis. The report found that among other conditions, the U.S. economy continues to heal from the 2007–09 recession (the longest since the Great Depression). Consumer spending and business investment have increased, but housing markets remain depressed and the unemployment rate is elevated. The global economy is also recovering, albeit at varying rates across advanced and emerging economies.

Moreover, the report found the financial crisis produced great upheaval in the U.S. financial sector, but the impact on the economy was even more devastating. At the height of the crisis, credit conditions tightened for households and businesses, as well as for financial firms of all sizes, reflecting severe disruptions to a range of financial markets that proved far more damaging than the disruptions from the initial credit losses themselves.

The FSOC notes, government budgets, both federal and nonfederal, have been strained by the cyclical response of revenues and expenditures to a weak economy as well as the fiscal actions taken to ease the recession and aid the recovery. The federal government deficit grew from 1.2 percent of GDP in 2007 to 8.9 percent in 2010, and net publicly held federal debt outstanding rose from $5 trillion to $9 trillion. This public borrowing largely replaced private borrowing in the credit markets, and global financial markets readily accommodated the increase in federal debt. Even after economic conditions return to normal, the federal government faces a long-run imbalance between revenues and expenditures. This need for long-run fiscal sustainability has been a focus of recent attention from credit rating agencies. Achieving longrun sustainability of the national budget is crucial to maintaining global market confidence in U.S. Treasury securities and the financial stability of the United States.

State and local government revenues were also severely affected by the economic downturn. While state finances started to improve in the second half of 2010, several quarters into the economic recovery, local governments remain challenged. The municipal debt market exhibited evidence of considerable stress last year.

In the period after the financial crisis, the legal, regulatory, and accounting framework of our financial system has changed significantly.

The Dodd-Frank Act, which created the Council, was intended to close gaps in the financial regulatory framework and strengthened supervisory, risk management, and disclosure standards in important ways. The new Basel III international standards for banks, negotiated with major input from U.S. regulators, will require banks globally to hold more capital, particularly when they take market risk, and will subject banks to a liquidity standard for the first time, and new accounting rules will serve to limit financial institutions’ off-balance-sheet activities.

For the first time, information on trading in swaps will be available through trade repositories. In addition, standardized derivatives will have to be traded on regulated trading platforms and centrally cleared, improving price transparency and reducing counterparty credit risk for market participants. Once regulators complete the implementation of the Dodd-Frank Act, the mix of complex structured credit products, derivatives, and short-term wholesale funding that helped produce the financial crisis is unlikely to reappear in its previous form.

Still, U.S. regulators continue to work out the details of several important initiatives, including those mandated by the Dodd-Frank Act and those agreed to with their international counterparts. For example, the Council has defined the characteristics under which it will designate systemically important financial market utilities for enhanced supervision.

The Council is also in the process of defining the characteristics under which it will designate nonbank financial institutions for Federal Reserve supervision, and the Federal Reserve, in consultation with other Council member agencies, is establishing tougher supervisory guidelines for large financial institutions. Regulators are also developing new reporting and disclosure requirements for designated nonbank financial companies.

Tomorrow’s bloticle will discuss issues related to federal regulation.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

Tags: Basel III, Dodd-Frank Act, Dodd–Frank Wall Street Reform and Consumer Protection Act, Federal Reserve System, Financial crisis of 2007–2010, Financial institution, Financial market, United States

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