Curtains for Global Financial Regulation


By Peter J. Wallison.


Last Wednesday was Daniel Tarullo’s last day as a Federal Reserve governor. As the Fed’s point man on banking regulation since 2009, he played a key role in the Obama administration’s attempt to create an international system of financial oversight. But the election of Donald Trump ended any realistic hope of achieving that goal. When Mr. Tarullo announced in February that he would step down, even though his term runs until 2022, no one should have been surprised.

The plan was audacious in its scope. When a Democratic Congress passed the Dodd-Frank financial overhaul law in 2010, it was by far the most restrictive financial regulation in the U.S. since the New Deal. But the proposal hatched at a 2009 meeting of the Group of 20 countries was even larger and more intrusive. The goal was to create a common set of financial regulations governing the activities of financial firms in all G-20 countries—from the U.S. and the European Union to Russia, Turkey, India and Argentina.

The G-20 plan was to be carried out by a newly deputized international body called the Financial Stability Board, made up of regulators from around the world, including the U.S. Treasury, the Fed and the Securities and Exchange Commission. Mr. Tarullo was the Fed’s representative on the FSB and helped develop its regulatory program.

There were two principal objectives: First, the G-20 wanted to impose more-stringent regulation on systemically important financial institutions, or SIFIs. Second, it wanted to put new regulatory controls on risk-taking by what the FSB called “shadow banks,” which it defined as any financial firm operating without a regulator for its risk-taking.

But the FSB did not have the independent authority—even under the auspices of the G-20—to impose these regulations on companies in the various countries. Instead G-20 members were supposed to use the laws and processes in their respective jurisdictions to put the FSB’s proposals into effect.

In the U.S., the main legal authority was the Financial Stability Oversight Council established by Dodd-Frank. The FSOC, led by the Treasury secretary, was authorized to designate “systemically important” firms and to restrict “ongoing activities” that could pose a threat to financial stability.

The Obama administration easily accomplished the G-20’s first goal, stricter regulation of SIFIs. The FSOC dutifully designated as systematically important every American financial institution the FSB had deemed as such. GE Capital, AIG , Prudential andMetLife were referred to the Fed, as required by Dodd-Frank, for what the act calls “stringent” regulation.

The G-20’s second goal was trickier in the U.S., because determining what constituted a shadow bank proved difficult. For the FSOC to regulate these institutions without new legislation, the definition of a shadow bank had to fit within its existing statutory authority.

Former Fed Chairman Ben Bernanke was particularly eager to control shadow banks’ risk-taking. In a 2012 speech to a Fed conference he argued that any firm that participated in “maturity transformation”—turning short-term liabilities into long-term assets—was a potential threat to the stability of the financial system. He cited as an example a firm that provides short-term funds for the purchase of a pool of five-year auto loans.

The FSB ultimately adopted this approach—and expanded on it. In a November 2013 paper, the FSB argued that any firm that participated in a “complex chain of transactions” resulting in a maturity transformation would count as a shadow bank and had to be subject to controls on its risk-taking. The Obama administration probably would have tried to impose this rule under the FSOC’s authority to control “activities” that could cause financial instability.

Despite regular urging by the FSB, the FSOC was never able to publish a regulation that adequately defined a “complex chain of transactions” in a way that aligned with its authority. Still, it was only a matter of time. A Hillary Clinton administration would have gotten it done.

Donald Trump’s victory has interrupted this march toward greater government power over global finance. Mr. Trump’s statements about regulatory relief have made clear that he will never sign on to the G-20’s agenda. Indeed, the FSB—unable to get its rules adopted in the world’s largest economy—will probably fold up its tent. The U.S. has dodged a bullet.

Mr. Tarullo rightly sensed that the opportunity to establish a global financial regulatory system had evaporated. The most sensible course was resignation.

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