In his final official speech, departing Federal Reserve Board member Daniel K. Tarullo offered a broad perspective on how financial regulation changed after the financial crisis and the capital requirements put in place by the Fed, including the stress testing program. He 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," stated Tarullo. He said that "it is crucial that the strong capital regime be maintained, especially as it applies to 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. Additionally, Tarullo cited the Volcker Rule as one with a strong case for change.
Tarullo listed the 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."
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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