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."
Tarullo's intellectual interests shifted dramatically during the ensuing decade. In the Clinton administration, he was seen as an international affairs expert and was tapped to work on the Asian financial crisis. But after Gramm-Leach-Bliley, Tarullo was intrigued and worried by what was happening in the domestic regulation of the financial services industry.
The only regulatory instrument he saw left for policymakers was capital, which prompted him to make capital adequacy and the efficacy of Basel II the focus of his work at Georgetown. Capital is "a very supple form of regulation because it can adapt," Tarullo says. "An activities restriction might miss something else going on in the bank, whereas a capital requirement might not be adequate, but whatever is there is available to help to buffer against any losses that may be sustained."
Tarullo's appointment to the Fed was a surprise to some. Many thought that with his background in international economic issues, he would be heading for the U.S. Trade Representative Office. But Alan Blinder, a former Fed governor and a friend of Tarullo's since the early days of the Clinton administration, understood why the Fed was Tarullo's top choice.
"I think it was completely obvious to himand to everybodywhen he joined the Fed early in 2009 that the country was going to be doing a major rewrite of its financial regulations," Blinder says. "This was not going to be just a touch-up. This was going to be a very, very big deal, and he knew that. He wanted to be in the middle of it."
Tarullo also suspected, as many did, that the Basel accord he had been so critical of was going to have to be reworked because it had performed so poorly.
"He was primed for both of those tasks," Blinder says.
Raised in Woburn, Mass., by his father, a salesman, and mother, a homemaker, Tarullo grew up with two sisters in a predominantly Italian and Irish middle-class suburb of Boston. He attended Roxbury Latin School, the country's oldest continuously operating private high school, at a time when politics had not been a remote subjectthe Vietnam War and the civil rights movement both were causing a groundswell of cultural change. Tarullo went to Washington to spend his undergraduate years at Georgetown, and went on to receive his law degree from the University of Michigan.
In 1981, he interrupted his practice in Washington for a teaching job at Harvard Law School. Six years later he returned to D.C. to advise Sen. Edward Kennedy on employment and labor market issues. More than anyone, Tarullo says, it was the pragmatic Kennedy who influenced his own approach to policy and politics.
"A part of the pragmatism was a willingness to work with anybody" on the Hill or in the White House, Democrat or Republican, Tarullo says. The Massachusetts Democrat "was intense about the things he believed in, but he also worked with people very successfully."
Today, as the Fed's point man on regulatory reform, Tarullo is tasked with coordinating the activities of multiple agencies, hearing out differing views and trying to build consensus. He says it's a role for which he draws heavily on his experience with the interagency and international work he performed during the Clinton administration.
"It's only experience that can really teach you how to get people moving toward consensus," Tarullo says. "Let's face it, it's not the kind of experience that the average central banker is trained for."
Tarullo may have more consensus-building experience than most trained macroeconomists, but his take-charge style and his willingness to tangle with staff on key decisions delivered a jolt to the genteel atmosphere at the Fed, where career staff historically played a leading role on supervision matters while the governors focused on monetary policy.
When Tarullo arrived, it was clear that he had his own priorities and that any policy recommendation going to the Board rested with him as chair of the Board's Committee on Banking Supervision.
"Decisions on major issues require approval by the full board, but as chairman of the committee, Tarullo strongly influences the content of the proposals that the board reviews, and his views on those proposals importantly influence the thinking of the chairman and the other governors," says Patrick Parkinson, who worked closely with Tarullo as director of the Fed's Division of Banking and Supervision.
Tarullo suggests that the policymaking process is more of an "interactive effort" in many respects, with draft proposals often circulating among governors. But there is little doubt as to who drives the Fed's thinking on supervision matters.
In his first four and a half years on the board, Tarullo has focused most of his speeches on financial regulation. Past Fed governors including Laurence Meyer and Roger Ferguson had responsibility over bank supervision delegated to them by the Fed chairman. But Tarullo, who has always voted with Fed Chairman Ben Bernanke on monetary policy decisions made by the Federal Open Market Committee, was different in that he arrived at the Fed already steeped in issues of bank supervision, having spent years researching and writing on the topic.
"Some of Tarullo's predecessors as chairman of the committee also were highly influential and effective leaders," notes Parkinson, now a managing director at Promontory Financial Group. "But given the extraordinary circumstances in which he arrived and given that he was President Obama's first appointment to the board, he had an unusual opportunity to shape policy at a critical time and he grabbed that bull by the horns."
Tarullo's influencehas arguably increased since the 2010 passage of the Dodd-Frank Act. Despite some of its own failings in the period leading up to the financial crisis, the Fed grew more powerful under the financial reform bill, and Tarullo was perfectly positioned to serve as the Fed's lead interpreter on a number of the new laws it contained.
"The Dodd-Frank Act basically gives a lot of marching orders to a lot of regulatory agencies to do a lot of work, and Dan has been in the lead of getting that done in terms of the responsibility the Fed has, in terms of turning Dodd-Frank into actual regulations," says New York Fed President William Dudley.
While the Fed waits on the White House to appoint to the agency a second vice chair of bank supervisiona post created under Dodd-FrankTarullo has cemented his status as the Fed's key voice on supervision. When he talks about capital or liquidity rules, bankers take note.
"The Greenspan Fed was generally very soft on regulation and the current Fed is tough on regulation," Blinder says. "This switch is not entirely due to Dan Tarullo, but he's a much tougher regulator."
Tarullo has amassed clout both at home and abroad. In March, he was named chairman of the Financial Stability Board's Standing Committee on Supervisory and Regulatory Cooperation for a two-year term. His predecessor in the role was Adair Turner, chairman of the U.K. Financial Services Authority.
Alongside Bernanke, Tarullo regularly participates in principal-level meetings of the Financial Stability Oversight Council and the Group of Governors and Heads of Supervision, the oversight body for the Basel Committee on Banking Supervision.
At FSOC gatherings, the Fed "might have been the only agency where more than one person was at the table," says Mary Schapiro, former chairman of the Securities and Exchange Commission.
Yet some remain skeptical that any Fed governor, without being in the chairman's seat, can exert as much influence as Tarullo seems to hold.
"It's always a mystery how much real power somebody who is on the Federal Reserve Board has" when he is not the chairman, says Marcus Stanley, policy director at Americans for Financial Reform. "Every agency has its own culture, and at the Fed, I really think the career staff and the chairman have the overwhelming power. But it's my impression that he's been able to get things done."
When Tarullo arrivedat the Fed in January 2009, the halls were calmunlike at the White House, where he had just come from leading Obama's economic transition team.
Tarullo stepped lightly at first, getting the important background he needed from the primary stewards of the Fed's unprecedented response to the financial crisis: Bernanke and Donald Kohn, the Fed's vice chairman at the time. "You've got to give yourself a little bit of time to learn the context, and there was some luxury for me because Ben and Don had been here already," Tarullo says. "It was not like the start of an administration."
Within weeks, Tarullo was working to shape the regulatory reform debate and the future direction of the Fed. He is widely credited for taking an instrumental role in the first round of stress tests conducted of the largest U.S. banks in May 2009. It was Tarullo who pushed the Fed to release the results to the public. "It was really important to get the results of the stress test out to the markets," he says. "Now we do it as a matter of routine, but it was very controversial at the time."
Some on the board feared that the market would lose confidence in the banks if the results were negative. But the market, argued Tarullo and others, already had come to fear the worst. Even a mixed bag of information about the actual condition of banks was better than knowing nothing and fearing a worst-case scenario.
Reflecting on that period, Tarullo says, "We were fortunate in the sense that things had bottomed a little bit. And we also were fortunate in the sense that while banks had been severely affected, they were not in as bad shape as some people might have inferred."
For Tarullo, the importance of getting information to the market had been a key takeaway from the Asian financial crisis in 1997 and 1998. "First, the only way that market actors are going to start regaining any confidence is if they think they understand what is going on," Tarullo says. "And second, you have to have a credible plan for restoring stability."
The sustained tension over the Asian crisis was good preparation for coming to the Fed when he did, he says. "It sounds like a clichÃ©, but you gotta keep your cool. You've got to be steeled for the fact that there's going to be a lot of bad news and a lot of bad stuff happening and you've got to absorb it and move through it."
Managing the Fed's sometimes tense relationship with the industry no doubt requires some of the same resolve.
"Every regulator's relationship with the industry is contentious at times, and probably should be," Schapiro says, citing her own struggles at the SEC with the money market mutual fund industry. "It is absolutely to be expected that there will be friction between regulator and regulated, and if there isn't I would be worried about that."
Friends admit that Tarullo's personality sometimes adds more fuel to the fire in his dealings with bankers. "He can be brusque," says Blinder. "You can be firm without being brusque, but Dan tends to be firm and brusque. It's his nature."
But the candor is sometimes appreciated, even by bankers. As the guest speaker at a 2010 meeting of CEOs involved in The Clearing House Association, which represents the biggest banks, "one of the things that Gov. Tarullo said is that large banks need to do a better job of explaining their value proposition, and I think he was right then and he's right now," says Paul Saltzman, the trade group's president, adding, "I think he fully understands the enormity and the consequences of the framework that the Fed is establishing."
Tarullo says he is willing to listen to the concerns of the largest banks, but otherwise he keeps a cautious distance from the industry. "When we do a regulation, it is not a negotiation with the entities to be regulated," he says. "It's our responsibility to listen to everybody who has viewsthe industry, academics, public interest groups, members of Congress, whomeverand then to make our best judgment under the authority delegated to us."
Tarullo acknowledgesthat there is only so much the Fed can do about pending rules authorized by Dodd-Frank, many of which require the input of no less than six regulatory agencies at a time, in addition to the involvement of the Treasury Department and members of Congress seeking to weigh in on the regulatory reform process. And he objects to the perception among some bankers that the Fed now plays an outsize role in deciding banks' capital distribution plans.
"We don't decide what the dividends are," he says. "What we are doing is fulfilling our statutory responsibility to assure the safe and sound condition of the largest bank holding companies. We have the stress test process, which allows us to take a forward look at the potential capital position of a large institution under stress, because the public interest is in having those financial institutions remain viable intermediaries under such conditions."
Colleagues commend Tarullo for helping to preserve the Fed's traditional identity as an apolitical body while building consensus on tough issues like Basel III liquidity rules and the Volcker rule, which bans banks from proprietary trading.
"I always found him extremely accessible, always willing to talk through any issue," says Schapiro. The former SEC head describes him as "somebody who was always motivated by trying to bring people together and get to the right answer."
Dudley, who sits on the Financial Stability Board's steering committee with Tarullo, calls him a "good debater" who "understands the art of the possible."
After criticizing the proposed capital rules in Basel III as not going far enough, Tarullo helped strike a deal to strengthen the requirements at least somewhat in exchange for giving countries and their respective banks more time to comply.
"We wanted the capital requirements to be raised significantly," Dudley says. "But the only way to do that was to extend the implementation timing. What's actually happened is that the market has brought forward de facto pressure on the banks to get to those requirements sooner, so I think that was a very successful negotiation. We made the right tradeoffs."
In July, Fed Gov. Elizabeth Duke publicly praised Tarullo for his leadership during "endless hours of lively discussion" with domestic and foreign counterparts, herself included, to finalize Basel III capital rules for U.S. banks. "Since the very first day he walked through those doors and joined the Board, he has been relentlessly determined to create a strong capital regime with appropriate incentives for responsible risk management and sturdy safeguards against regulatory arbitrage," Duke said just before the Fed voted on the Basel III rules package.
Other aspects of reformthe Volcker rule, for exampleare moving slower than anticipated, with a significant amount of rulemaking still to be done.
"It just takes an awful lot of time to do almost anything," Tarullo says of the joint rulemaking process. Even Volcker himself has suggested that having too many agencies jointly implementing Dodd-Frank has been "a recipe for indecision, neglect and stalemate, adding up to ineffectiveness."
With so many rules yet to be written, it's hard to say just how much influence Tarullo has had on the regulatory reform process. But Tarullo seems keen to see it through. "You come in at a point and you leave at a point, and you should be a little humble about understanding what are to be your own accomplishments and the accomplishments of a particular group of people at a particular moment," he says.
"And the meaning of what you've done may seem quite different a few years later," he adds. "Like William Faulkner said, 'The past is never dead. It's not even past.'"