Knightian Uncertainty, Systemic Risk Regulation, and the Limits of Judicial Review

Abstract

In MetLife, Inc. v. Financial Stability Oversight Council, Civil Action No. 15-0045 (RMC) (D.D.C. March 30, 2016), the U.S. District Court for the District of Columbia overturned the designation of MetLife, Inc., as a systemically important financial institution regulated by the Federal Reserve Board. It reversed on two grounds. First, it held that the Financial Stability Oversight Council ignored its published guidance by not calculating the statistical probability of MetLife experiencing material financial distress or the magnitude of ensuing losses to MetLife’s counterparties. In addition, it determined that FSOC failed to but should have considered the costs of designation to MetLife. In doing so, the District Court ignored the fact that much of systemic risk oversight operates on the frontiers of what the economist Frank H. Knight termed the unknowable. It is impossible to quantify the likelihood of material financial distress (in its systemic sense) at any given nonbank financial services provider through multivariate statistical analysis. For that reason, in the Dodd-Frank Act, Congress permitted FSOC to evaluate systemic risk at nonbank firms based on qualitative factors and descriptive statistics without the need for multivariate statistical regressions or multivariate similar techniques. By requiring FSOC to make statistical projections that are impossible to make with confidence, the District Court not only vacated MetLife’s designation but undermined major aspects of the broader scheme for regulating systemic risk that Congress mandated in Dodd-Frank.