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Not long after President Barack Obama picked Daniel Tarullo for a seat on the Federal Reserve Board, the Fed official sat down for the standard briefing with the staff, and promptly turned the tables on them.
Tarullo told them they had made mistakes in supervision, and he wouldn’t defend their past actions. Later, Tarullo told Alabama’s Richard Shelby, the leading Republican on the Senate Banking Committee, that he endorsed Shelby’s view that regulators had fallen down on the job and said it was time to “reshape” regulation.
In the past three years, no one has done more to strengthen government’s grip on the financial system than Tarullo. A former law professor and aide to President Bill Clinton, he has piloted implementation of the Dodd-Frank Act, the most sweeping overhaul of financial regulation since the 1930s. As the Fed governor in charge of bank supervision and regulation, he has a larger say in banks’ decisions on compensation, dividends, stock buybacks, mergers, and risk-taking than anyone else at the Fed. In the third round of tests since Tarullo took office, 15 of the 19 largest U.S. banks proved to have enough capital to survive a scenario of deep recession, the Fed said on March 13. The market took note: The KBW Bank Index of bank stocks is up 27 percent this year.
“There is no question that there is a view at the Fed that they are going to be both more rigorous and more intrusive,” says H. Rodgin Cohen, senior chairman at Sullivan & Cromwell, a law firm whose clients include JPMorgan Chase (JPM) and Goldman Sachs (GS). The changes represent “a true revolution in regulation, and Governor Tarullo is the Fed point person on this.” Tarullo will also be deeply involved in enforcing a ban on proprietary trading by banks under the so-called Volcker Rule, which becomes effective on July 21 and could take five years to implement.
Some bankers say Tarullo and the Fed have gone too far. “If you take a major segment of your economy, and all it is trying to do is preserve itself, then that slows growth, it slows employment creation, and it probably, over time, drives big chunks of that business to someplace else,” says John Allison, a BB&T (BBT) director and former CEO of the banking group. In response, Tarullo points to the ruinous costs of last decade’s regulatory detachment, and the banks’ own performance. “If bankers look at the relatively recent history of their firms, some would see that senior management didn’t do a great job managing risk,” he says.
Tarullo has focused a sprawling bureaucracy on preventing the next financial catastrophe.“Dan is the first governor that I can recall in recent memory that has taken on an issue, run the staff, and dictated policy,” says Karen Shaw Petrou, who has watched financial policy for 27 years as head of Federal Financial Analytics. “Supervision and regulation have been an afterthought for most governors.”
Under Tarullo, stress tests now emphasize capital planning, giving the central bank influence over decisions to issue dividends and buy back stock. The tests have also expanded Washington’s role in analyzing the biggest banks, a task once left largely to the Fed’s regional branches. At the same time, he must count on thousands of examiners nationwide, so he has tried to elevate their status. When he arrived, their work was “often regarded as midlevel supervisory tasks, and I said to myself, ‘Gee, these are our people on the ground. Shouldn’t they be regarded as supervisory stars?’ ” Tarullo says. He has increased the budgets for local supervisors and shifted their focus toward supervising risk at the banks. Instead of acting like traffic cops issuing tickets for noncompliance, the supervisors are now gathering loads of information on just about everything a bank does.
Tarullo says he knows the Fed must achieve balance: “With sufficiently stringent regulation, you could have an incredibly stable banking system, but it wouldn’t be lending to too many people.” Banks should take well-managed risks, with the Fed watching closely, “because what happened in the 2000s was a rapid buildup of certain kinds of lending without the recognition that it was built on a house of cards.”
The bottom line: Daniel Tarullo is beefing up the regulatory clout of the Federal Reserve, and the banks are feeling the pain.