Nearly a decade after a devastating financial crisis, the U.S. remains poorly prepared for a repeat. So itâ€™s unsettling that Daniel Tarullo, the Federal Reserve official who has done the most to make the countryâ€™s banks stronger, plans to step down â€” and all the more important that President Donald Trump find a worthy replacement.
The 2008 crisis exposed weaknesses at the heart of the U.S. financial system. Big banks had so little loss-absorbing capital that they rapidly faltered, bringing down the economy and leaving the government with no option but to rescue them at taxpayer expense. Shortages of cash made matters worse, forcing emergency asset sales that added to the losses.
Appointed in 2009, and guided by the Dodd-Frank financial reform, Tarullo led efforts to strengthen the financial system. The Fed adopted capital requirements significantly more demanding than those laid down by international regulators, and tied them to liquidity rules aimed at ensuring banks would always have enough cash to meet their near-term obligations. It introduced regular stress tests designed to assess banksâ€™ ability to weather a crisis, and demanded that they produce â€œliving willsâ€ describing how they could go bust without causing wider harm.
Tarulloâ€™s work is far from done. On average, the largest U.S. banks now have about $6 in equity for each $100 in assets (according to international accounting standards). Thatâ€™s more than in 2007, but still not enough. The stress tests arenâ€™t yet sufficiently realistic. Tarullo had a plan for improving them, but he wonâ€™t be around to see it through. And the living wills still give the public too little information.
Tarullo seems optimistic about what will happen after he leaves. He says Trumpâ€™s â€œcore principlesâ€ for financial regulation â€” which include avoiding bailouts and addressing systemic risk â€” are a â€œgood starting point.â€ Certainly, maintaining Tarulloâ€™s push for more equity capital would be an excellent way to further those principles. Crucially, by making the whole system more resilient, that would also allow the regulatory burden to be lifted in other areas.
Trump now has three vacancies to fill on the Fedâ€™s board of governors. The presidentâ€™s top economic adviser believes that â€œpersonnel is policy.â€ Letâ€™s hope they choose someone capable of finishing what Tarullo started.