In the wake of the recent financial crisis, many commentators have called for systemic risk or "macroprudential" regulation to help avoid future crises. 4173 ), which was signed into law on July 21, 2010, as P.L. 111-203 . Finally, it discusses parts of the Dodd-Frank Act involving the Fed and systemic risk, including the creation of a Financial Stability Oversight Council; regulation of systemically significant firms; resolution authority; modifications to the Fed's emergency lending authority and new disclosure requirements; the Consumer Financial Protection Bureau; the regulation of payment, clearing, and settlement systems and activities; and limits on proprietary trading. What is Systemic Risk? Conversely, it has been argued that those systemic risk episodes could not have been prevented precisely because they were systemic risk episodes—by their nature, the problems that arose were unlikely to be foreseen or neutralized. This scenario is referred to as a run. An argument for reducing the number of regulators is that firms can "forum shop" in the current system, choosing the regulator whom they believe will be most sympathetic or have the lightest touch. At the time of the crisis, the Fed could have used its existing regulatory powers over bank holding companies and certain consumer financial products to limit the likelihood of a systemic risk episode, and it could have used its existing lender-of last-resort powers to ameliorate the fallout following a systemic risk episode. This emergency authority was used extensively during the recent crisis to provide assistance to non-bank parts of the financial system. Although regulators may have used their powers to attempt to prevent systemic risk before and during the crisis, it may be the case that they did not have all the legal authority needed to respond to the types of systemic issues that emerged. Too Big to Fail or Systemically Important Firms

The Fed had primary regulatory responsibility for bank holding companies and financial holding companies. Because the Fed could already regulate banks for safety and soundness, it already had authority to take the too big to fail problem into account when setting regulation for these types of holding companies. The Fed used its emergency lending authority (Section 13(3) of the Federal Reserve Act), which is broad enough to allow it to lend to troubled firms, provided the loan is "secured to the satisfaction of the Federal Reserve bank." Some economists argue that the crisis has demonstrated that existing requirements were either too low or too pro-cyclical. Other payment, settlement, and clearing systems, as well as activities that did not occur through a clearinghouse, were not directly regulated by the Fed. The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act ( H.R. Systemic Risk Provisions

New systemic risk responsibilities in the Dodd-Frank Act were mostly divided between the newly created Financial Stability Oversight Council and the Federal Reserve, although resolution authority was largely shared between the Treasury Secretary and the Federal Deposit Insurance Corporation. Foreign financial firms operating in the United States could be identified by the Council as systemically significant. If the Board determines, and at least two-thirds of the Council confirms, that a systemically significant firm poses a "grave threat" to financial stability, it may:
(1) limit the ability of the company to merge with, acquire, consolidate with, or otherwise become affiliated with another company;
(2) restrict the ability of the company to offer a financial product or products;
(3) require the company to terminate one or more activities;
(4) impose conditions on the manner in which the company conducts one or more activities; or
(5) if the Board of Governors determines that the actions described in paragraphs (1) through (4) are inadequate to mitigate a threat to the financial stability of the United States in its recommendation, require the company to sell or otherwise transfer assets or off-balance-sheet items to unaffiliated entities. If necessary to pay off such obligations to the Treasury, the FDIC would have the authority to assess claimants of the failed institution that received more through the receivership than they would have received had the failed firm been liquidated in bankruptcy, as well as the power to assess certain large financial institutions (bank holding companies and nonbank financial companies eligible for the special resolution regime that have more than $50 billion in assets and all nonbank financial institutions supervised by the Fed as systemically significant). Such institutions are also barred from owning interests in or sponsoring hedge funds or private equity funds. Payment, Clearing, and Settlement Systems and Activities

In addition to the duties listed above, the Council, by a two-thirds vote including the chairman, is authorized to identify systemically significant systems for payment, clearing, and settlement (PCS) of financial transactions (also called utilities) and (PCS) activities for regulation by the SEC or the CFTC if registered therewith; otherwise, by the Fed. These requirements are phased in, and certain small firms are exempted. The Bureau is established within the Federal Reserve System, but it has some measure of independence from the Fed. The legislation does not authorize the GAO to conduct policy evaluations of the Fed's monetary actions.
The recent financial crisis contained a number of systemic risk episodes, or episodes that caused instability for large parts of the financial system. The lesson some policymakers have taken from this crisis is that a systemic risk or "macroprudential" regulator is needed to prevent similar episodes in the future. But what types of risk would this new regulator be tasked with preventing, and is it the case that those activities are currently unsupervised?
Some of the major financial market phenomena that have been identified as posing systemic risk include liquidity problems; "too big to fail" or "systemically important" firms; the cycle of rising leverage followed by rapid deleverage; weaknesses in payment, settlement, and clearing systems; and asset bubbles. At the time of the crisis, the Federal Reserve (Fed) already regulated bank holding companies and financial holding companies for capital and liquidity requirements, and it could influence their behavior in markets that it did not regulate. In addition, the Fed directly regulated or operated in some payment, settlement, and clearing systems. Many systemically significant firms are already regulated by the Fed because they are bank holding companies, although some may exist in what is referred to as the shadow banking system, which was largely free of federal regulation for safety and soundness. The Fed's monetary policy mandate was broad enough to allow it to prick asset bubbles, although it has not chosen to do so. Neither the Board of Governors of the Federal Reserve System (Fed) nor other existing regulators had the authority to address gaps in existing regulation that they believed pose systemic risk.
Opponents of giving regulators new systemic risk responsibilities argue that the crisis did not occur because regulators lacked the necessary authority to prevent it, but because they used their authority poorly and failed to identify systemic risk until it was too late. They fear that greater regulation of financial markets will lead to moral hazard problems that increase systemic risk. The recent crisis has demonstrated that government intervention may become unavoidable, however, even when firms or markets are not explicitly regulated or protected by the government.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173, P.L. 111-203) was signed into law on July 21, 2010. Provisions of this legislation involving the Federal Reserve and systemic risk are discussed in this report. The act creates a Financial Stability Oversight Council (Council) to identify (but not rectify) emerging threats and regulatory gaps. It authorizes the Fed to regulate systemically significant firms identified by the Council for safety and soundness. If the Secretary of the Treasury believes that a failure of a firm would threaten financial stability, the firm can be placed in receivership. It prohibits banks from engaging in proprietary trading, limits their ability to invest in hedge funds and private equity funds, and authorizes the Fed to regulate those activities at systemically significant firms. It also authorizes the Fed to regulate certain payment, clearing, or settlement systems identified as systemically significant by the Council. To prevent assistance to failing firms, it limits the Fed's authority to lend to non-banks in emergencies and requires more oversight and disclosure of Federal Reserve activities. It imposes minimum capital requirements on a greater array of institutions and calls for capital requirements to be made counter-cyclical. It attempts to move more derivatives into clearinghouses and exchanges.
Although the act could be portrayed as an expansion of the Fed's powers, the legislation also strips the Fed of certain powers, such as consumer financial protection responsibilities, and creates new checks on other powers, such as requirements to obtain approval from the Council or the Treasury Secretary before undertaking certain decisions.