A Departing Bank Regulator's Advice To Stave Off Another Financial Crisis

Departing Federal Reserve Board member Daniel Tarullo was a key architect of post-crisis financial reforms. He talks about how those reforms have worked and what could help in the future.

STEVE INSKEEP, HOST:

A leading bank regulator is leaving his job. Daniel Tarullo joined the Federal Reserve back in 2009 amid the financial crisis. He became a leading voice in demanding that banks rework their finances to be ready for the next crisis. He helped to implement new regulations under what's called the Dodd-Frank law. Now, he says he's leaving as of April, which means President Trump can name his replacement. And he talked with us about his legacy.

What was your central goal these last several years?

DANIEL TARULLO: Over the last eight years, my goal has been to create a safer regulatory system to be able to contain the risks that the financial system of the 21st century poses.

INSKEEP: And so when we heard in recent years about banks, for example, being required to keep more capital on hand, more cash on hand should they need it in an emergency, that was you doing part of that.

TARULLO: That certainly was the Federal Reserve doing it. And, you know, Steve, if you think back to the situation in 2004, '05 and '06, at that time, the large banks simply didn't have enough capital to protect against the risks that they were taking. And in some cases, they really weren't even aware of the risks they had. You know, I recall when we did the first stress test in the winter of 2009 and we asked banks to aggregate their exposures to individual counterparties, for example, some of them really weren't able to do that.

INSKEEP: You're reminding us of the situation where if you asked a bank what is the worst case scenario for you on a given day, they couldn't even tell you.

TARULLO: Precisely.

INSKEEP: And now they can?

TARULLO: Now they are in much better shape.

INSKEEP: So is the system strong enough?

TARULLO: Strong enough - look, when someone tells you the system is strong enough, that's when you want to get worried. The financial system adapts regularly, continuously. There's always innovation. There are always new instruments being created. People are always looking for new ways to make money. And that means that the regulatory system has to be adaptable as well.

INSKEEP: So what have you thought about when banks have sometimes said you are regulating us way too much now?

TARULLO: You know, it is the case that for the very largest institutions they do need an extra level of regulation. They need more capital than - relative to their balance sheets - than other banks would need. And that's because of the collateral damage to the economy that would be entailed were they to fail.

INSKEEP: People around President Trump have suggested that regulation of banks may be a major reason that the economy is not growing as rapidly as many people would like. We had some weeks ago on the program Anthony Scaramucci. He's a hedge fund manager. He's been an adviser to the president. He briefly was considered for a post in the White House. And this is what he said about the Dodd-Frank regulations that you've helped to implement.

(SOUNDBITE OF ARCHIVED BROADCAST)

ANTHONY SCARAMUCCI: One of the biggest problems that Dodd-Frank has caused is it has restricted the lending to small businesses. If you're restricting that arterial flow, which is what Dodd-Frank has done, well, that's a very big mistake for the economy because what we know about life is that we don't want to make ourselves too, too safe and then we can't get the innovation, the growth and the things that we need to do to populate the economy with terrific entrepreneurs.

INSKEEP: Is Scaramucci correct that that's the trade-off that we have made - less economic growth in order to be more safe?

TARULLO: Well, I think the aim should be sustainable economic growth. You know, Steve, there was an enormous amount of lending in the 2003, '04, '05 and '06 period, a lot of mortgages written that seemed at the time to be producing more growth and more homeownership, but they weren't built on a solid foundation. And of course people defaulted on those mortgages. Housing prices went down. You know, I agree with much of what Mr. Scaramucci said in your clip. The point where I would disagree is that regulation has been the dominant or primary reason why there hasn't been more lending. Everybody's still pretty cautious even eight years after the financial crisis.

INSKEEP: Did you read in The Wall Street Journal that when your departure was announced from the Fed that bank stocks went up?

TARULLO: Yeah. Well - yeah, I saw it on the wires.

INSKEEP: What did you think of that?

TARULLO: To some degree, it's a compliment I guess. One thing you learn as a central banker is to try to look through short-term developments. And I think that the core reforms I have been part of putting in place will have a lot of durability, particularly as they apply to the biggest institutions. So I don't know that my departure is going to make a particular difference as it applies to those kinds of regulations. And I think in general, the run-up in bank and other stock prices has been more a function of expectations for more growth in the economy, which again may or may not be realized.

INSKEEP: I think you're telling me that that boost in stock prices may have suggested some people buying bank stocks were excited that banks were about to become more profitable, the regulations were about to change, and you're responding that maybe the regulations aren't going to change so much after all.

TARULLO: Well, I think banks are going to continue to become more profitable because they have gotten themselves into a stronger situation. They've made the investments that they need in risk management, and so to the degree people are banking on significant cutbacks in the regulation of the largest institutions, I don't expect that that's going to happen. And I don't think the American people would want it either. I mean, people do remember how we got into this situation and why we put these regulatory reforms in place over the last eight years. All you need to do is think back to 2007, '08 and '09.

INSKEEP: Federal Reserve Governor Daniel Tarullo, who has announced he is leaving in early April, thanks very much.

TARULLO: Thank you.

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