FRB Governor Tarullo Advocates for Broader Capital and Liquidity Regulations

Federal Reserve Governor Daniel Tarullo suggested that the U.S. central bank may have plans to “reshape” capital regulation for some large insurance firms, as well as for other financial market participants, including asset managers. As to insurance companies, due to a state-by-state implementation of the current U.S. rules for the insurance sector, Mr. Tarullo argued that the rules fail to make distinctions between traditional insurance firms and those that could pose risks to the broader economy. In light of the weaknesses exposed during the financial crisis, Mr. Tarullo stated that it is important to recognize that while some insurance products are not likely to play a role in a financial meltdown, other firm activities, such as derivatives, are more entangled with the financial system.

Further, Mr. Tarullo claimed that differences in the liability side of the balance sheet provide a good policy justification for having varying capital requirements even among the same types of financial intermediaries (that is, that different insurance companies might be subject to differing capital rules). He argued that “traditional capital regulation, with an implicit aim of protecting only conventional policyholders over time . . . does not reflect the balance risk sheets” of more complex insurance firms. He suggested that implementation of stricter rules would likely target big wealth-management or annuities businesses, rather than property insurers.

Mr. Tarullo then discussed the possible adoption of an integrated capital and liquidity regulatory regime, emphasizing his belief that insufficient regulatory attention has been paid to liquidity requirements, particularly to dependence on short-term wholesale funding.

Additionally, Mr. Tarullo discussed entities other than banks and insurance companies that would be appropriate targets of capital/liquidity regulation. In his view, broker-dealers present the “clearest case” for becoming subject to additional liquidity requirements.

Near the beginning of his speech, Mr. Tarullo conceded that “we should remind ourselves that the capital regulation of private corporations is unusual.” However, by the end of his speech, Mr. Tarullo indicated his support for the imposition of “prudential market regulation” on asset managers and rules about liquidity requirements and redemption limits on funds.

Lofchie Comment: Ultimately, Mr. Tarullo argues for a degree of governmental control over both public and private capital that is unprecedented both in its scope, but also in its subjectivity; i.e., government regulators creating rules that might be applicable to a single institution. Even if one were to believe that the government is capable of exercising as much wisdom as Mr. Tarullo seems to believe (on what basis?), one should be uncomfortable with conceding to the government as much power as Mr. Tarullo would have it take. In fact, it is not clear that there is any limit to the power that Mr. Tarullo would have the government assert over private investment and asset allocation decisions so long as he could argue that the government was acting in the public interest.

In this regard, it is somewhat telling that Mr. Tarullo feels it necessary that “we should remind ourselves that the capital regulation of private corporations is unusual.” Perhaps it is a such a good reminder that he ought to repeat it to himself several times a day.

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