Thursday, April 6, 2017

Fed’s Tarullo gives his final thoughts on post-crisis regulation

By Colleen M. Svelnis, J.D.

In his final official speech, departing Federal Reserve Board member Daniel K. Tarullo offered a broad perspective on regulatory reform enacted by the Dodd-Frank Act in 2010, while identifying areas where “the case for change has become fairly strong.” 
 
Describing how financial regulation changed after the financial crisis with capital requirements put in place by the Fed, including the stress testing program, Tarullo concentrated on capital regulation because it is the single most important element of prudential financial regulation. “Eight years at the Federal Reserve has only reinforced my belief that strong capital requirements are central to a safe and stable financial system,” Tarullo said, especially for the most systemically important banks.
 
Tarullo discussed the Fed’s response to the worst recession since the Great Depression, which he stated was felt by the following three parts:
  • the sheer magnitude of the impact on the economy;
  • the dramatic freezing up of many parts of the financial market; and
  • the rapid deterioration of financial firms.
 
Too-big-to-fail. Tarullo also discussed the too-big-to-fail “problem” saying that Congress and financial regulators developed responses to the “woefully inadequate capital levels of prudentially regulated firms.” The most important element of regulatory strengthening, according to Tarullo, was to increase the amount of capital held by banks. “The quick action in assessing the firms, recapitalizing them where needed, and sharing the results of the stress tests with the public stands as one of the turning points in the crisis,” stated Tarullo.
 
Dodd-Frank Act. A pivotal choice of the Dodd-Frank Act was to make prudential regulation of the practices and activities of large banking organizations the presumptive approach to taming too-big-to-fail problems, stated Tarullo. According to Tarullo, a law like the Dodd-Frank Act would normally “have been followed some months later by another law denominated as containing technical corrections, but also usually containing some substantive changes deemed warranted by analysis and experience. But partisan divisions prevented this from happening.” He acknowledged that there are “clearly some changes that can be made without endangering financial stability.” Among these, Tarullo pointed to bank size thresholds, and the burdensome effect on the compliance capabilities of community banks subject to the Dodd-Frank Act rules.
 
Volcker Rule. Tarullo expressed concern that the Volcker Rule is too complicated, with problems in the statute and the regulatory approach. He saw a statutory problem involved in having five different agencies participating in joint or parallel rulemaking. He also stated that “the approach taken in the regulation in pursuit of consistency was one that essentially contemplated an inquiry into the intent of the bankers making trades.” Tarullo said the intention was that, “as the application of the rule and understanding of the metrics resulting from it evolved, it would become easier to use objective data to infer subjective intent. This hasn’t happened, though.”
 
An additional problem in his view, also in the statute, is that the Volcker rule applies to a much broader group of banks than is necessary to achieve its purpose. One regulatory approach to lessen the burden, he said, would be to exempt all banks with less than $10 billion in assets and other banks that report less than some nominal amount of trading assets.
 
Don’t publish the model. Tarullo stated that it would be “unwise” to give the stress testing supervisory model to the banks. He discussed how, in 1992, the details of a stress test model for revised capital standards for Fannie Mae and Freddie Mac were made public and any changes went through the standard notice and comment process. According to Tarullo, this is an example of what appeared to be a reasonable transparency measure in publishing the models that resulted in less protection for the financial system. 

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