Inside Financial Services

Tarullo Freelances

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Now Fed governor Dan Tarullo thinks Congress should move to limit banks’ size by mandating a cap on their non-deposit liabilities. This is from a speech he gave on the topic in Philadelphia last week:

In addition to the virtue of simplicity, [capping non-deposit liabs.] has the advantage of tying the limitation on growth of financial firms to the growth of the national economy and its capacity to absorb losses, as well as to the extent of a firm’s dependence on funding from sources other than the stable base of deposits.

Brilliant. Put aside for a moment the fact that the size and complexity of big banks, which addles Tarullo so, had nothing to do with causing the financial crisis. It wasn’t proprietary trading, or derivatives, or quant models that caused the problems. It was credit: too many lenders wrote too many sub-prime mortgages to the wrong people; once the tidal wave of defaults began, the whole system came crashing down. It’s that simple. If, prior to the crisis, the banking system consisted of many more of the smaller banks Tarullo prefers and fewer of the big ones he doesn’t, the crackup would have happened anyway. Tarullo’s proposal would have prevented precisely nothing.

What’s more, this notion he has of “tying the limitation on growth of financial firms to the growth of the national economy” would have a serious, and negative, macro effect. Credit creation-which is what financial firms do-drives economic growth, not the other way around. So if the government decides to artificially slow the growth in financial firms by enacting measures like the one Tarullo has in mind, it will also artificially slow growth in GDP. It’s not immediately clear why that would be a good idea.

But I have a broader question. How is it that Dan Tarullo, a single Fed governor, is out on his own putting forth legislative proposals for how big banks should be regulated? The entire Fed is tasked with bank supervision, remember-not just those governors who decide to take an interest in the topic. That means that the entire Fed, especially including Chairman Bernanke, should develop a formal policy and proposals regarding how big banks should be. Reasonable people-and reasonable Fed governors-can have an honest debate on what those policy proposals should be. (Tarullo sure isn’t the only Fed governor pushing for size limits, by the way.) And if the Fed isn’t interested in carrying out its supervision mandate, the structure of bank regulation ought to be revised to get the Fed out of the supervision business. But this middle ground of a few governors free-lancing their own proposals isn’t helpful. If Congress is going legislate based on input from the Fed, it ought to act based on what the Fed as a whole has to say. In the meantime, one-off proposals by individual governors are distractions that don’t necessarily add a lot of value.

What do you think? Let me know!

5 Responses to “Tarullo Freelances”

  1. Avatar PureDakota

    If the perverse incentives were gone, if the implicit guaranties were gone—size would matter much less than it does. But size is an easy target. It’s objective, and there is at least the illusion that if you limit size, you substantially reduce the risk—even if the cause had very little to do with size. For the last 4 years, the regulatory solution has been to (1) reduce income opportunities, (2) impose significantly higher compliance costs, and (3) raise capital requirements. How this makes banks attractive as an investment is beyond me. If it’s not an attractive investment, where is the capital going to come from to support it? What does it say about the future If all of this is really necessary in order to assure a sound banking system?

  2. Avatar rivvir

    I’ll tend to agree with that, more smaller banks simply adding up to the same total amount of $$ at risk. So, instead of too big to fail we would’ve had too many to fail. Can’t see why not. That makes it seem like the only way to avoid a repeat though would be all those regulations and costs you’ve been complaining about. Unless you want the system overly exposed to risk. Surely you’re not gonna sit there and write how much you trust the bankers not too pull that repeat if left to their own devices. How about coming up with some good solutions of your own instead of complaining about everyone else’s? Could it be there aren’t any, at least none that are effective enough without having the restrictions and/or costs you bitch about?

  3. Avatar PureDakota

    I’m assuing your comment was directed toward mine. There are so many places I could start, but I’m going to select mortgage lending in community banks. This is a line of business many have had to exit because of the overly burdensome regulations. I know many people find this hard to believe. But banks don’t quit doing business out of spite. There in the business of making loans, and they can’t make any money without making loans. When the cost of making loans (including the compliance costs) is greater than the income they can generate by making them, they won’t do it. I am a big believer in disclosures, yet even I can’t stand to read the voluminous disclosures the regulations have forced banks to provide. Can you? It seems there should be a better way, and making things more complicated is never the answer.

  4. Avatar jmb

    Wait, the problem that caused the crisis was too much credit–but the availability of credit is somehow not tied to the size (or complexity) of large banks? You see the logical problem with this, right? Also, Tarullo is suggesting limiting size by limiting non-dep. liabilities. Would this not have the effect of reducing leverage and the likelihood of runs?

  5. Avatar Oy

    I don’t buy your argument about causation, but that aside, if one little bank goes belly up it’s less likely to take down the rest of the system than if one monster bank goes belly up.

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