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C. Peter McColough Series on International Economics: Regulatory Reform Since the Financial Crisis

Speaker: Daniel K. Tarullo, Member, Board of Governors, Federal Reserve System
Presider: Jeffrey E. Garten, Juan Trippe Professor in the Practice of International Trade, Finance, and Business, Yale School of Management
May 2, 2012
Council on Foreign Relations

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JEFFREY GARTEN: Good morning, everyone. It's my great pleasure to moderate this meeting with Dan Tarullo, a member of the Board of Governors of the Federal Reserve System. This meeting is part of the C. Peter McColough Series on International Economics.

I'd like to ask everybody to please turn off their phone. Please don't put it on vibrate; just turn it off altogether. And I'd like to remind everyone that this meeting is on the record.

Our next meeting will be the McKeon Lecture with the service chiefs tomorrow evening.

I think Dan needs no introduction. You have his bio. I'd just like to say it's a particular pleasure for me to introduce him because we go way back, and I have been a great admirer of Dan both as a public servant, as a professor and writer and certainly in his present capacity in one of the most challenging financial environments that any of us has been in.

So the program for the morning is that Dan is going to give a talk, we'll come up here, I'll ask him a question or two, and then we'll open it up to the audience.

Dan.

DANIEL TARULLO: Thank you, Jeff.

And it's a pleasure to be back at the council. (Chuckles.) When we were doing the world economic updates, before I was in the government, they used to give the audience breakfast. But I guess they don't do that anymore. The -- whether it's austerity or just thinking they didn't need to draw people in, I don't know.

As Jeff said, I'm going to speak today about financial regulation since the crisis. What I intend to do is step back a bit because as you all know, the process of post-crisis financial regulatory reform has been both elaborate and extended. There have been numerous rulemakings. Most of them involve multiple agencies. Many are quite complex. They're all required to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act as well as various international frameworks that have been developed under the auspices of the Basel Committee on Banking Supervision.

So it's natural and it's appropriate that those of us involved in this process both inside and outside government have been focused on the details of one or another of these regulations. But this necessary attention to details also places us at risk of losing sight of the broader reform picture.

So this morning I'd like to do some stock-taking to review briefly the vulnerabilities in the financial systems that contributed to the crisis and compel regulatory response, to outline some key reforms adopted to date and to identify some important tasks that remain.

Now, this is certainly not the occasion for an extended discussion of the origins of the crisis. But, in assessing the progress of reform, it's important to recall the basic problems that we should be addressing. Financial reforms adopted during the New Deal and grafted onto pre-existing restrictions in the National Bank Act and state banking laws largely confined commercial banks to traditional lending activities within a circumscribed geographic area while protecting them from runs and panics through the provision of Federal Deposit Insurance and access to the Federal Reserve Discount Window. So this is beginning of course in the 1930s. At the same time, investment banks and broker-dealers were essentially prohibited from affiliation with traditional banks. This approach fostered a system that was, for the better part of 40 years, very stable and reasonably profitable though not particularly innovative in meeting the needs of savers on the one hand and of households and businesses wishing to borrow funds on the other.

Beginning in the 1970s, the separation of traditional lending and capital market activities began to break down under the weight of macroeconomic turbulence, technological and business innovation, and competition. The dominant trend of the next 30 years was the progressive integration of these activities, fueling the expansion of what has become known as the shadow banking system, including the explosive growth of securitization and derivative instruments in the first decade of this century.

This trend entailed two major and related changes. First, it diminished the importance of deposits as a source of funding for credit intermediation in favor of capital market instruments sold to institutional investors. Over time, these markets began to serve some of the same maturity transformation functions as the traditional banking system, which in turn led to both an expansion and alteration of traditional money markets. Ultimately there was a vast increase in the creation of so-called cash equivalent instruments which were supposedly safe, short term and liquid.

The second change was that this trend altered the structure of the industry, both transforming the activities of broker-dealers and fostering the emergence of large financial conglomerates. Though motivated in part by regulatory arbitrage, these developments were driven by more than regulatory evasion. Such factors as the growth and deepening of capital markets and the rise of institutional investors as guardians of household savings accelerated the fracturing of the system established in 1933. Whatever the relative importance of these various causal factors however, one thing is clear: Neither the statutory framework for nor supervisory oversight of the financial system adapted to take account of the new risks posed by the broader trend. On the contrary, regulatory change for the 30 years preceding the crisis was largely (a ?) deregulatory program, designed at least in part to address the erosion of banks' franchise value caused by the rapid growth of credit intermediation through capital markets.

The consequences of this neglect were dramatic. When questions arose about the quality of the assets on which the shadow banking system was based, notably those tied to poorly underwritten subprime mortgages, a classic adverse feedback loop ensued. With lenders increasingly unwilling to extend credit against these assets, liquidity-strained institutions found themselves forced to sell positions which placed additional downward pressure on asset prices, thereby accelerating margin calls for (leveraged ?) actors and amplifying mark-to-market losses for all holders of the assets. The margin calls and book losses would start another round in the adverse feedback loop. Meanwhile, as demonstrated by the intervention of the government when Bear Stearns and AIG were failing and by the repercussions of Lehman Brothers' failure, the universe of financial firms that appeared "too big to fail" during periods of stress included more than insured depository institutions and extended beyond the perimeter of traditional safety and soundness regulation.

The investments by the Treasury Department from the Troubled Asset Relief Program, or TARP, and guarantees by the FDIC from their Temporary Liquidity Guarantee Program to each of the nation's largest institutions in the fall of 2008 revealed the government's view that, under the then prevailing circumstances, a very real threat to the nation's entire financial system was best addressed by shoring up the nation's largest financial firms.

This brief and highly stylized history is intended to recall that there were two major regulatory challenges revealed by the crisis. First was the problem of "too big to fail" financial firms, both those that had been inadequately regulated within the perimeter of prudential rules and those like the large free-standing investment banks that lay outside that perimeter.

Second was the problem of credit intermediation, partly or wholly outside the limits of the traditional banking system. This shadow banking system involved not only sizable commercial and investment banks, but also a host of smaller firms active across a range of markets and a global community of institutional investors.

To date the post-crisis regulatory program has been substantially directed at the "too big to fail" problem and more generally at enhancing the resiliency of the largest financial firms.

First, the Dodd-Frank Act established the Financial Stability Oversight Council, or FSOC, which has the authority to bring within the perimeter of prudential regulation any nonbank financial firm whose failure could be the source of systemic problems. The FSOC has just issued a final rule that will guide the process of assessing and designating such firms. Of course, the formerly free-standing investment banks have already been either converted or absorbed into bank holding companies.

Second, the serious shortcomings of precrisis capital requirements for banking firms have been addressed through several complementary initiatives. While robust bank capital requirements alone cannot ensure the safety and soundness of our financial system, they are central to good financial regulation precisely because they are available to absorb all kinds of potential losses, unanticipated as well as anticipated.

With the encouragement and support of the U.S. bank regulatory agencies, the Basel Committee has strengthened the traditional individual-firm approach to capital requirements, raising risk weightings for traded assets, improving the quality of loss-absorbing capital through a new minimum common equity ratio standard, creating a capital conservation buffer and introducing an international leverage ratio requirement.

In addition, Dodd-Frank codified a requirement for stress testing of the sort already in use by the Federal Reserve, which makes capital requirements more forward-looking by estimating the impact of an adverse economic scenario on the firm's capital.

Now, as has long been recognized, no single capital requirement can capture all credit and market risks, much less other risks to which a banking organization may be exposed. But when implemented fully, the various capital measures should complement one another and together provide considerable reassurance to investors, counterparties, regulators and the public that our banks are well-capitalized. The banking agencies have been working simultaneously on all the implementing regulations so that we can take into account the inter-relationships among the various rules. And as we publish proposed and final regulations in the coming months, banks will have a complete picture of the capital requirements to which they will be subject.

A third reform, also related to capital, is directed specifically at the unusual systemic importance of certain institutions. The Basel Committee has released a framework for calibrating capital surcharges for banks of global systemic importance, an initiative that is consistent with the Federal Reserve's obligation under section 165 of the Dodd-Frank Act, to impose more stringent capital standards on systemically important firms.

It is important to note that this requirement has a motivation different from that of traditional capital standards. The failure of a systemically important firm would have substantially greater negative consequences for the entire financial system than the failure of other even quite large firms. The surcharges, to be phased in beginning in 2016, will be graduated based on criteria weighted toward size and interconnectedness with the financial system as a whole. Thus, the more systemically important the institution, the greater the capital surcharge.

A fourth reform, intended to ensure that no firm is too big to fail, was the creation by Dodd-Frank of orderly liquidation authority. Under this authority, the FDIC can impose losses on a failed institution's shareholders and creditors and replace its management while avoiding runs by short-term counterparties and preserving, to the degree possible, the operations of sound, functioning parts of the firm. By granting this authority, the law gives the government a third alternative to the Hobson's choice of bailout or disorderly bankruptcy that authorities faced in 2008. Further, the credible possibility of losses should enhance market discipline by diminishing expectations among shareholders and long-term creditors that they effectively hold a put option because of a belief that the government would bail out a large firm in order to preclude contagion from a disorderly failure.

The FDIC has already done considerable work in developing an approach to its potential exercise of orderly liquidation authority. Other home countries of globally significant financial firms are working toward enacting their own resolution regimes. But even with comparable regimes in place around the world, a number of significant cross-border issues will need to be addressed, such as the effect on certain contractual obligations of a firm in a host country when the home country places that firm into resolution. Moreover, for the resolution mechanism to be credible ex ante and effective ex post, the capital and liability structure of major firms must be able to absorb losses without either threatening short-term funding liabilities or necessitating injections of capital from the government.

In this regard, it is useful to remember that the original rationale for Basel's two tiers of capital requirements was that tier 1 capital would be available to absorb losses so as to allow the firm to continue as a going concern while the additional tier 2 capital would be available to absorb losses if the firm nonetheless failed. As I have already noted, the various Basel frameworks have materially strengthened both the quantity and quality of tier 1 capital. Now we also need to attend to the characteristics and size of the components of a firm's balance sheet that would be available to a resolution authority for loss absorption or conversion to equity. A good starting point will be the idea of using long-term unsecured debt with appropriately tailored characteristics as a gone-concern complement to going-concern common equity requirements.

A fifth reform is a proposed set of quantitative liquidity requirements. As seen during the crisis, a financial firm, particularly one with a significant amount of short-term funding, can become illiquid before it becomes insolvent as creditors run in the face of uncertainty about the firm's solvency. While higher levels and quality of capital can mitigate some of this risk, it was widely agreed that quantitative liquidity requirements should be developed. The Basel Committee generated two proposals: one, the Liquidity Coverage Ratio, or LCR, with a 30-day time frame; the other, the Net Stable Funding Ratio with a one-year time frame. However, insofar as this was the first-ever effort to specify such quantitative liquidity requirements, the governors and heads of supervision of the countries represented on the Basel Committee determined that implementation of both frameworks should be delayed while they are subject to further examination and possible revision. The LCR has been actively reconsidered within the Basel Committee over the last year or so.

As this work proceeds, I think we should be considering three types of additional changes. First, some of the assumptions embedded in the LCR about run rates of liabilities and the liquidity of assets might be grounded more firmly in actual experience during the crisis. The current LCR seems to me to overstate in particular the liquidity risks of commercial bank activities. Second, it would be worthwhile to pay more attention to the liquidity risks inherent in the use of large amounts of short-term wholesale funding. Third, the LCR should be better adapted to a crisis environment as, for example, by making credibly clear that ordinary minimum liquidity levels need not be maintained in the midst of a crisis. As currently constituted, the LCR might have the unintended effect of exacerbating a period of stress by forcing liquidity hoarding.

Now, I'm often asked whether the reforms I've just described, along with others, will solve the "too big to fail" problem. In response, I would say that "too big to fail" is not a binary problem. Expectations of government support for a particular firm can range from essentially zero to near certainty and can also vary substantially, depending on the degree of overall stress in the financial system at a given moment.

While it is probably unrealistic to expect that any set of reforms, no matter how far-reaching, will eliminate "too big to fail" concerns entirely, I do think that full implementation of the reforms discussed today would go a considerable distance toward diminishing expectations of government support for large banking organizations, as well as the potential for damage to the financial system from the failure of a large firm.

Of one thing I am sure: If we do not complete rigorous implementation of this complementary set of reforms, we will have lost the opportunity to reverse the precrisis trajectory of increasing "too big to fail" risks.

While there is a well-defined set of regulatory measures to address "too big to fail," the same cannot be said for the second major challenge revealed by the crisis: the instability of the shadow banking system. Although some elements of precrisis shadow banking are probably gone forever, others persist. Moreover, as time passes, memories fade and the financial system normalizes, it seems likely that new forms of shadow banking will emerge.

Indeed, the increased regulation of the major securities firms may well encourage the migration of some parts of the shadow banking system further into the darkness, that is, into largely unregulated markets. And it bears reminding that just as the fragility of major financial firms elicited government support measures during the crisis, so the runs and threats on the shadow banking system brought forth government programs such as the Treasury's insuring of money market funds.

Reform measures to date are not wholly unrelated to the shadow banking system and wholesale funding more generally. Dodd-Frank addresses the associated issue of derivatives trading by requiring central clearing of all standardized derivatives and margining of noncleared trades by major actors in over-the-counter derivatives markets. Strengthened capital and liquidity standards for prudentially regulated institutions should help by giving increased assurance to counterparties about the soundness of these firms.

But in periods of high stress, with substantial uncertainty as to the value of important asset classes, questions about liquidity and solvency could still arise, even with respect to well-regulated institutions. In fact, the supposed low-risk lending transactions, typically secured by apparently safe assets, that dominate the shadow banking system are likely to be questioned only in a period of high stress. It cannot be overemphasized that this systemic effect can materialize even if no firms were individually considered "too big to fail."

Interesting and productive academic debates continue over the sources of the rapid growth of the shadow banking system, the precise reasons for the runs of 2007 and 2008 and the possible sources of future problems. The conclusions drawn from these debates could be important in eventually framing a broadly directed regulatory plan for the shadow banking system.

Domestically among member agencies of the FSOC and internationally among members of the Financial Stability Board, policy officials are engaged in these debates and their implications for reform. But policymakers cannot and should not wait for the conclusion of these deliberations to address some obvious vulnerabilities in today's shadow banking system.

Two areas where the case for reform in the short run is compelling are money market funds and the triparty repo market. The requirement adopted by the Securities and Exchange Commission in 2010 for a greater liquidity buffer in money market funds was a step in the right direction. But the combination of fixed net asset value, the lack of loss absorption capacity and the demonstrated propensity for institutional investors to run together make clear that Chairman Schapiro is right to call for additional measures.

As to the tri-party repo market, there are several important concerns. One major vulnerability lies in the large amount of intraday credit extended by clearing banks on a daily basis. An industry initiative to address the issue led to some important operational improvements to the tri-party market but, to be frank, fell short of dealing comprehensively with this problem. So it now falls to the regulatory agencies to take appropriate regulatory and supervisory measures to mitigate these and other risks.

It is sobering to recognize that more than four years after the failure of Bear Stearns began the acute phase of the financial crisis, so much remains to be done -- in implementing reforms that have already been developed, in modifying or supplementing these reforms as needed and in fashioning a reform program to address shadow banking concerns. For some time, my concern has been that the momentum generated during the crisis will wane or be redirected to other issues before reforms have been completed. As you can tell from my remarks today, this remains a very real concern.

Still, I would like to conclude on a somewhat different -- though, I think, not inconsistent -- note. Almost by definition, prudential reforms are injunctions to firms or markets about what they should not do. Even affirmatively stated requirements to maintain specific -- specified capital ratios can be understood as prohibitions upon extending more credit, purchasing another instrument or distributing a dividend unless the minimum ratio would be maintained. Prohibition and constraint are quite appropriately at the center of a regulatory system. Yet the policies that underlie regulation should embody a more affirmative set of social goals.

One obvious example is the housing market, which remains depressed today, although there are at least -- at last some signs of gradual improvement. As has been widely observed, mortgages are not available to many potential homebuyers who appear creditworthy by most reasonable measures, despite the fact that home affordability, judged by traditional measures, is greater than at any time in decades. The flawed mortgage securitization system that provided too much financing on too lax terms has been eliminated or constrained, and important steps have been taken to protect consumers from unfair and deceptive practices seen in the last decade.

But having addressed the unhealthy and unsustainable mortgage-related practices of recent years, we must also recognize that there is not currently in place an effective system for funding well-underwritten mortgages. To return to and maintain a healthy housing market, we will need a healthy system of mortgage finance. That end, in turn, could be much advanced by a public policy debate focused on the cost, availability and risks associated with mortgage financing that will likely be available under possible combinations of government policies, including all relevant forms of regulation, housing assistance programs and the critical issue of the future of the government-sponsored enterprises.

Finance and financial intermediation are not ends in themselves but means for pursuing savings, investment and consumption goals. Our debate about what we don't want intermediaries and financial markets doing must be informed by a better articulated view of what we do want them doing.

Thank you very much. (Applause.)

GARTEN: Dan, thanks. Thanks a million for a very comprehensive overview.

I'm going to just ask one question and then we'll open it up. And when we do, will you raise your hand, please stand and give your affiliation, and wait for the microphone, and I'd ask you just to ask one question -- (laughter) -- not a six-part question.

But let me start. There are so many moving parts, as you -- as you mentioned. I'd like to just focus for a second on the role of the Fed. I would interpret what you said as the Fed's being far more riveted on financial regulation than it was before the crisis.

And my question is, when you think about the traditional mandates of the Fed -- price stability, full employment -- would you say that now financial stability is a goal that is on the same par as those two? And if so, how -- what is the nature of the discussion within the Fed about how you balance these three major goals?

TARULLO: So -- it's a very good question. And as many, though perhaps not all, the people in the audience know, by statute the Fed has a dual mandate, which, as Jeff said, was -- is the pursuit of price stability and maximum employment. I think that -- well, that's point one.

Point two, if you think about the origins of the Federal Reserve nearly a hundred years ago, the origins arose out of a financial crisis, the panic of 1907, which was difficult for private banks to handle through the traditional mechanisms that they had -- the clearinghouse mechanisms -- that had been used to work through the financial crises of the late 19th century. So it's not insignificant that the motivation for the creation of the Fed was not, I would say, monetary policy as we classically think of it but instead was a financial crisis.

I believe that now the way I would state things is that we -- or at least I would certainly recognize -- and I think most of my colleagues would agree -- that the pursuit of price stability and maximum employment cannot, in a sensible and effective way, be achieved without being very mindful of financial stability consequences. The last four or five years are testament to that. One can achieve neither price stability nor maximal employment if one is going to have highly unstable financial financial circumstances that produce crises or regular periods of stress.

So I don't -- I don't think it's a matter of us in grafting some third aim into the Federal Reserve Act, but in recognizing that a pursuit of those two statutory mandates requires substantial attention to financial stability. And that can manifest itself in a couple of ways. First, of course, the Fed has an independent regulatory responsibility, which is the regulation and supervision of financial institutions, bank holding companies, state nonmember banks and eventually any large nonbank systemically important institutions designated by the FSOC.

That's a mandate to the Board of Governors, not to the whole FOMC, but it is, obviously, done in the same buildings where we do monetary policy, and thus we are in a position to see the relationship between macroeconomic monetary policies on the one hand and the situations of, circumstances of stability of large financial institutions on the other.

And I would say that our movement over the course of the last three years towards a much more horizontal, interdisciplinary, simultaneous way of supervising the largest financial institutions is a way of bringing financial stability concerns, more of an overview on what's happening in the financial industry as a whole, more to the fore and allowing us to get, I would say, a better synthesized view of what's going on.

Finally, there is a host of potential financial stability concerns that are not necessarily either most easily seen or even, in some cases, visible by just looking on an institution-by-institution basis within the largest financial institutions. Shadow -- various shadow banking channels would be one of them, but there are others.

So we've also undertaken to have a more systematic observation of what is going on in financial markets more generally, quite apart from whether our regulated institutions are heavy actors in those markets. So for that among other reasons, we established, a year and a half ago, an Office of Financial Stability, which has the responsibility for and indeed does generate regular reports and briefings on financial stability matters that are not necessarily connected to our regulated institutions at all, what's going on (in a ?) market for particular kinds of securities, a particular kind of credit.

This is something that is being done in cooperation with the Financial Stability Oversight Council, but also within the Fed. And we do now have briefings produced for the FOMC on financial stability matters, which again are not just the kinds of macroeconomic briefings that I think the FOMC has traditionally had.

And one final point: I think financial stability, as you can tell from the creation of the FSOC, is a mandate not just to the Fed, but to many U.S. government agencies. That -- the FSOC pulls together all the relevant regulators. The meetings and all the staff work in between the meetings are intended, I think, to focus people on the kinds of issues and questions that, to be honest, were not focused or not asked in the years preceding the crisis. So I didn't -- having detailed all the things the Fed is doing, I don't want to leave you with the impression that this is just us or that we think this is our job or our job alone. It really is, by Congress' requirement, a shared responsibility of many regulatory agencies.

GARTEN: Great.

TARULLO: I would say that if -- what lies behind Jeff's question is sort of have things changed at the Fed? I think the answer is an unqualified yes.

GARTEN: Yes.

QUESTIONER: Dan Rodriguez, Credit Suisse. You just talked about regulatory reform there. I work at a banking institution, and we've been involved in dealing with those regulatory reforms, particularly on Basel. So I was heartened to hear your support for Basel, (particularly ?) Basel III. But a lot of the U.S.-based banks have not been moving in that direction and are a little bit behind on some of those capital requirements. Is there an effort at the Fed to coordinate those capital requirements more broadly across global financial institutions, one? And then two, I guess --

GARTEN: One question.

QUESTIONER: Yeah.

GARTEN: Thank you. (Laughter.)

TARULLO: This is why we want him as a moderator, right? (Laughter.)

GARTEN: Thanks very much.

TARULLO: So I would -- I guess I would question and disagree with your premise that U.S. financial institutions are not moving towards Basel III. As part of the stress tests that we just concluded six weeks ago, we required that our financial institutions show us their path for Basel III compliance, quite separate from the current stress testing exercise. Their path for Basel III compliance -- and indeed, we indicated our expectation that they would be -- that they comply more quickly than the transition requirements of the Basel agreement itself does.

Basically -- just not to get too deeply into the weeds, but basically, the Basel III transition timeline is kind of back-loaded so that the requirements start coming in next year, but they're somewhat gradually phased in, and then towards the end, in the out-years, there's a heavier imposition of requirements. That didn't strike us as the best course because you never know; you might -- in that period, you might be in a -- in a(n) economic downturn where it's particularly hard for institutions to build up capital. So we basically have straight-lined it and said, we want you -- we want to see that you've -- that you've met these obligations by drawing a line between here and the final date and making sure that in a -- in a very gradual and regular fashion, you are meeting those requirements.

Again, I will leave to individual banks their communication as to when they think they're going to meet them. But I will say that as a whole, we are quite confident that our banks are well ahead of even our accelerated expectations. So I think that one of the many virtues of the stress test regime that we've put in place is that is -- allows us to look at the capital situation of our 19 largest institutions and forces each of the institutions to look at their own capital planning position in such a way as to -- as to make the meeting of the new capital requirements a regular part of thinking within the firm and the -- and the regulators.

Final point on that is we do -- we do take seriously the idea that everybody should implement these understandings that were reached in Basel, and that's why we're very supportive of the Basel Committee's program for monitoring implementation of the various Basel capital agreements, like the phase that the Basel Committee is in now is one of looking to see how in liberal terms the agreements are being implemented into the laws and regulations of the members of the Basel Committee. We hope the next step and we expect the next step is going to be looking to see that on a firm-by-firm basis, the implementation of things such as required risk weightings are being done in a manner consistent with the agreements themselves.

GARTEN: Yes, sir.

QUESTIONER: Hi. David Malpass with Encima Global. Hi, Dan. Could you tell us more about your thinking on the evolution of the mortgage market? And I'm specifically interested in the relationship between write-downs of first mortgages versus second mortgages. What's the prioritization? And then in the longer term, how do we get back to a private sector mortgage market? Thanks.

TARULLO: Well, I think the back to a private sector mortgage -- I guess, David, there may be an implicit end in your question, which is -- but let me ask -- can I ask him to say more? Is that OK? (Laughter.) Are you -- are you talking about how to get back to an entirely private mortgage and mortgage securitization market or how to -- how to restart what will be the private part of that market?

QUESTIONER: More the latter -- (off mic).

TARULLO: OK, good. OK. Yeah.

So I think this -- I condensed a good bit into that one paragraph in the conclusion of my prepared remarks, but I guess it's because I was -- I was struck -- I have been struck by the phenomenon I alluded to of not as much discussion of affirmatively what kind of system do we want as focus on what we know we don't want people doing. And as important as the latter is, as I said, the former is very important to inform judgments about the latter.

And so I guess, David, I'd say a couple of things. I think first, it's reasonably clear to me -- but I say "reasonably" because one never wants to be too confident about such matters -- but it's reasonably clear to me that it -- we're not likely to see the restart of a sustainable, well-developed, well-functioning private securitization market until there is more clarity on what the GSEs -- what role the GSEs are going to play in the future -- and I don't mean to try to prejudge that -- some role between zero and much more than they did in the past, and it's -- and it's not up to -- not up to me to decide where that falls.

But I think until private market actors have some sense of that, their steps into private securitization, which I think are beginning now and we hope to see more of, will probably not be as ambitious because people just won't know how much space there is going to be there for them to occupy. So I think that's one thing.

I think secondly, we are going to have to have more of these regulations out so that people will again know what the structure of legal obligations is going to be, and thus they can make judgments are to what kinds of securitization or other financing activities are going to be profitable and which are not. And you know, until we kind of get to these points, I think it's going to be hard to see more than moderate increases in private securitization activity.

So I -- you know, as difficult as all of these things are, I think we do need -- we in the government more generally, not just -- not the Fed by any means, just the government more generally -- need to recognize that the kinds of rebounding that we'd like to see -- more private-level securitization on a sustainable, sensible basis -- is going to require an articulation of a legal and policy environment that lets private actors see where the opportunities are. And that -- I mean, that's -- it's not -- it's not exactly the most profound insight in the world, but it's -- I think it actually is the right -- is the right way to look at it.

GARTEN: Yes, in the back. Please.

QUESTIONER: Matthew Lee, Inner City Press. I wanted to ask about what some people see as kind of evasion of regulation. Earlier this year you were asked about Deutsche Bank restructuring itself in such a way as to avoid the capital rules. You said it changed your thinking and that the Fed needed to respond in some way. So I wanted to know what -- since then, what -- what's actually -- how's your thinking changed?

And if you won't answer about particular institutions, you're saying that the Fed is more transparent. I've recently had the experience of doing a Freedom of Information request and having 2,000 pages denied in their entirety simply because they involved Exemption 8 and regulations. So I wonder: Do you think the Fed has actually become more transparent since the financial meltdown? Thanks.

TARULLO: Well, so I think what I said, Matthew, if you're quoting from when I testified last, I think I said it had affected my thinking, not changed it. "Changed" implies a dramatic shift.

I think the most -- it's going to be -- it is incumbent on all of the regulators going forward to be able to fulfill the regulatory missions that Congress has given us.

In the case of the Fed, we are asked to oversee systemically important institutions, which -- this is defined by Congress in dollar terms, in terms of their operations here in the United States. And what I was alluding to was that in order to do that -- that we need to -- in order to do that effectively, to make sure that the various expectations in Dodd-Frank are realized with respect to capital, for example, which is a critical one -- that the kinds of activities or changes that some private actors are engaged in need to affect our thinking about what the scope of our regulations are going to be.

Now, we will have forthcoming a regulation on foreign banking organizations, which is kind of pursuant to or related to the overall 165 responsibilities for more stringent standards for systemically important institutions. And that's the appropriate locus for making sure that we're in a position to oversee effectively and to implement congressional concerns. So that's where -- that's where I think it'll come.

On transparency generally, I mean, I certainly think that there's been substantially more transparency, but you know, I don't know what FOIA request -- what particular FOIA request you're referring to. But you know, you think about what's the administrative process. The administrative process for rule-making is one that says we want for agencies' notions of proposed -- their ideas of how to regulate a congressional authority to be formulated in a provisional fashion and then published so that anybody who wants has an opportunity to comment on it.

And I must say interested parties have taken us up more than a bit at our word, with, you know, 17,000 Volcker rule submissions and multiple thousands on many others as well, but to the point --

QUESTIONER: (Off mic.)

TARULLO: -- to the point where our staff now has two lines. There's the number of submissions and number of so-called unique submissions.

QUESTIONER: (Off mic.)

TARULLO: Which basically means not a form letter.

And in some respects, the most remarkable thing about the -- about a lot of these regulations is how many unique submissions there are. These are not just letters that a trade association or some other group has put together and gotten a lot of people to sign. These are actually very thoughtful letters that are originally developed by someone with a perspective they'd like to offer.

And so then -- again, the administrative process is we and -- as you know, for many of these regulations it's not just us; it's either the other banking agencies or the banking agencies and the market regulators are doing joint rule-making. We have to then consider all of the responses, including responses to a lot of questions we've asked, and then we've got to formulate a final rule.

And so I think -- I mean, it's almost a prototype of, you know, what an administrative law process is supposed to be. Here's what we're thinking about doing; what do people think about it? And you eventually say what we are doing and explain why we've done it.

And that -- it's -- absorbing all the comments is actually a fairly substantial undertaking, which is one of the reasons why some of these rules are not out yet, because you've got so many thousands of comments on so many different rules that are being done more or less simultaneously. But I think it is -- it is the right -- it is the right process to pursue. And if it takes somewhat longer to give due respect to all of those comments and to think it through as best we can, I think that is what we should do.

GARTEN: OK.

Yes, ma'am.

QUESTIONER: I'm Maureen Adolf from Prudential Financial. Can you give us some -- your perspective on the rule of the insurance sector and the current state of insurance solvency regulation?

TARULLO: I'm going to -- I'm going to use the prerogative of the speaker to ask you to elaborate a bit what kind of lies behind that question.

QUESTIONER: Well -- (laughter) -- we --

TARULLO: Do you want to know if you're going to be designated by FSOC? (Laughter.) Is that what you're asking?

QUESTIONER: Not publicly. (Chuckles.)

TARULLO: Because I got nothing to say about that.

QUESTIONER: Just basically, you know, in your comments, you talked a lot about Basel and the -- you know, the role of Basel and the formation of capital standards. But the capital standards now could apply to insurance companies.

TARULLO: Oh, I see. I see -- OK, I see what you're saying. Well, in fact, of course, there already are insurance companies -- at least one insurance company that is one of the -- one of the 19 major institutions. And insurance companies that would own thrifts, own savings and loans as holding companies would presumably also be brought into a holding company capital regulatory regime. So yeah, the capital requirements which we have are obviously intended to provide buffers against loss, as I explained in my prepared remarks.

There are -- there are some forms of insurance products, I think, and insurance practices which were not contemplated when Basel I was being decided and then implemented in the United States because they literally were directed at banks, depository institutions, which by law were not allowed to engage in insurance activities. But eventually -- as an agent, yes, but never as a principal.

So there -- as we have seen, there are some elements of insurance practice the application of capital standards to which might lead to a somewhat anomalous result basically because the way Basel I is constructed, if you don't fall into a specified, defined risk category, you go into a residual category. And the point, I think, has been made, quite reasonably, that some of -- at least a few of the products and practices are not of the sort of riskiness that would -- that would warrant their being put in the residual category.

And that's something which we -- our guys were aware of in the course of doing various capital reviews and examinations. It's being borne in mind as we do the new capital regulations, understanding that there may be some things that are specific to insurance companies. So it's a -- it's a bit of a -- it's a bit of a challenge, but it's one that's been identified, and I think people are focused on it and do understand it.

I can tell you that it was shortly after Dodd-Frank, I think, that people on -- I -- it was -- (inaudible) -- late July of 2010 that some of our staff who do capital regulation identified this to me as something that was going to have to be thought about in the implementation of Basel III and the Collins Amendment and other of the capital requirements.

GARTEN: Dan, we just have a minute or two. So let me -- let me just ask you the final question. It's a historical one.

If you looked at the spate of regulation after the crash of 1929, it took a long time for the new regulatory setup to be put in place, by some measures, 15, 20 years. You mentioned in your speech that there is some urgency in implementing all of the ideas that are on the table, let alone some of the things that have yet to be focused on in the shadow banking system. What is your sense of the time frame in which -- after which one could say, a new regulatory framework in response to the crisis of 2008, 2009 is more or less in place? What are we looking at practically speaking, you know, with the assumption everybody's working as hard as they can, you have the normal political push-back. But what is -- what is the -- what is the time frame?

TARULLO: So I think it's a -- I'd break that up, Jeff, into two pieces. One, at what point does it become reasonably clear to people what that fully elaborated framework is going to look like? And then the second piece -- and at what point is that fully implemented? And I would say, as to the latter, I think, given Basel implementation, given Volcker rule conformance, I -- you know, (we all ?) have to recognize that it's going to be several -- it will be several years before the full implementation of the major sets of reforms we're talking about would actually be in place in the sense that firms were conforming to all of the new requirements, had met all the capital standards/liquidity standards, whatever they may be.

It is my hope and expectation that, as to the former, we're going to be there considerably more quickly. I don't think the -- (that ?) -- I alluded to this with the -- with the various capital standards. It -- on the one hand, it's -- I know it's frustrating for people not to have the proposed rules out; on the other hand, doing them simultaneously does allow us to see whether, you know, something in one of the proposed capital rules will be -- will affect something in another proposed capital rule, so that we end up, when we publish the final rules, with fewer anomalies, questions and the like, which will undermine the ability of a firm or an academic or just anyone in the public to see what and understand how these things are actually going to function.

I hesitate to give a timeline on exactly when we'll get there. But I think -- I mean, just thinking in terms of what I said about capital and liquidity, with proposed and final rules, it does seem to me -- it seems to me reasonable to expect that sometime next year the basic outlines -- and I just don't mean the ideas, but I mean the details associated with the major reform elements -- should be reasonably clear to people, even though questions will inevitably arise in implementation. And I'll -- you know, don't want to take that as a promise, but that is my -- as I think about these various streams, that is my expectation.

And you know, it might have been -- could -- would it have been better to get it done this year if we could? Yeah, it would have been better to get it done this year. But I think to have gotten it done this year would have meant that the sheer -- the sheer magnitude of the task would have led to a lot of inconsistencies or open questions which then would have just produced another round of change.

So you got me on the record saying sometime next year, but I tried to qualify it as much as possible. For all you people in the back -- (laughter) -- note the qualification of it as well as -- as well as the date.

GARTEN: (All right ?), thank you very much.

TARULLO: OK. (Applause.)

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