An article in yesterday’s The New York Times discusses the U.S. House Financial Services Committee’s review of the processes behind the Financial Services Oversight Council’s designation of non-bank financial entities. Under section 113 of the Dodd-Frank Wall Street Reform Act, the FSOC can designate a non-bank financial company as one that may threaten the stability of the financial system due to its financial stress and the level of connectivity it has with other bank and non-bank financial institutions. The author of the article takes issue with committee chairman U.S. Representative Jeb Hensarling’s position that the failure of asset management companies did not lead to the financial crisis. What I have found lacking in the Dodd Frank discussion is a clear definition for “threat to the financial system” and “systemic risk.” What I have heard so far does not take into account the entrepreneur’s perspective. I would define threat to the financial system in the following way.
From the entrepreneurial view, a threat to the financial system is where the market fails to provide alternative pools of loanable funds for entrepreneurs and small businesses to tap into when a supplier or a number of suppliers can no longer provide credit to potential borrowers. After family and friends have been tapped out, banks and other financial institutions are the next stop. If the road starts getting littered with financial institutions that are no longer lending, is there a framework in place that provides the entrepreneur with a safe detour toward ones that will extend credit?
The conversation in the media and among policy makers doesn’t seem to include that question. The focus has been on increasing capital requirements for banks and issuing rules that restrict a bank’s ability to engage in proprietary trade. The aforementioned article focuses on the conduct and duties of the FSOC. There is more concern about artificial stimulation of the markets by monetary policy than concern for keeping capital flowing to entrepreneurs.
If entrepreneurs are the drivers of the economy and capital is the fuel, then policy is placing the fuel in the wrong gas tanks. During a crisis a lifeline to entrepreneurs would be an appropriate short term fix since we don’t want to see entrepreneurs curtail production or send employees home with pink slips. The very next step should be to have an action plan in place to redirect business borrowers to alternative lenders should the supply-side of the loanable funds market be unable to send the proper signals to borrowers.
Government should be acting as an information clearinghouse during a financial crisis, allowing the market to clear out failed financial institutions and clearing the road of the debris so entrepreneurs can find the financial firms that can satisfy its needs. .