Addressing Systemic Risk Without More Bureaucracy

By Robert A. DiMuccio | April 24, 2009

America’s market-based economic system once created the largest economic engine in the world and gave this country one of the highest standards of living in history. However, that system now faces a credibility crisis of great proportions.

The extraordinary and severe contraction we are experiencing has disrupted not just financial markets, but more importantly, it has also disrupted people’s lives. Hundreds of thousands of Americans are losing their jobs every month as a result of the economic domino effect produced by the interconnectedness of a number of important financial services companies. That interconnectivity is known as systemic risk: the likelihood that a company’s failure or imminent failure would require government intervention to prevent or limit the failures of other vital companies.

The existing system failed to anticipate the problems that created the condition in which we find ourselves today, and people only want to know one thing: how are we, as a nation, going to avoid similar crises in the future?

The onus is on the financial services sector to present a compelling vision to address the current crisis to Congress and the American people, who are demanding action to restore economic opportunity and well-being. If we fail to present a viable plan, we can rest assured that Congress will put forth its own plan. If that happens, it is likely that our ability to innovate and our freedom to adapt or fail — which are necessary in a market economy — will be severely limited.

My company, Amica Mutual Group, is a member of a trade association that has proposed to Congress a detailed and focused framework for monitoring, limiting, and addressing systemic risk. This plan, proposed by the Property Casualty Insurers Association of America (PCI), would help America respond to the current crisis and restore investor confidence in our marketplace.

PCI has proposed a definition and analysis of systemic risk focusing on entities that are “too interconnected to fail” rather than “too big to fail.” This level of interconnectivity is measured by the counter-party risks and third-party leveraging tied to a company’s activities — in other words, how many additional failures would be caused by a company’s impairment — and the correlation of a company’s risks with other systemic waves and economic cycles.

We now know that even relatively small derivatives firms can create enormous leveraging throughout the global economy, vulnerable to market downturns, and becoming too interconnected to fail. This stands in contrast to large auto insurers whose risk exposures are independent from economic cycles and who can fail with negligible systemic impact.

What is needed is a single federal overseer with the institutional expertise and independence to monitor systemic risk. Systemic risk oversight must be flexible, to quickly adjust to market innovations. It also should be tiered, focused on greater transparency and disclosure to the regulator to allow broader risk monitoring, with increased information sharing for larger risks, and specific risk management standards and oversight for significant systemic risks. Additionally, it requires the ability to coordinate responsive action that allows failure to occur within an organized, predictable, and managed framework.

PCI has also made specific proposals for greater regulatory coordination and anti-fraud information-sharing globally, in a manner avoiding duplicative or excess reporting burdens.

PCI’s suggestion of a systemic risk overseer, which has been rapidly gaining support, fills the regulatory gaps and addresses the vulnerabilities identified by Congress. Importantly, it does so without imposing a massive new regulatory system or opening the door to social engineering that would create moral hazards and undermine our nation’s competitiveness.

It is clear that the federal government is going to take action in response to the existing economic crisis and the causes that precipitated it. We advocate that this action address the specific problem of systemic risk and do so without creating needless additional bureaucracy, and we believe our plan accomplishes these ends. (See related article here.)

DiMuccio is president and CEO of Amica Mutual Group in Providence, R.I.

Was this article valuable?

Here are more articles you may enjoy.