The Most Important Agency You’ve Never Heard Of

The Office of Financial Research is meant to be the early-warning system for the next financial crisis. Is it doing its job?

Among the many lessons learned from the 2008 financial crisis, one thing stands out: ignorance—willful or otherwise—drove the system to the brink of collapse. While banks were busily writing mortgages destined to default, there was a blithe, system-wide failure to recognize what those toxic mortgages could do to the economy. Not only were regulators asleep at the wheel, they didn’t even know the car was moving.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, took a number of steps aimed at righting the wrongs of the financial crisis. One was the creation of a new agency, the Office of Financial Research (OFR), tasked with ensuring that Washington would never get caught so flat-footed ever again. Headquartered in a nondescript office building in downtown D.C., the 225-person bureau collects data and produces reports aimed at identifying potential threats to the financial system. Although technically part of the Treasury Department, the body is by law independent. Its budget, $99 million in fiscal year 2016, is funded through fees paid by the country’s largest banks. To help the OFR carry out its mission, Congress granted it sweeping powers, including the right to demand certain data from banking regulators and financial institutions, either voluntarily or with a subpoena, as well as from banking regulators.

Yet given its vital role, the OFR is a body that is surprisingly—perhaps worryingly—low-key. Its director, Richard Berner, hasn’t testified before Congress since 2014. Its numerous reports are highly technical, specialized, and rarely grab headlines. And given its vast powers, it’s unclear why it hasn’t collected more data from financial institutions or exercised its subpoena power to do so. Nearly six years after its creation, the OFR has yet to establish the credibility and influence its champions had hoped for, leading some to worry whether it will be able to fulfill its mission of averting the next financial crisis. “OFR was created to be the beating heart of the financial circulatory system for the U.S. government,” says Dennis Kelleher, president and chief executive of Better Markets, an advocacy group. “I don’t think anybody would claim that it’s lived up to that goal.”

The idea for the OFR took root in early 2009 during the fallout from the financial crisis. Regulators struggled to make decisions during the height of the meltdown in part because they lacked real-time information about which banks were connected through financial relationships, and how. The crisis also exposed how little federal regulators knew about the world of “shadow banking,” such as the vast market for credit default swaps, collateralized debt obligations, and other complex securities that played a role in the meltdown. Regulators had no idea how much money was at risk in these activities, let alone who was involved or what the results would be if there were massive defaults.

To resolve this problem, reformers called for the creation of a new agency, initially called the National Institute of Finance, that would help analyze system-wide information about financial transactions and positions. The agency would build two reference databases so the regulatory community would be able to collect and assess data from financial firms and their subsidiaries, at the level of individual financial instruments or contracts. By creating a data standard for this, regulators would be able to drill down on the markets—to look, for example, at individual loans and credit default swaps and assess the risks. This would give regulators better insight about the system’s health in a way that much of the current, backwards-looking accounting data is unable to do. The agency’s rule-making authority would be confined to writing data standards so it could focus on rooting out problems in the financial system rather than having to act on those problems, thereby avoiding at least some of the lobbying and political pressures that regulators face. Its independence would allow it to honestly assess new threats. “Our view was that it would be like a biblical prophet—speaking truth to power,” says Allan Mendelowitz, a former housing finance regulator who, along with a group of like-minded wonks calling themselves the Committee to Establish the National Institute of Finance, lobbied for the agency from the early days.

Although critics on all sides disliked the idea of adding another standalone banking agency at a time when many wanted to consolidate oversight, the strong support of Senator Jack Reed, a top Democrat on the Banking Committee, helped the concept survive the legislative process. In its final incarnation as the OFR, the agency was placed inside Treasury and given as one of its tasks the job of providing research to the also newly created Financial Stability Oversight Council (FSOC)—a “Jedi council” of sorts, chaired by the Treasury secretary, headed by top regulators at the other banking agencies, and charged with keeping tabs on the health of the financial system.

In January 2013, Richard Berner, the agency’s first official director, was confirmed by a Senate voice vote with little fanfare, after being hired in April 2011 to help get the agency up and running. A macroeconomist who previously served on the research staff at the Federal Reserve, Berner was also a top economist at Morgan Stanley and Mellon Bank.

The agency has been mostly invisible since.

What’s baffling is why. While the creation of the agency garnered some pushback, it never came under the same sort of sustained attack as the Consumer Financial Protection Bureau, the highly controversial conservative punching bag. Lobbyists and critics have occasionally warned that the OFR could become the “CIA of financial regulators,” but opposition overall has been muted. House Republicans have threatened to put the agency under congressional appropriations and increase its transparency by making its reports subject to public comment, but these aims are low on the GOP’s wish list.

Another source of the agency’s low profile could stem from its subordinate position within Treasury. Although the OFR is technically independent, an agency spokesman confirmed that the director of the office reports to Treasury’s undersecretary for domestic finance. That seat is currently vacant, so Berner often consults with the special counselor to the Treasury, Antonio Weiss, who is filling the slot. Given the hybrid setup, the decision to assert independence rests in some ways with the leadership. Critics point to the Office of the Comptroller of the Currency, one of the bank regulators, as a model for the agency to follow: it too is housed in Treasury, but there’s no question that it’s autonomous when it comes to supervision and rule making.

The OFR also took an early hit to its credibility when it released a report reviewing the systemic risks of the asset management industry. The study was widely panned by lawmakers, regulators, industry officials, and advocacy groups, with some critics arguing that it mischaracterized the way asset managers worked. “It just seems to me a listing of possible horror stories with no indications that there was any significant likelihood of any of it happening,” former Representative Barney Frank said about the report in 2013. “The office has to raise its game,” said Reed, after the study was released.

Berner, for his part, has repeatedly said that the agency stands by the report, and the OFR has noted that other governments across the world are adopting an oversight approach along the lines of what the agency suggested. The director also defends what the OFR has achieved. “I do think we’ve made contributions on both the data and analysis fronts, and the evidence for that is that others cite our work and Congress looks to our work to inform their decisions,” he says.

Behind the scenes, OFR officials have led the effort to create a global reference database with more than 435,000 bar codes, called “legal entity identifiers,” to track financial firms and their subsidiaries. At the height of the financial crisis, banks and regulators were unable to fully assess counterparty risk to a Lehman Brothers failure, because no database of exposures existed. The hope is that having this system in place and identifying exactly how the entities connect to one another will better clarify the structure of markets, particularly if use of the bar codes is required by regulators.

At the same time, the OFR has started two pilot projects to collect data on a voluntary basis from financial firms on the largely hidden market for short-term loans between financial institutions and securities lending transactions. It has also published a series of annual reports assessing a range of threats to the system and issued several significant studies examining the risks of the country’s largest banks, one of which was held up by the Republican chairman of the Senate Banking Committee in support of a bill to raise a Dodd-Frank threshold for big banks.

But for critics, this activity, nearly six years after the passage of Dodd-Frank, is far too little, too late. While the OFR has had piecemeal responses to some of the high-profile debates in banking—over whether there’s enough liquidity in the markets or the role of high-frequency trading—critics charge that it has yet to influence those discussions through the collection of fresh data or deep analysis. It’s not yet a go-to authority on the matters of the day. “Many people hoped OFR would operate like a sentinel providing urgent warnings of potential crises, but it has not followed a practice of saying ‘danger’ or ‘warning,’ ” says Art Wilmarth, a law professor at George Washington University. “Instead, the tone of many OFR reports has been relatively neutral, bland and low-key.”

In addition, the agency is only in the early stages of its work to create a reference database of financial instruments that would give regulators more data about the workings of the market. (Mendelowitz, one of the bureau’s early advocates, launched his own project, a nonprofit called ACTUS, that’s creating an open-source data dictionary and set of algorithms to help fill the void.) People close to the agency also suggest that it’s still having trouble collaborating with some of the banking regulators, though it’s required by law to check with the other agencies about filling data gaps before going directly to financial institutions. “Getting to a place where there’s good information sharing across agencies is critical,” says Michael Barr, a professor at the University of Michigan and a former Treasury official who helped write Dodd-Frank. “In Washington, there are always turf fights among agencies because access to information is a kind of power, and I think that’s an area where you’re going to need to see the OFR assert itself more strongly going forward.”

In January 2013, with little fanfare, the Senate confirmed the macroeconomist and former Federal Reserve staffer Richard Berner as the OFR’s first official director. The agency has been mostly invisible since.

A GAO report from February, for example, found that the OFR and the Fed aren’t working closely enough together and could be duplicating efforts when it comes to monitoring risk. Berner says that the agency is working to “find the right balance between access and confidentiality” in terms of sharing intel.

One of the agency’s toughest challenges is juggling the many demands that have been placed on it. It must collect and standardize massive amounts of new and complex data distributed across the system and help support research for the financial stability council—a tall order in itself, and one that’s bound to take years to complete, particularly for a relatively new agency.

Moreover, some of the OFR’s toughest critics have lofty aims for the agency. In addition to supporting the FSOC, it’s supposed to serve as a counterweight to the very regulators that head that council. Reformers have likened this role to a “storm-warning system” that can sound an early alarm in case of financial danger—and, in this case, it’s armed to do so even when there might be political pressure to stay quiet. But the very nature of financial crises is that most people don’t see them coming. Can one small agency really be charged with ensuring that the next one doesn’t hit? Much like the country’s other intelligence agencies, there’s often little credit awarded for crises averted.

“It’s not like we can say, well, we did this, and can immediately see the result. Financial resilience doesn’t quite work that way,” says Berner. “It’s not easy to measure, it’s not easy to calibrate. Unfortunately, the answer’s going to come over time when we see how the system responds to shocks.” Nevertheless, says advocate Dennis Kelleher, the OFR has “a very long way to go living up to its mission and the requirements in the law.” Congress gave the OFR the teeth of a watchdog. It should use them.

Victoria Finkle

Victoria Finkle is a Washington writer, previously with American Banker.