In our daily briefing yesterday, we noted an exchange between Sen. Shelby and Secretary Geithner on whether the U.S.-China trade imbalance poses systemic risk. No one made much of this in the furor over broader Chinese-currency issues. However, it points to a critical implication of the Dodd-Frank systemic-risk regime: it could be used as a potent clamp on anything Treasury doesn’t like, not just on the financial activities at which it’s clearly aimed. This power could be used for good – dealing with asset bubbles – or for ill – price controls, anyone – but it clearly can be used with few, if any, limits on the Treasury Department’s discretion.

We aren’t agreeing here that Chinese trade imbalances are systemic, as Sen. Shelby suggested and Secretary Geithner said they well might be. Rather, we want now to make clear just what could happen were Treasury to take up Sen. Shelby’s suggestion or any to follow in arenas going far afield from the China battle. Under the Dodd-Frank Act, Treasury can do what it wants on whatever troubles it as long as sanctions are implemented through controls on systemic banks and non-bank financial companies.

Where is this in the law? We have previously drawn client attention to section 120, an often-overlooked provision in the plethora of so many sweeping ones. This part of the Dodd-Frank Act allows the Financial Stability Oversight Council (FSOC) to “recommend” activities or practices that by virtue of their nature, size or “inter-connectedness” (among other criteria) raise significant liquidity, credit or other problems for big financial firms or low-income, minority or “underserved” communities.

To be sure, all FSOC can seem to do is recommend rules on these activities. However, Section 120 then instructs primary regulators to follow the FSOC’s recommendations within ninety days or tell the world why not. FSOC “recommendations” come from the Council, but there is no requirement for an affirmative vote of the majority (as dictated for other FSOC actions by the new law). The law sets in place procedures for all of this, including public notice and comment, with criteria dictating factors the FSOC should consider when wreaking its will.

The scope here is clearly very broad and the power granted thereby far-reaching not only in the financial realm first envisioned, but also well beyond it. The law not only permits new rules to govern sanctioned activities or practices, but also flat-out prohibitions. The first taste of how this will work will come when new federal mortgage underwriting and securitization standards are released. These will be top-down rules that go well beyond what the Bureau of Consumer Financial Protection can do at the retail level. Are there other activities in the retail sector to shut down or redesign as Treasury sees fit? Repo-market or other wholesale practices that can’t be fully restructured under the “financial market utility” powers elsewhere in Dodd-Frank? Foreign countries we really don’t like with big enough financial books of business in the U.S.? Payments systems (think SWIFT) that aren’t hopping to Treasury? Anything or anyone else?

.