The Government Is Still Having Trouble Defining Systemic Risk

See Systemically Confused: Even the regulators can't agree on which firms pose a financial risk in today's WSJ. Excerpt:

"Should mutual funds and private equity shops be regulated as potential threats to the financial system? A battle over this question has broken out among Beltway regulators, but don't expect any winners in this bureaucratic tussle. The safer bet is a taxpayer loss.

Washington spent over a year debating and then enacting a plan to limit "systemic risk," without ever defining what it means. But the 2010 Dodd-Frank law did make one thing clear: Financial regulators now enjoy broad authority to identify and regulate whatever they think it means.

So far the regulators can't decide either. A draft January rule from the new Financial Stability Oversight Council drew fire even inside the bureaucracy for simply parroting the vague language of the law. The rule was supposed to clarify which nonbanks were so large, so indebted and so "interconnected" that they could threaten the financial system. But nowhere in the draft rule did it say how large is large, how much is too much leverage, or what exactly "interconnectedness" means.

The Council, which includes the chiefs of Washington's financial regulatory bodies, will ultimately decide which firms are "systemically important." The Federal Reserve, the Council member that will oversee these firms, issued its own draft rules in February for collecting data from the nonbanks that might be systemic.

The Fed also suggested that a firm's relationship to other systemically important firms is the key to its own systemic importance. Hmmm. So Washington hasn't decided what it means to be a systemically important financial company, except that such firms have connections to other systemic companies?"