Fed: Dodd-Frank Not Enough For Too Big To Fail

In the eyes of Daniel Tarullo, the problem with “too big to fail” is not enough cash in the bank. Tarullo — who serves as a governor at the Federal Reserve — has numerous ideas on how the world could avoid tying its fate to the largest banks and their reliance on short-term financing policies. These are ideas that go well beyond Dodd-Frank reform legislation.

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Tarullo delivered his remarks in a speech on Friday at the Peterson Institute for International Economics, as political pressure continues to be shrugged off by large banks like JPMorgan (NYSE:JPM) and Bank of America (NYSE:BAC). While skeptics maintain the Obama Administration won’t push further regulations on the banking industry, an important voice in the debate has made his opinions public.

“The important question is not whether capital requirements for large banking firms need to be stronger than those included in Basel III…” Tarullo said, “but how to make them so.” The Fed governor went on to say the reform process won’t be complete “until a more comprehensive set of measures to address this problem is in place.” Specifically, Tarullo sees vulnerability in the capital holdings of banks holding giant amounts of short-term debt…

When there is no market to cover that lack of capital, the world (namely, the taxpayers) encounters a situation where the entire economy is in danger. Legislation is now circulating in the Senate that aims to dramatically improve the ratio of capital to debt. Known as the Brown-Vitter bill (after its co-sponsors), the regulations would force banks to hold more capital or shrink assets and in effect become smaller banks — ones that theoretically could fail without taking the financial system down with them.

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Among the most controversial elements of the Brown-Vitter bill is a 15 percent capital requirement for banks. Observers of the political scene don’t think Brown-Vitter can pass, but Tarullo and the Fed don’t have to wait for Congress to act. They have the power to impose regulations they consider essential to the country’s long-term prosperity. While Tarullo doesn’t believe the 15 percent requirement should be instituted, he may force several of his recommended reform measures on the largest banks.

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