Raising the Stakes on Too Big to Fail

If the goal of Wall Street reform is to prevent U.S. taxpayers from having to bail out the big financial institutions again, the remarks by two Federal Reserve governors today were good news.

Fed governors Daniel Tarullo and Jerome Powell, in separate public comments on Thursday, said the Fed would require eight of the largest U.S. banks to maintain more equity to pass the central bank’s annual “stress tests.”

“Effectively, this will be a significant increase in capital,” Mr. Tarullo said on Bloomberg television.

He had said in a recent interview that he expected big banks to have to change their size, organization, or business model in response to the Fed’s regulatory moves.

Mr. Powell said at a banking conference that the Fed’s move would make big banks “fully internalize the risk” they pose to the economy. “I have not reached any conclusion that a particular bank needs to be broken up or anything like that,” he said. The point is to “raise capital requirements to the point at which it becomes a question that banks have to ask themselves.”

As we’ve seen, the Dodd-Frank bill required three things of systemically important financial institutions (i.e., “too big to fail”): (1) increased capital requirements, (2) annual stress tests, and (3) living wills. The capital requirements that are in place now have already incentivized some of them to downsize. Today the Feds signaled that they are going to up the ante.

When Mr. Powell says that his goal is to make these banks “fully internalize the risk,” he is suggesting that they need to have enough capital on hand so that a taxpayer bailout is never required. If they can’t do that – they’ll need to downsize themselves. Unlike Bernie Sanders’ proposal for the Treasury Department to decide which banks need to be broken up, this has been the basic approach of Dodd-Frank.

One of the critiques we sometimes hear about Wall Street reform is that regulations are only as effective as the people who serve as regulators. In this example, it seems clear that these Fed governors are intent on doing their job.

Nancy LeTourneau

Nancy LeTourneau is a contributing writer for the Washington Monthly.