Massive Insurer Convinces Judge It Isn't Too Big To Fail

Because it went ​so well​ the last time we let our too-big-to-fail institutions make their own rules.

MetLife, a giant insurer the Obama administration deemed in 2014 was too big to fail, has convinced a judge that it's not. The move puts the entire financial system at higher risk of future crashes and taxpayer-funded bailouts, says one prominent Wall Street reform group.

The federal court's decision undermines the White House's efforts to end "too big to fail," which analysts at Compass Point Research & Trading described as a "core pillar" of the Dodd-Frank Act, the 2010 response to the most punishing financial crisis and recession since the Great Depression. Opponents of the law are likely to see a boost in their efforts to repeal parts of it.

The decision also validates the decision by Dodd-Frank opponents to vigorously contest every part of the law they dislike. Since a financial industry lobbyist said the law's passage was merely "halftime," industry groups have sued to overturn key parts in court, spent millions of dollars to lobby regulators to soften its blow and showered millions in campaign contributions on allies in Congress to repeal or weaken the law. In some cases they've even drafted proposed laws for legislators to approve.

Dodd-Frank is supposed to forever prevent a repeat of 2008, when the federal government rescued several large financial companies deemed "too big to fail," by effectively taxing bigness and giving the federal government greater power.

The MetLife decision is almost certain to force the Obama administration to delay, if not halt, its efforts to crack down, experts said. Financial regulators are concerned by the potential threat posed by so-called nonbanks, such as large asset managers, big hedge funds and insurance companies, because they're not subject to the same rules as big banks. Companies such as BlackRock collectively oversee trillions of dollars in investments, but the court's decision has thrown a wrench in any plans to put the label on new companies.

"This district court’s decision appears to give global financial conglomerates like MetLife a license to be a too-big-to-fail systemic threat without any increased supervision to protect the country," said Dennis Kelleher, who heads the financial reform group Better Markets. He called it a "direct threat to the economic security, opportunity and prosperity of the American people."

A Treasury Department representative said "we strongly disagree with the court's decision." The administration probably will appeal the ruling.

Steven Kandarian, MetLife chairman, president and chief executive, cast the decision as a "win" for the company's employees, shareholders and customers. "From the beginning, MetLife has said that its business model does not pose a threat to the financial stability of the United States," Kandarian said.

MetLife, the nation's largest insurance company with $878 billion in assets and $4.6 trillion in life insurance policies, challenged the Treasury Department and federal regulators on their efforts to police the company.

In December 2014, the U.S. government concluded that it needed to regulate the company more closely after federal agencies voted to formally designate the insurer as a potential threat to the nation's financial system.

At the time, the federal government determined that MetLife was so big, had borrowed so much money and was so connected to other financial companies that its imminent failure could impair broader financial markets and "inflict significant damage on the economy."

One month later, in January of last year, the insurer sued the U.S. government to overturn the decision.

The lawsuit came before the agency charged with supervising the company, the Federal Reserve, had finalized rules that would govern its supervision of companies such as MetLife. Potential rules are still pending. Of the four nonbank financial companies that share MetLife's designation -- AIG, GE Capital and Prudential Financial -- only MetLife sued the government over it.

Earlier this year the company announced it was exploring a sale or spinoff of a large chunk of its business. It also agreed to sell a separate part of the company to a competitor. While it was challenging the government it also was bracing for a possible courtroom loss.

In the years leading up to the 2007-09 financial crisis, the federal government -- especially the Federal Reserve -- barely policed the financial sector, allowing for bad practices to proliferate until the financial system nearly failed. That changed after the crisis, leading to higher regulatory and compliance costs for companies such as MetLife.

Judge Rosemary Collyer on Wednesday put a stop to some of the federal government's efforts, rescinding the government's tag of the company in a sealed decision. In the public portion of her ruling, she agreed with MetLife that the government had failed to assess the company's vulnerability to distress and the economic effect of MetLife's designation.

MetLife stock rose 5 percent Wednesday on the court's decision.

Collyer gave the government and MetLife until next Wednesday to argue whether portions of her ruling should remain sealed.

While Collyer's decision could be overturned on appeal, some analysts reckon that at the very least it'll chill the government's efforts to more aggressively police financial companies.

Republicans in Congress, who have vowed to repeal the Dodd-Frank financial reform law, cheered Collyer's decision. House Financial Services Committee Chairman Jeb Hensarling (R-Texas) said the government's power to designate companies such as MetLife for more intense supervision represents "one of the greatest dangers facing hardworking taxpayers" on the grounds that designations today "are just tomorrow’s taxpayer-funded bailouts."

The ruling is likely to bolster Republicans' efforts to curtail the federal government's authority to supervise companies such as MetLife, said Isaac Boltansky, an analyst at Compass Point. 

Prudential and AIG may be more likely to challenge their designations as a result of the judge's ruling, he added.

Collyer's decision represents a "dangerous development that threatens the entire structure that protects the country and its taxpayers from future financial crashes" caused by nonbank financial companies, Kelleher said.

Large financial companies that aren't structured as banks aren't subject to the same rules as big banks. For example, big banks are more limited in how much they can borrow to fund the loans they make and securities they buy. Large financial companies generally prefer to borrow money rather than to raise equity.

Collyer's ruling could push so-called nonbanks to take on greater risk if they know the federal government won't be able to clamp down, Kelleher said.

But there's also a good chance the ruling does little more than force the federal government to more rigorously determine whether certain companies pose outsized risk to the economy, said Justin Schardin, a financial regulation expert at the Bipartisan Policy Center.

That's because there are two ways the government can designate firms as warranting extra supervision, he said: Federal agencies can either assume certain companies will fail and label them as potentially risky because of the potential consequences of their hypothetical failure, or agencies could conclude a certain company is inherently risky due to its activities.

The Obama administration has used the first avenue for all four of its nonbank designations, Schardin said. Collyer's ruling, if it stands, could simply force the federal government to use the second option. "It doesn't undermine the government but it makes it more difficult for them," he said.