You've said the regulatory reform legislation doesn't do enough to rein in the shadow banking system. Which companies are you talking about? Aren't most large financial firms bank holding companies now?
JAMES B. BULLARD: It's true that during the crisis some previously nonbanks converted over to bank holding companies. Even for those I think only a small fraction of their business is actually what we would call traditional commercial banking. Plus you have big insurers and you've got hybrid institutions like GE Capital and others. During the crisis, these institutions turned out to be susceptible to run-like phenomena and that created a lot of problems for the economy, and I am not really seeing us addressing that.
What is the solution?
BULLARD: I am not sure I have a great solution to it, but I wish people would be thinking about it more than they are. … There is one major change that we could make that makes a lot of sense and would help a lot, which is to change the tax code in a way that discourages short-term debt finance if you think short-term debt finance is what's really causing all these problems.
Are you really saying the regulatory reform bill doesn't address the interconnectedness of financial firms, how dependent they are on each other?
BULLARD: I know that has been a concern of some people, but I haven't really seen that borne out by data or even theories.
You need convincing after Lehman Brothers?
BULLARD: Bear Stearns was No. 47 on the list of S&P 500 financial firms at the beginning of the crisis, and as soon as you did something for Bear Stearns, that meant everyone on the list above Bear Stearns was evidently considered "too big to fail." … People will just say casually that there is too much interconnectedness, but what is it exactly and what kind of metrics do we have on that kind of thing and how does that work in some kind of coherent framework where you could trace it out and see how it worked?
What is your position on the Volcker Rule?
BULLARD: I think it makes sense to put some restrictions on the activities of institutions that are accepting government assistance in the form of deposit insurance. … I think it makes sense to put some limits on the types of risk that they can take. I think it's not so easy to see how that is actually going to work in practice, but it does make some sense if you are going to accept deposit insurance.
The bill would create a systemic-risk council, but you've said lawmakers aren't going far enough to ensure that the council takes action when risks to the system are spotted. What should Congress do?
BULLARD: If the systemic-risk council had existed in the past I think it's unlikely that it would have actually taken any action to mitigate the risks that might have been on the horizon, and I haven't seen very much in the legislation that is going to guarantee action. The reason you have an institution that's like the Federal Reserve that is quasi-independent is to take what might appear to be unpopular actions in the short term because you get better long-run policy. That's kind of what raising interest rates is like. It's that kind of decision. And so the systemic-risk decision would be something similar. You see excesses developing somewhere in the economy and you want to take action.
