The Deal: Tarullo Overlooked in Race to Head Fed

NEW YORK ( TheStreet) - The battle over the Obama administration's pick to be the next Federal Reserve chairman -- whether it is Larry Summers, Janet Yellen or someone else -- raises overlooked questions about a key position directly below the central bank chief- that of the Fed's top bank supervisor.

Since 2009, that role has been filled by Daniel Tarullo, a member of the Fed's board of governors, in a semi-formal basis. Fed Chairman Ben Bernanke, who most observers agree will step down by the end of the year, has largely given Tarullo free rein to carry out his own ambitious regulatory agenda for big banks, including tough capital and leverage restrictions that could eventually drive some large financial institutions to downsize and divest assets or raise billions of dollars in capital.

All of this has made Tarullo persona non-grata with the bank lobby. "The banks are unhappy with Tarullo because he is trying to make changes to how they do business," said a former top bank regulator.

The former Georgetown University law professor has often succeeded at getting reluctant Fed governors to back his efforts and he has unveiled a to-do list of harsh restrictions to come, including a measure that would set forth just how much long-term debt and equity a megabank must maintain so that its collapse doesn't cause collateral damage to the markets.

Tarullo's effort in this regard is particularly notable because Sunday marks the five-year anniversary of the failure of Lehman Brothers Holdings Inc., the first in a series of big bank collapses that wreaked havoc on our economy. The delay in implementing these changes, which are enshrined in the post-crisis Dodd-Frank Act approved three-years ago, demonstrates the difficulty Tarullo and other bank regulators have faced implementing banking rules since the crisis abated.

As the Obama administration looks to replace Bernanke at the top of the central bank, it is unclear whether Tarullo will remain in control of the Fed's bank capital and rule-setting agenda.

Some observers contend that Tarullo -- already at the Fed for four-and-a-half years -- will resign unless he is installed formally as vice-chairman for supervision at the Federal Reserve, a position that was authorized as part of the Dodd-Frank financial reform law. A Fed spokeswoman declined to comment.

That slot has remained unfilled so far, partly due to Republican opposition on Capitol Hill. Backers argue that Tarullo would be a perfect fit. Sheila Bair, former chief of the Federal Deposit Insurance Corp., argues that the Dodd-Frank provision creating a Senate-confirmed vice-chairman position in charge of bank supervision is important because it would permanently elevate the status of bank supervision at the central bank. Many have pointed to the 2008 financial crisis as proof that the Fed historically has given short shrift to its bank supervision duties.

"The Fed governors still spend much of their time on monetary policy, yet monetary policy only works if you have a stable banking sector," Bair said.

Whoever the Obama administration nominates for the role would have a difficult time obtaining the filibuster-proof 60 votes to be approved by the Senate for the position. Opponents contend that Tarullo would have a particularly hard time gaining approval.

"They Republicans think he's a big government guy who is too close to Obama," said Brookings Institution fellow Douglas Elliott. "The Republicans have chosen to say that Dodd-Frank didn't do anything and was a sell-out to the banks and blocking a confirmation of Tarullo or any Obama pick in this position fits in that narrative."

It is also unclear whether Tarullo would have the same working relationship with a new Fed chief as he did with Bernanke.

People familiar with Tarullo and Summers, who is a top candidate for the Fed chairman job, point out that they are friends who speak frequently. However, they also note that the two individuals are also strong-willed and might butt heads on approaches to bank supervision as well as responsibilities. Some believe the hands-on Summers would try taking authority away from Tarullo if he can.

Michael Krimminger, former general counsel at the FDIC, said he believes it is likely that Tarullo leaves the central bank if Summers is appointed. "Perhaps they could work together as they interacted in the transition, but both have strong personalities," Krimminger said.

A Fed with Yellen in charge would likely move in lock-step with Tarullo's agenda. Yellen, another leading candidate for the job, previously telegraphed that she supports an approach championed by Tarullo to implement steeper capital surcharges on firms that pose the greatest risk to financial stability. She recently said she is opposed to "blunt approaches" like limits on bank size or the resurrection of Glass-Steagall-style separation of commercial banking from investment banking. Tarullo recently said that restoring the Depression-era law was not high on his list of priorities.

Nevertheless, Tarullo has outlined a long-list of regulatory initiatives for reform and his departure would raise questions about the central bank's direction and whether his items would receive any priority if he departs.

For example, the Fed governor is a leading advocate for a controversial leverage ratio proposal introduced by regulators in July requiring big banks to hold significantly more equity against their total assets than currently recommended by international bank capital guidelines. The proposal, once adopted, could require large financial institutions to raise billions in additional capital or divest assets to meet the requirement. People tracking the Fed's deliberations argue that Tarullo worked hard to bring the measure to fruition by getting some reluctant Fed governors to back it. Backers hope the Fed will adopt the limit before Bernanke leaves, which is expected at the end of the year.

He also appears to support the concept of "bail-in" capital, that would have big banks hold a special kind of capital that would act like debt in good times, but convert into common equity in a crisis. The idea would be for big banks to provide their own life support in a crisis.

"The concept of bail-in capital appears to have substantial intellectual appeal to Tarullo," said John Dearie, a former Fed official who is now an executive vice president of the big bank lobby group, the Financial Services Forum.

The Fed governor also is an eager advocate to hike capital requirements for large firms that substantially depend on short-term funding. Recently, the Fed governor noted that letting banks rely on short term funding played a substantial role in the 2008 collapse of Lehman and Bear Stearns.

Another initiative on Tarullo's agenda: The so-called Volcker Rule. Named after former Fed chairman Paul Volcker, the measure would prohibit big insured banks from trading derivatives and stocks with their own money. It also requires banks to cut their holdings in new hedge funds and buyout shops down to 3% within a year. Tarullo has pushed for a tough rule, according to people familiar with the Fed, but so far the provision has become bogged-down with inter-agency disputes.

With Syria on the back-burner, the Fed chief could be picked as early as next week. But only time will tell if Tarullo and his agenda remain at the Fed.

Written by Ronald Orol in New York

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