Resurrecting the Office of Financial Research

The Office of Financial Research (“OFR”) was created by the Dodd-Frank Act to help address the gaps in data availability and analysis that had hampered governmental authorities in their response to the financial crisis of 2008.  It was hoped that the OFR would serve as an “early warning system” that would detect emerging systemic risks through data collection and analysis, but the OFR never really had the opportunity to live up to its promise.  During the Obama administration, it suffered from an unsupportive Treasury Department and pushback from other federal financial regulatory agencies; under the Trump administration, the staff and resources of the OFR have been decimated.  In a new article, I argue that the Biden administration should seize the opportunity to rebuild the OFR – not only to fulfill the OFR’s initial data collection and analysis functions, but also to address new sources of systemic risk that have emerged since 2010.  In particular, the OFR should be rebuilt with the new types of expertise needed to address the growing systemic threats that may arise from climate change and fintech innovation.

If it is resurrected as a hub of climate, data, computer, and complexity science expertise (in addition to economic expertise), the OFR will be better positioned to monitor systemic risks, develop innovative solutions to those risks, and also assist the other U.S. financial federal regulatory agencies with their new regulatory challenges.  At present, climate, data, computer, and complexity science expertise are largely unrepresented in the financial regulatory agencies, but financial regulation – particularly financial stability regulation – can no longer be fully effective without them.   While the OFR can and should partner with academic institutions that specialize in these areas, it also needs these kinds of expertise in-house.  Unfortunately, climate, computer, complexity, and particularly data science expertise are in increasingly high demand in the private sector.  The OFR has the flexibility to offer higher salaries than most government agencies, but it still won’t be possible for it to compete with the likes of Google and Goldman Sachs on salary alone.  The OFR will therefore have to compete in other ways, seeking out employees who may be somewhat disenchanted with the private sector and would relish the opportunity to do something public-minded (and then the OFR should pay them the highest salaries it can).

To attract talented individuals who are interested in public service, the OFR should strive to create an environment that encourages innovation and interdisciplinary collaboration.  There is a robust organizational management literature that the OFR can draw on to create such an environment, but a large part of the effort will involve creating a culture that manages expectations about and tolerates failure.  While regulators should of course be held accountable for misfeasance and dereliction of their mission, they should be allowed some leeway in experimenting with the best ways to advance their mission – even if this results in some wasted funds.  Tone is set at the top, and so the best way to create this kind of culture is to appoint a director firmly committed to innovation and interdisciplinary collaboration. If the OFR is successfully rebuilt in this way, it could become a mecca for sophisticated and innovative public service, attracting more highly skilled employees in a virtuous cycle.  At the very least, by concentrating expertise in the OFR rather than scattering it through the financial regulatory agencies, we can avoid a scenario where the individual agencies are continually trying to poach personnel from one another.  Concentrating expertise in the OFR will also facilitate collaboration on cross-cutting issues that could affect disparate parts of the financial system, avoiding the silo mentality that is anathema to systemic risk regulation.

To get a flavor of the types of things that a revitalized and interdisciplinary OFR could do, consider the possibility of creating internationally-accepted identifiers for the physical location of assets around the world (following the playbook that the OFR developed for encouraging international adoption of Legal Entity Identifiers for transaction counterparties) in order to better assess the financial risks associated with extreme weather events.  The OFR could also assist with modeling the financial impacts of extreme weather events and technological glitches that cascade through financial infrastructures – these models could then be used to improve capital and margin regulations, as well as to develop hypothetical scenarios for use in stress testing and for training machine-learning algorithms.  A revamped OFR could develop new types of circuit breakers for financial assets that are hosted on distributed ledgers, as well as monitoring systems that would inform regulators in their decisions about deploying such circuit breakers.  And of course, the OFR’s traditional economic expertise needs to be rebuilt as a matter of urgency to assess vulnerabilities in the financial system that have been highlighted and exacerbated by the stressed financial conditions caused by the pandemic.

There are legislative reforms that would maximize the efficacy of the OFR as an independent hub of interdisciplinary expertise (including making the OFR an independent body separate from the Treasury Department, making the OFR a voting member of the FSOC, and compelling other financial regulatory agencies to share data with the OFR).  However, given the uncertain composition of Congress, it’s hard to say whether financial reform legislation will be possible in the next few years.  Fortunately, the OFR can be rebuilt even without legislative reform, so long as the incoming Treasury Secretary and other financial regulatory agencies are supportive of the OFR’s mission.  The OFR already has the legal authority to engage in interdisciplinary work[1] and to subpoena data from private sector entities,[2] and there are informal ways to encourage interagency data sharing.  Section 155 of Dodd-Frank, which allows the OFR to fund itself with amounts assessed from large private sector financial institutions, already provides the OFR with an adequate funding apparatus.    Rebuilding the OFR is therefore a relatively easy priority for the incoming Biden administration, low hanging fruit that could have a significant payoff for financial stability.

ENDNOTES

[1] See Sections 153(a)(3), 153(a)(5) and 154(c)(1)(C) of Dodd-Frank.

[2] See Section 153(f) of Dodd-Frank.

This post comes to us from Professor Hilary J. Allen at American University’s Washington College of Law, It is based on her recent article, “Resurrecting the OFR,” available here.

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