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The Increasing Leverage of Daniel Tarullo

Days after the 2008 collapse of Bear Sterns, presidential candidate Barack Obama spoke at Cooper Union, in its famed Great Hall, laying out his ideas for a new financial regulatory framework. The deregulation that had swept through the industry in the 1990s had removed the guardrails on the largest institutions and put taxpayers at risk, he said. It was now time to consider serious reforms, not a throwback to Depression-era laws but an approach that mirrored the complexity of the times, especially as a crisis drew nearer.

It would be one of two speeches Obama gave in New York that provided the blueprint for what eventually would become the Dodd-Frank Act. He called then for higher capital requirements for the biggest, most complex banks, and advocated finding a new way to manage firms' liquidity risks. The Federal Reserve, he said, should have supervisory authority over any institution to which it was forced to act as lender of last resort. A financial markets oversight committee should be established to catch threats missed by individual agencies. And U.S. financial regulators should work closely with their counterparts overseas.

It's doubtful that any presidential candidate had ever uttered the words "Basel Committee" in a campaign speech before. But one of Obama's advisors, a Georgetown Law professor who had worked closely with the candidate's policy staff during the campaign and on drafts of the speech, had slipped it in, never suspecting it would actually be used.

The adviser, Daniel Tarullo, had spent the past nine years at Georgetown honing his ideas about supervision and capital. He had been deeply critical of the international regulatory agreement known as Basel II, going so far as to write a book on the subject, and he lectured his students on the "unstable equilibrium" created in bank regulation after the Gramm-Leach-Bliley Act had been signed into law in 1999. And now the young, charismatic presidential candidate of a major party was putting the issue front and center at a campaign stop within walking distance of Wall Street.

"One of the things that struck people about the Cooper Union speech was how substantive it was," Tarullo says now. "But it was an indication that the policy people, right up to the candidate, were getting into the real substance of financial regulation."

Less than a year after that speech, President Obama announced his plans to nominate Tarullo to a 14-year term on the Federal Reserve Board of Governors. It was a job that Tarullo, a 60-year old Massachusetts native who had spent more than two decades in Washington in various policy roles, began coveting soon after Obama had been elected to office.

"I thought about the other regulatory agencies, but I thought the Fed was the best place to come to try to help in the process of overhauling regulatory policy," says Tarullo, whose own speeches on bank capital and liquidity rules regularly captivate the industry now.

Tarullo met Obama in 2005. He was invited by the recently elected Illinois senator to several informal dinners, usually involving takeout in the conference room of Obama's office in the Hart Senate building. "We hit it off in the sense that I liked the questions he was asking, and I stayed in touch with his staff," Tarullo says.

By the time of the Cooper Union speech, Tarullo had become an important resource for the Obama campaign's policy staff in Chicago. A full-blown financial crisis was becoming a real possibility, and the candidate wanted to weigh in substantively on the topic. In addition to Tarullo, Obama enlisted former Fed Chairman Paul Volcker to help him.

"He wanted to learn. He wanted to get into more detail," says Austan Goolsbee, Obama's senior economic advisor during the campaign who later chaired the White House Council of Economic Advisers. Tarullo was "highly influential on that speech, which in many ways proved to be a template ... [for] how we ought to think about the role of financial regulation."

One of Tarullo's key arguments, which came through in Obama's speech, was that it hadn't been wrong for the policymakers to recognize that the old regulatory system needed to be changed; it was in figuring out what should replace it that they had fallen short.

"People needed to understand it was the culmination of 30 years of deregulation," says Tarullo, who left his role as an economic policy advisor in the Clinton White House just as discussions began on crafting a bill to replace the Glass-Steagall Act, the Depression-era law separating commercial and investment banks.

When the Gramm-Leach-Bliley era officially began, a year after Sandy Weill merged Travelers Group with Citicorp, "it was not itself a huge deregulatory moment," Tarullo says. "People didn't set out to say, 'Oh, let's deregulate the banks.' They did it because the commercial banks had been squeezed so much by the growth of money market mutual funds and the very healthy growth of capital markets. But there wasn't some new paradigm of banking regulation to replace the idea that activities and affiliations should be highly restricted."